My esteemed colleague, Martha Harris Myron, CPA PFS CFP JSM, Masters of Law, sums it up very nicely: “Every border crossing has a consequence”…and, she adds, mobility inevitably “generates tax accountability”. Martha provides a nice summary of some recent border activities triggering taxation issues for the unsuspecting rolling stone. This blog post will focus on a “consequence” currently brewing for those in transit, as Japan recently announced it is considering an “Exit Tax” on the wealthy who say “sayonara” and move elsewhere.
A tax upon termination of residency in a country is sometimes referred to as an “Exit Tax” or “Departure Tax”. Generally, the tax is imposed on persons who cease to be “tax resident” in the country and typically imposes a tax on the built-in, but yet unrealized capital gains on property held by the individual at departure. Not many countries have any variation of this type of “Exit” or “Departure” Tax.
Canada has long imposed a “departure tax” on individuals who become non-resident of Canada. Unlike US citizens or residents, Canadian citizens and residents are taxed on their worldwide income only while they are considered tax residents of Canada. The US taxes its citizens on their worldwide income no matter where they reside — merely holding US citizenship means taxation on all income from all global sources. In contrast, when individuals depart Canada they are no longer responsible for Canadian income tax, except to the extent they earn Canadian-source income. Those who terminate tax residency and depart Canada must complete a final personal tax return, also known as an ‘exit return’. Under Canada’s tax rules, such departing individuals are deemed to have disposed of their assets at fair market value, thus giving rise to phantom capital gain on which tax must be paid on the final return. If the fair market value of all the property owned when leaving Canada is more than CAD$25,000, Form T1161, List of Properties by an Emigrant of Canada must be completed and attached to the final return.
A real-life case study illustrating how the lack of planning for Canada’s Departure Tax can devastate the finances of an average couple is here .
The US “expatriation tax” provisions are much harsher and far-reaching than those imposed by Canada. The expatriation rules apply only to certain US citizens who have renounced or relinquished their citizenship and certain long-term residents (generally those holding a green card for 8 out of the past 15 years), who have ended their US resident status for federal tax purposes.
Under the US expatriation rules, these individuals will be treated as a so-called “covered expatriate” if any of the following tests apply:
- The individual’s average annual net income tax for the 5 years ending before the date of expatriation or termination of residency is more than a specified amount that is adjusted for inflation ($147,000 for 2011, $151,000 for 2012, $155,000 for 2013, $157,000 for 2014 and $160,000 for 2015).
- The individual’s net worth is $2 million or more on the date of expatriation or termination of residency.
- The individual fails to certify on Form 8854 that he or she has complied with all US federal tax obligations for the 5 years preceding the date of expatriation or termination of residency.
If any of these tests are triggered, the individual is a “covered expatriate” subject to the “Exit Tax” or “Mark-to-Market” regime which generally means that all property owned by the covered expatriate worldwide is treated as sold for its fair market value on the day before the expatriation date. This phantom gain is then taken into account for the tax year of the deemed sale and subject to tax, usually at capital gains rates. In addition to the Exit Tax, US recipients of any gift or bequest at any time in the future from the “covered expatriate” will be hit with a special tax upon receiving that gift or inheritance. In essence, this is an alternative way for the US to recoup US Gift or Estate taxes that it would otherwise have received (upon the making of lifetime gifts, or upon death) had the individual not given up his US citizenship or long-term residency. More information about the current expatriation tax regime can be found on my tax blog posting here.
Aside from the tax consequences of expatriation, current US immigration laws provide that former US citizens who are deemed to have renounced their US citizenship for tax avoidance purposes may be banned from entering the US by including them in a class of “inadmissible” aliens. This law is commonly referred to as the “Reed Amendment” and was enacted in 1996. [Public Law 104-208, § 352; INA § 212(a)(10)(E); 8 USC § 1182(a)(10)(E)]. The law has never been enforced in part because Immigration guidelines have never been established for what is meant by “tax avoidance” and probably because doubts as to its constitutionality have been expressed by legal scholars. Furthermore, legislative proposals have cropped up very recently time and again to make the expatriation regime even harsher.
Even if the Reed Amendment is not being enforced, there are other ways to keep expatriates out of the country, as demonstrated last month by the case involving Roger Ver, the virtual currency millionaire commonly known as “Bitcoin Jesus”. Ver was denied re-entry to US after taking on Saint Kitts’ citizenship and then expatriating.
When an individual is a tax resident in Japan and sells certain financial assets, any resulting gain is subject to a capital gains tax. If the assets are sold after the individual has departed Japan and become resident in another country, no such tax is imposed. The Japanese government apparently believes that larger numbers of Japanese citizens and permanent residents are moving to countries such as Singapore or Hong Kong that do not impose capital gains tax. Furthermore, because Japanese tax treaties allocate exclusive taxing rights to the jurisdiction of residence, a Japanese resident with significant unrealized capital gains in his financial assets can emigrate to one of these countries, sell those appreciated assets and escape all capital gains tax.
The Japanese Government recently unveiled its 2015 tax reform plan and addresses this issue. The plan includes a proposal for an “Exit Tax” and has now been submitted for debate to the Japanese parliament.
Individuals subject to the Exit Tax are those whose “financial assets” at the time of departure have an assessed value of JPY 100 million (approximately US$850,000) or greater, and who meet certain residency requirements. The Exit Tax would apply only to taxpayers who have been resident in Japan for five or more of the ten years at their date of departure. Significantly, the visa category the individual holds will be important for the purpose of determining this five-year residency period. Certain visa holders can escape the tax because in determining the duration of residence in Japan, time spent while the individual is under certain visa categories will not be counted. These include, for example, visas in the following categories — Investor/Business Manager, Temporary Visitor, Intra-Company Transferee, and Specialist in Humanities/International Services.
Unlike the US Exit Tax which is assessed on worldwide assets, Japan’s proposed “Exit Tax” will target only “financial assets”: securities stipulated in the Income Tax Law (cash or cash deposits are not included); contributions under a Tokumei-Kumiai agreement; unsettled derivatives transactions; unsettled margin transactions; unsettled when-issued transactions (e.g. trading transactions in advance of shares being issued). Non-financial assets such as real estate are not subject to the proposed Exit Tax.
Unlike the US expatriation rules, which include the so-called Reed Amendment under the US Immigration laws, there are no provisions in the Japanese proposal for possibly banning those who depart Japan and who are subject to the Exit Tax.
If enacted, the Exit Tax is expected to be effective from 1 July 2015. The new rule will apply not only to “exits”, but also to gifts and inheritances of property, made by a Japanese resident to a Japanese nonresident on or after 1 July 2015.
More detailed information about the proposed Japanese Exit Tax can be found at http://www.kpmg.com/jp/en/knowledge/article/japan-tax-newsletter/documents/2015-tax-reform-20150106.pdf (the link seems to work only if you cut and paste same into your browser).
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