Most high-net-worth investors have accumulated a good chunk of their wealth in non-registered investments. Once they max out RRSPs and TFSAs, there's little choice but to add investments to non-registered, taxable accounts.
If you opt to hold the most tax-inefficient assets – fixed income – in registered accounts, odds are you're holding a lot of stocks outside them. If they're considered foreign property, you need to pay close attention to their cost base.
Registered retirement savings plans (RRSP) and tax-free savings accounts (TFSA) shield us from a lot of tax, at least in the short term, but what's less appreciated is that registered plans also shield us from a lot of tax-related, form-filling paperwork.
Not so for non-registered accounts. When you fill out your annual tax return, there's a question on whether or not you own more than $100,000 of "specified foreign property" (SFP). If you do and tick "yes" on the accompanying box, you're on the hook to file a T1135 form. Failure to do so can generate penalties of $25 a day up to $2,500, plus other possible gross negligence penalties, says Frank DiPietro, assistant vice-president, tax and estate planning for Mackenzie Investments.
While a casual read might lead you to think this box referred only to foreign real estate, such as a Florida condo you rent out, or business assets held outside the Canadian border, it's more all-encompassing than that, extending to many of the publicly traded individual foreign securities – including those in the U.S. – that investors own in their taxable accounts.
Your Canadian-based financial institution is required to issue to both you and the Canada Revenue Agency T-3 and T-5 slips recording this income from securities trading on domestic stock exchanges. But the CRA also wants to keep tabs on U.S. or foreign stocks that Canadians hold in U.S. accounts where they are not obligated to issue Canadian tax slips, says Brent Soucie, a vice-president at T.E.Wealth and cross border financial planning expert. The T1135 form is the CRA's way of keeping track of these kinds of foreign investments.
There's a long list of items considered SFP, including individual U.S. stocks and ADRs (American Depository Receipts) but also U.S.-listed exchange-traded funds (ETFs) and foreign mutual funds that may invest outside North America or in the U.S.
If you wish to avoid the paperwork and not tick off the box on the tax return, your SFP cost base must be below $100,000 (Canadian): that's the original cost, not current market value. (At recent exchange rates, $100,000 Canadian is roughly $79,000 U.S.) If at any time in the year a Canadian resident's SFP cost base rises above this threshold then he or she must file the form, as is the requirement for Canadian corporations and trusts.
(Included in the list is interests in partnerships that hold SFP, foreign rental properties, tangible and intangible properties located outside Canada, life insurance policies issued by foreign issuers, and even precious metals, gold certificates and futures contracts held outside Canada.)
Fortunately, SFP does not include foreign property held in Canadian-based mutual funds or ETFs, so if you find yourself approaching the $100,000 limit and don't wish to exceed it, you may want to put future foreign investments in Canadian-domiciled investment funds, even if they in turn invest outside the country. Shares of Canadian public corporations trading on foreign stock exchanges are also not considered SFP if held with a Canadian broker, Mr. DiPetro says.
Also not considered SFP is foreign property held for personal use and enjoyment – for example, a U.S. property that you own and don't rent out – and foreign property held in registered plans like RRSPs, RRIFs, LIRAs, TFSAs and RESPs.
Mr. DiPietro says as of 2013 a revised T1135 form required that for each foreign asset, investors must name the entity holding the SFP, the maximum cost of the SFP during the year, and at year end, and any gains or losses generated by it.
Things got tougher in 2015 for investors with SFP with a cost base of $250,000 or more at any time in the year. This triggers the need to use the detailed reporting method. (The first tier between $100,000 and $250,000 is the simplified reporting method.) Under detailed reporting, you must provide details of each SFP, including the asset's location and maximum cost during the year and at year-end, plus any income generated by the asset.
Brent Soucie says going from the simplified to the detail form creates a lot of extra paperwork. "It doesn't mean any extra tax, but it's more of a pain." Little wonder one broker told me, "The T1135 is getting up the noses of a lot of people."
All of which in my mind is good reason to avoid building up a cost base of more than $100,000 in these securities. If you're one half of a couple with a jointly held investment account, it will be $100,000 each or $200,000 between the couple, assuming both have half-ownership of the assets.
If this seems overwhelming, you could choose to cease adding to non-registered SFP positions if you're even close to the bottom threshold, or sell off a few holdings. Instead, be content with holding foreign securities in registered accounts, and use Canadian-domiciled investment funds for non-registered foreign exposure.
What you do may hinge on your views on tax-efficient asset location. An adviser friend holds mostly fixed income in his registered accounts, which forces him to put U.S. stocks in taxable plans, even though foreign dividends are taxed like Canadian interest. "So I have no choice but to hold U.S. and foreign stocks non-registered and fill out the form."
For him, the extra paperwork is worth the potentially enhanced returns. Others may conclude it's not worth the hassle.
Jonathan Chevreau is founder of the Financial Independence Hub and co-author of Victory Lap Retirement. He can be reached at firstname.lastname@example.org