Principal Issues: 1. A resident of Canada dies while owning a capital property in Denmark which is an immovable property. Should the final return of the deceased include a gain from the disposition of the capital property?
2. Does the inheritance tax paid on the value of the property to Denmark give right to a foreign tax credit or a deduction of the Canadian tax payable?
Position: 1. There is a deemed disposition of the capital property by the resident of Canada even if the immovable property is situated in Denmark. The deemed disposition is at fair market value.
2. A Canadian taxpayer cannot reduce tax payable in Canada by any inheritance tax paid in Denmark because the inheritance tax is not an "income or profits tax", as required in Canada for determining foreign tax credits or deduction from income for taxes paid to a foreign government.
Reasons: 1. Subsection 70(5) of the Act.
2. Subsection 126(7) of the Act.
XXXXXXXXXX 2005-015408
Sylvie Labarre, CA
November 10, 2005
Dear XXXXXXXXXX:
Re: Estate of XXXXXXXXXX
We are writing in response to your letter of October 5, 2005 wherein you requested information concerning the final return of XXXXXXXXXX (hereinafter the "Taxpayer").
The Taxpayer was a resident of Canada when he died on XXXXXXXXXX. At the time of his death, the Taxpayer owned monetary assets in Canada and a farmhouse in Denmark. The state of Denmark required the payment of an estate duty on the value of the farmhouse. The estate duty amounted to approximately $XXXXXXXXXX CDN.
You ask us whether a disposition of the farmhouse situated in Denmark should be included in the deceased's T1 final return and whether the estate duty paid to the state of Denmark could reduce the Canadian tax payable.
Our comments
For the purpose of our comments, we assume that the farmhouse was a capital property of the Taxpayer that was not used in any business.
For Canadian income tax purposes, the Taxpayer is deemed to have disposed of any capital property owned by him immediately before his death at fair market value pursuant to paragraph 70(5)(a) of the Income Tax Act (the "Act"). A capital gain will arise from that deemed disposition if the fair market value of the capital property is greater than its adjusted cost base.
The capital property to which paragraph 70(5) of the Act applies may be an immovable property that is situated in Denmark. Paragraph 1 of Article XIII of the Canada-Denmark Income Tax Convention states that gains from the alienation of immovable property may be taxed in the Contracting State (in this case, Denmark) in which such property is situated. The paragraph gives Denmark the right (but not an exclusive right) to tax the gains from the alienation of immovable property situated in Denmark whether the person who alienates such property is a resident of Denmark or not. It does not prevent Canada from taxing such gains.
Pursuant to section 3 and paragraph 38(a) of the Act, in order to determine taxable income, the Taxpayer must then include in income, in his final return, a taxable capital gain on the farmhouse that is equal to 1/2 of the fair market value of the farmhouse less the cost of the farmhouse. If the Taxpayer became resident of Canada after 1971 and he owned the farmhouse in Denmark at the time he became such a resident, the cost of the farmhouse would be its fair market value at the time he became resident of Canada.
A Canadian taxpayer cannot reduce tax payable in Canada by any inheritance tax (estate duty) paid in Denmark because the inheritance tax or estate duty is not an "income or profits tax", as required in Canada for determining foreign tax credits or deductions from income for taxes paid to a foreign government. Indeed, the inheritance tax (estate duty) is based upon the value of a property situated in Denmark and is not based on income or profits. There is no provision in the Canada-Denmark Income Tax Convention that would allow us to conclude otherwise because that Convention does not apply to the inheritance tax or estate duty, pursuant to subparagraph 3(b) of Article 2.
We trust the above has been of some assistance.
Yours truly,
Alain Godin, Manager
for Director
International and Trusts Division
Income Tax Rulings Directorate
Policy and Planning Branch