Treaty-Protected Returns, the 18-Month Rule, and the Swallows Holding Decision

Canadian corporations earning U.S.-source revenue and relying on treaty protection face significant risk if IRS Form 1120-F is not filed on a timely basis. Where such a return is filed more than 18 months after its original due date, the Internal Revenue Code and Treasury Regulations generally mandate the disallowance of all deductions and credits, effectively subjecting the corporation to U.S. tax on its gross income. The Swallows Holding, Ltd. v. Commissioner decision confirmed the IRS's authority to enforce this strict filing deadline, rejecting challenges to the validity of the underlying regulations. As a result, the 18-month rule operates as a hard cutoff, with limited relief available only in narrow circumstances. Foreign corporations and their advisors should take proactive steps to ensure timely filing of protective Form 1120-F returns, even where a treaty-based position is expected to eliminate the U.S. tax liability. Failure to do so can result in severe and unintended tax exposure.

Background: Form 1120-F and Treaty-Protected Returns

Canadian corporations that have, or may have, U.S.-source income or activities are generally required to file Form 1120-F (U.S. Income Tax Return of a Foreign Corporation). This includes situations where a foreign corporation is relying on an income tax treaty to claim that its income is not subject to U.S. tax because its activities do not give rise to a "permanent establishment" (i.e. a fixed place of business) in the U.S. This filing is referred to as a "treaty-protected" return position.

The Protective Return

A treaty-protected tax filing preserves the right to claim deductions and credits against gross income if the IRS later determines U.S. tax is owed.

The Filing Deadlines

The standard Form 1120-F due date is the 15th day of the 4th month after the tax year ends (if the corporation has a U.S. office) or the 15th day of the 6th month (if it does not). A 6-month extension is available via Form 7004, filed by the original due date. Notably, an extension to file is not an extension to pay. As a result, the tax owed remains due on the original deadline.

The 18-Month Rule

The Internal Revenue Code ("IRC") preserves a foreign corporation's right to deductions and credits if it files "a true and accurate return, in the manner prescribed by Regulations". Those Regulations elaborate on this requirement by imposing a hard deadline: to preserve deductions and credits, a Form 1120-F must be filed within 18 months of the original due date.

The practical effect is severe. A foreign corporation that files its Form 1120-F after the 18-month window loses all deductions and credits and is taxed on its gross effectively connected income at regular U.S. corporate rates — a dramatically worse outcome than taxation on net income.

The Swallows Holding Decision

Facts

Swallows Holding, Ltd. (Swallows) was a Barbados corporation that owned approximately 160 acres of unimproved real property in San Diego County, California. The property was leased and generated rental and option income from 1993 through 1996. Swallows did not file Form 1120-F returns for those tax years until 1999, between three to six years late. The IRS disallowed all deductions and issued deficiency notices on the theory that the corporation had not satisfied the prerequisites of a timely filed tax return.

The Tax Court: Regulation Invalid (Taxpayer Wins — Initially)

Swallows petitioned the Tax Court, arguing that the IRC contains no timely filing requirement because the statute refers only to filing in the "manner prescribed" — not the "time and manner," a phrase used elsewhere in the Code. The Tax Court agreed with the taxpayer.

The Third Circuit Reverses: IRS Wins

The IRS appealed, and the Third Circuit reversed. The Third Circuit held that the 18-month rule in Treas. Reg. § 1.882-4(a)(3)(i) is valid and enforceable. Swallows' deductions were disallowed in their entirety.

The Adams Challenge Follow-On (2021)

The issues crystallized in Swallows resurfaced in Adams Challenge (UK) Ltd. v. Commissioner, 156 T.C. No. 2 (2021). The taxpayer was a UK corporation whose sole U.S. income-producing asset was a ship. It failed to file Form 1120-F for the 2009 to 2011 taxation years. The IRS issued a Notice of Jeopardy Assessment in October 2013, after which the taxpayer filed a delinquent Form 1120-F for 2011 in December 2013.

The Tax Court denied deductions for 2009 and 2010 (filed well past the 18-month window). The court's reasoning introduced an important additional principle. Once the IRS prepares a substitute return for a foreign corporation under its statutory authority, the foreign corporation loses the right to claim deductions regardless of whether 18 months have elapsed from the original due date.

Tax Implications for Treaty-Protected Returns Filed Late

1. Loss of Deductions and Credits

The most severe consequence of a late filing is not a monetary penalty, but the structural disallowance of all deductions. A foreign corporation will be taxed on its gross U.S. effectively connected income, with no offsetting deductions for interest expense, depreciation, wages, or other ordinary business costs. This results in an effective tax rate many multiples of what would apply to net income.

