How to Leave the Canadian Tax System: Departure Tax Explained

Canada's departure tax is among the broadest in the world. Under Section 128.1 of the Income Tax Act (ITA), an individual who emigrates from Canada is deemed to have disposed of virtually all property at fair market value immediately before departure. The resulting gains are taxable in Canada at the applicable capital gains inclusion rate. For entrepreneurs, investors, and professionals with substantial portfolios or private company holdings, this creates a significant tax event that must be planned around, not discovered at departure.

Canadian Tax Residency: How It Works

Canada determines tax residency based on factual criteria rather than a statutory test. The Canada Revenue Agency (CRA) considers:

• Dwelling place in Canada (owned or leased)
• Spouse or common-law partner in Canada
• Dependants in Canada
• Personal property in Canada (furniture, clothing, vehicles)
• Social ties (memberships, professional associations, bank accounts, driver's licence)
• Economic ties (employment, business, investments managed from Canada)

The critical factor is the maintenance of residential ties. An individual who severs all significant residential ties (disposes of dwelling, moves spouse and dependants, closes bank accounts) is generally considered to have become a non-resident on the date of departure.

An individual who maintains significant residential ties in Canada while living abroad may be considered to remain a Canadian tax resident regardless of where they spend most of their time. The CRA's determination is based on the totality of circumstances.

The Deemed Disposition: Section 128.1 ITA

On the date you cease Canadian tax residency, you are deemed to have disposed of all property at fair market value and to have reacquired it at the same value.

Property caught by the deemed disposition:

• Shares of public and private corporations
• Partnership interests
• Trust interests
• Mutual fund units
• Stock options (subject to special rules)
• Intellectual property
• Cryptocurrency
• Foreign real estate
• Bonds and debt instruments
• Personal-use property valued above CAD 1,000

Property excluded from the deemed disposition:

• Canadian real property (taxable Canadian property -- remains subject to Canadian tax on actual disposal)
• Property used in a Canadian business
• Canadian resource properties
• Timber resource properties
• Property in a registered retirement savings plan (RRSP), TFSA, or other registered account
• Life insurance policies
• Employee stock options (subject to deferred triggering rules)

Capital Gains Inclusion Rate

Canada's capital gains inclusion rate was increased from 50% to 66.67% for gains exceeding CAD 250,000 annually, effective June 25, 2024. This means:

• First CAD 250,000 of capital gains: 50% inclusion (effective rate approximately 26.8% at top marginal rate)
• Gains above CAD 250,000: 66.67% inclusion (effective rate approximately 35.7% at top marginal rate)

For departing residents with substantial unrealised gains, the increased inclusion rate makes pre-departure planning more important than ever.

Security and Deferral Options

The deemed disposition tax does not need to be paid immediately. Under Section 220(4.5) ITA, departing residents can defer payment by providing adequate security to the CRA.

How deferral works:

• File Form T1244 to report the deemed disposition
• Provide acceptable security (bank letter of credit, government bond, or other approved form) equal to the tax owing
• Interest accrues on the deferred amount at the prescribed rate
• The deferred tax becomes payable when the property is actually disposed of, or when the CRA demands payment

Returning to Canada:

• An individual who returns to Canada can elect under Section 128.1(6) to unwind the deemed disposition and the deemed reacquisition
• This restores the original cost base and eliminates the departure tax charge
• The election must be filed with the return for the year of return

RRSPs, TFSAs, and Registered Accounts

RRSP

• No deemed disposition on departure
• Contributions made before departure remain sheltered
• Withdrawals by non-residents are subject to 25% withholding tax (reduced under many DTAs to 15% for periodic payments)
• Non-residents cannot make new RRSP contributions unless they have Canadian earned income

TFSA

• No deemed disposition on departure
• Earnings within the TFSA continue to accumulate tax-free in Canada
• Canada does not tax withdrawals by non-residents
• However, many other countries (particularly the US) do not recognise the TFSA's tax-exempt status and may tax income within the account

RESP

• No deemed disposition, but non-residents cannot receive new Canada Education Savings Grants
• The RESP can remain open

Principal Residence Exemption

The principal residence exemption under Section 40(2)(b) ITA eliminates or reduces capital gains on the disposition of a qualifying principal residence. On departure:

• If your Canadian home is your principal residence, you can designate it for all years of ownership
• The deemed disposition triggers a gain on the home, but the principal residence exemption should eliminate most or all of it
• After departure, the home is taxable Canadian property and any future gain on actual sale is subject to Canadian tax (with the exemption available only for the years it was your principal residence)

Stock Options and Deferred Share Units

Employee stock options receive special treatment on departure:

• Unexercised in-the-money stock options are not subject to the deemed disposition
• Instead, Canada retains the right to tax the employment benefit when the options are exercised, regardless of where the individual is resident at that time
• The benefit is calculated as the difference between the exercise price and the fair market value at the date of exercise, attributable to the Canadian employment period

Deferred share units (DSUs) and similar deferred compensation arrangements may also have specific departure rules.

Practical Planning Strategies

Pre-Departure Crystallisation

Triggering gains before departure to use up the CAD 250,000 lower inclusion rate threshold in years prior to departure. By disposing of and reacquiring assets in the years preceding departure, gains can be spread across multiple tax years at the 50% inclusion rate.

Loss Harvesting

Crystallising losses before departure to offset against deemed disposition gains. Superficial loss rules (30-day rule) must be observed.

Corporate Restructuring

For private company owners, reducing the fair market value of shares before departure through:

• Bonus payments (converting retained earnings to salary, deductible at the corporate level)
• Dividend distributions (reducing retained earnings)
• Corporate reorganisations to separate operating value from passive investment value

Timing

The departure date determines the tax year in which the deemed disposition falls. Departing early in a tax year may result in lower marginal rates (if other income in that year is lower than usual).

Filing Obligations

Departing residents must file:

• T1 return for the year of departure (covering income from January 1 to date of departure as a resident, plus Canadian-source income thereafter as a non-resident)
• Form T1161 (List of Properties by an Emigrant of Canada) -- listing all properties with a total fair market value exceeding CAD 25,000
• Form T1243 (Deemed Disposition of Property by an Emigrant of Canada)
• Form T1244 (Election to Defer the Payment of Tax on the Deemed Disposition of Property) if deferral is elected

Failure to file T1161 carries penalties of CAD 25 per day, up to a maximum of CAD 2,500.

Key Takeaways

• Canada's departure tax applies a deemed disposition at fair market value to virtually all property on the date of emigration.
• The capital gains inclusion rate increase to 66.67% above CAD 250,000 makes the departure charge significantly more expensive from 2024.
• Canadian real property and registered accounts (RRSP, TFSA) are excluded from the deemed disposition.
• Deferral of payment is available by providing security to the CRA, and the charge can be reversed entirely by returning to Canada.
• Pre-departure planning should focus on loss harvesting, gain crystallisation at lower inclusion rates, and corporate restructuring to reduce share values.
• Filing obligations include T1161, T1243, and T1244 forms, with penalties for non-compliance.