Introduction
Exit/Departure taxes are imposed when an individual severs tax residency with a country. In a system of residency based taxation, the tax is imposed when the individual severs residency with the country. For example, if a Canadian were to move from Canada to the United States and ceases to be a resident of Canada, that person would be subject to Canada’s “Departure Tax”. U.S. citizenship is the world’s only “Taxation-based Citizenship”. When an individual relinquishes U.S. citizenship, that person may be subject to the U.S. 877A Exit Tax rules.
Canada and the United States are examples of the most brutal tax systems the world has ever known. This is largely because they both impose taxation on unrealized income. Examples are exit taxes and their CFC rules. Imagine paying tax on income that you have never received?
In the spirit of taxing income that an individual has never received, the United States Exit Tax imposes on certain Americans abroad, who renounce their U.S. citizenship a tax on “pretend” or “deemed” income. The U.S. 877A tax goes beyond – in its scope – any departure tax the world has ever known. Not only does it force a deemed distribution of pensions. But, 877A taxes the pensions of Americans abroad, accumulated while that American was not resident in the United States. Furthermore, 877A taxes that non-U.S. pension more punitively than it would tax a U.S. based pension.
The following post compares the U.S. 877A Exit Tax imposed on the relinquishment of U.S. citizenship with Canada’s Departure Tax imposed when tax residency is severed with Canada.
Both Canada’s Departure Tax and the U.S. Exit Tax were designed to target the super wealthy. They have had their heaviest impact on middle class people. They are examples of the mantra that:
“Sooner or later a class tax becomes a mass tax.”
The History Of Canada’s 1996 Departure Tax
Some years ago I was in New Brunswick and walked into a used bookstore. I saw of copy of Jacques Poitras’s book about the Irving family of New Brunswick. (Jacques Poitras is a Canadian journalist.) A significant part of the book describes how the Irving family managed to move very significant wealth out of Canada and outside of the jurisdiction of Canadian taxation. (Who said that lawyers can’t be helpful?) It is a fascinating history of BOTH (1) The history and evolution of taxation in Canada and (2) how people can rearrange their affairs to avoid taxation. It is also (accidentally and incidentally) one of the best books on international tax avoidance I have ever read.
Here is a short version of the history of Canada’s Departure Tax that includes ONLY the parts that are relevant:
1. Believe it or not, Canada did NOT have a capital gains tax until 1972. The last major reform of Canada’s tax system took effect in 1972 and was the subject of much public discussion in the years leading up to 1972. In other words, it was common knowledge that “capital gains taxes were coming”.
2. Obviously, no self respecting wealthy Canadadian who stood to lose large amounts of wealth because of a new tax would want to continue living in Canada. Therefore, a very wealthy New Brunswick individual simply moved from New Brunswick to Bermuda in 1971 – eight days before the capital gains law came into effect.
3. That individual returned to Canada to run his vast business empire for fewer than 183 days a year (taking the position that he was not a resident of Canada).
4. Pursuant to international tax treaties, the country of the taxpayer’s residence (in this case not Canada) had the right to tax capital gains. Bermuda was the country of residence. But course, Bermuda did NOT have a capital gains tax. Therefore, by severing tax residence with Canada and moving to the Bahamas and later Bermuda this individual ensured that Canada could not tax his capital gains (under the treaty) and Bermuda would NOT tax his capital gains (under the law of Bermuda). How cool is that?
5. As you can imagine, this enraged the Government of Canada. Hence, the creation of Canada’s modern exit tax which was significantly enhanced and given teeth in 1996.
I have kept this description brief (only five points) and simple (to keep it understandable). Yes, there is more to the drama.
But, there’s more, much more …
For the tax geeks (but only for you) I will add that this New Brunswick family also created a “Captive Insurance Company” in Bermuda as a way of reducing Canadian profits (by expensing them out of Canada). This has discussed by Financial Post reporter Diane Francis (who by the way is a Canada/U.S. dual citizen and is apparently not offended by U.S. citizenship taxation.)
Interestingly (well probably not for most people) this is exactly one of the circumstances specifically punished by the U.S. Subpart F rules.) No need to reread the previous sentence if it didn’t remotely capture your interest.
To listen to this story of taxpionage and intrigue …
John Richardson – Follow me on X.com/Expatriationlaw