This blog has been written by Rahul Sharma, Partner at Fasken LLP

A couple of recent telephone calls reminded me of the perils of estate and tax planning that crosses borders without proper planning.

The first case is regrettably quite common.  An entrepreneur in the technology sector (we will call him “John”) is a resident of Ontario.  John partners with other like-minded, and equally talented, entrepreneurs based in the United States to develop an application for smartphones.  The partners’ business is incorporated and organised as a corporation formed under the laws of the State of Texas (we will call it “Techco”).  John, like his three Texas-based partners, personally owns a 25% interest in the corporation.  Busy with developing the smartphone application, John does not turn his attention to the U.S. estate tax implications of his personal ownership of Techco shares.  John’s accountant also attends to all income tax compliance issues concerning John’s interest in Techco, but no thought is given to potential U.S. estate tax consequences.  Meanwhile, Techco’s technology is hugely successful and John’s Techco shares balloon in value in a short timeframe.

Now insert the proverbial question asked by all estate planning lawyers the world over when they first meet John—what happens if he gets run over by a bus this afternoon (and while he presumably continues to personally own Techco shares)?  While the Canada-US Tax Treaty would provide John’s estate with some relief from double taxation at his death, the Techco shares are U.S. situs assets for U.S. estate tax purposes.  As such, although John is not a U.S. tax resident (and assuming he is not a U.S. citizen) at his passing, John’s ownership of Techco shares could nevertheless expose his estate to U.S. estate tax liability.  The top marginal rate for U.S. estate tax is 40%.

The problem with John’s case is that he does not need to leave his estate with a potential U.S. estate tax liability.  With the benefit of advice from a U.S. tax professional, perhaps all that John needs to do is to own the Techco shares through an Ontario corporation that could block his personal exposure to U.S. estate tax at death.  A ballooning of Techco’s value over time would therefore not have a potentially deleterious U.S. estate tax impact on John’s estate.  John may be able to transfer the Techco shares to an Ontario holding corporation on a tax-deferred basis, pursuant to subsection 85(1) of the Income Tax Act (Canada).

The second case, although also common, provides a useful example of the benefits of good planning.  Continuing with the above example of John, assume that his daughter, Jane, relocates from Ontario to the U.S. to pursue her own entrepreneurial ventures.  Jane becomes a U.S. Person, subject to the full extent of the U.S. income and gift/estate tax regimes.  Further assume that John is able to sell Techco for over USD$100 million, meaning that Jane stands to receive a significant inheritance from her father at his passing.  Accepting that John, as a person domiciled and resident in Ontario, would engage in Ontario estate planning, a simple estate plan that has him leaving the entire estate to Jane outright could cause Jane’s estate, on her passing, to face U.S. estate tax liability.  It could also mean U.S. estate tax liability exposure for Jane’s issue on their subsequent passings.

Once again, this result could have been avoided through cross-border estate planning for John.  Instead of an outright bequest of the residue of his estate, John could have provided for Jane through a trust that, if properly prepared with the assistance of U.S. counsel, would have shielded Jane’s estate from U.S. estate tax exposure on her passing.  Is this planning more complex than the more straightforward planning that John had otherwise envisaged?  Yes, but with potentially significant benefits to Jane and her issue.  Moreover, while there are U.S. income tax complexities associated with foreign trusts that have U.S. beneficiaries, planning may nonetheless be calibrated so as to eliminate or minimise such complexities.  Technical complexities on the Canadian tax end can also be practically addressed.

Needless to say, there are other planning options and opportunities for John—and also Jane.  The simple point is that they need to be alive to them, and guided towards them, in order to not miss out.

We unfortunately continue to see situations where individuals are dying with planning that is not tax-efficient from an international or cross-border perspective, or where existing planning—if not reworked—could give rise to sometimes serious tax inefficiencies.  Good international tax and estate planning requires advisors in different jurisdictions to work collaboratively, with a view to achieving the client’s global objectives.  It is done every day with excellent results and needs to be prioritised by all successful, global entrepreneurs like John and Jane.