2. Monetary Penalties

Separate from the deduction forfeiture, the IRS may assert the following penalties on a late Form 1120-F:

• Failure-to-file penalty: 5% of unpaid tax per month (or partial month), capped at 25% of unpaid tax;
• Minimum late-filing penalty: for returns filed more than 60 days late, the lesser of the tax due or $525 (increased for returns required to be filed in 2026);
• Accuracy-related penalty: 20% of any underpayment attributable to negligence or substantial understatement of income tax; and
• Interest: accruing at the federal short-term rate plus 3%, from the original return due date to the date of payment.

3. Failure to Disclose Treaty Position (Form 8833)

A foreign corporation asserting that a tax treaty modifies or overrides a provision of the Internal Revenue Code must disclose that position on Form 8833. Failure to file Form 8833 triggers a separate $10,000 per-year penalty, independent of any other penalties arising from a late Form 1120-F. This applies even where the underlying treaty claim is valid.

4. IRS Substitute Return and Collection Action

If a foreign corporation fails to file both a regular and a protective Form 1120-F, the IRS may prepare a substitute return based on available information — ordinarily on terms highly unfavorable to the taxpayer — disallow all deductions and credits, assess the resulting deficiency, and initiate collection action. As Adams Challenge confirmed, once the IRS takes this step, the corporation's window to claim deductions closes, irrespective of the 18-month period.

Summary: Filing Scenarios and Consequences

Action Items for Foreign Corporations

• Review all prior-year filing obligations to identify any unfiled or late-filed Forms 1120-F, including protective returns;
• If a protective return was required because of a treaty position and was not timely filed, assess immediately whether the 18-month window remains open;
• Ensure Form 8833 is attached to any Form 1120-F asserting a treaty-based return position, to avoid the standalone $10,000 annual penalty;
• Consider late-filing waiver procedures where reasonable cause exists, and engage experienced international tax counsel to prepare a compelling reasonable-cause-and-good-faith showing; and
• Do not assume the IRS has not already initiated substitute return procedures — confirm status before filing a delinquent return.

GG Observations

Given the volume of cross-border trade with the United States, it is common for Canadian corporations to generate U.S.-source revenue at some stage of their business lifecycle. In such cases, U.S. tax filing obligations may arise, and failure to comply can result in significant tax exposure, including the denial of deductions and the imposition of substantial penalties. The IRS does not generally accept ignorance of these requirements as reasonable cause for non-compliance. Canadian businesses should therefore proactively assess their U.S. filing obligations. Our cross-border tax team is well positioned to assist in navigating these complexities and ensuring compliance with applicable U.S. tax rules

Are you planning on leaving Canada? Here’s what you need to know about Taxes and how we can help.

If you are planning to permanently leave Canada, whether for work, retirement, or a new adventure abroad, it is important to ensure you have considered the tax implications associated with your departure. Individuals that leave Canada, and become non-residents for Canadian tax purposes, are subject to specific tax rules with respect to their assets. This article examines what you need to know about your tax obligations upon leaving Canada and how we can help to plan a seamless transition to your new home country.

Emigrating From Canada

You are considered to have emigrated from Canada for income tax purposes if you left Canada to live in another country, and you severed your residential ties with Canada.

Residential ties include a home, family connections, social relationships, personal property, and economic links.

You become a non-resident of Canada for income tax purposes on the latest of:

• the date you leave Canada;
• the date your spouse or common-law partner and dependants leave Canada; or
• the date you become a resident of the country you settle in.

When leaving Canada, you will need to ensure that you have severed sufficient residential ties with Canada to establish that you have become a non-resident of Canada. Otherwise, you may still be considered a Canadian resident for tax purposes.

Exit/Departure Tax

Canada levies an exit/departure tax on residents when they leave Canada. Individual taxpayers are deemed to have disposed of their assets (subject to certain exceptions) at fair market value on the date Canadian residency is ceased. In other words, Canada treats your departure as if you have sold your assets at fair market value, immediately before you become a non-resident, and have reacquired the same property at fair market value. This creates what is commonly referred to as “Exit/Departure Tax”, which arises from a “deemed disposition” and results in capital gains on the assets that have appreciated in value. Understanding the implications of the deemed disposition rules is important for owner-managers holding shares of Canadian private corporations.

It is also essential to obtain valuations of the assets that are subject to departure tax to determine the fair market value on departure. For individuals who own shares in a Canadian private company, determining the fair market value of the shares may require the assistance of a Chartered Business Valuator (CBV).

Certain tax deductions, such as the lifetime capital gains exemption, may help reduce departure tax. It is therefore important to plan ahead to ensure that the assets or shares you own can qualify for such exemptions on departure.

The deadline for the departure tax return is April 30th of the year after an individual leaves Canada. For Instance, if you emigrate from Canada on December 31, 2026, your Departure tax return will be due on April 30th, 2027. This deadline is extended to June 15 if you are self-employed. When filing the departure tax return, Individual taxpayers must file Form 1243 “Deemed Disposition of Property by an Emigrant of Canada”. There may be additional disclosure forms if the total value of all property owned at the time of departure is more than $25,000 and failure to file could result in penalties of up to $2,500.

Planning for Holding Canadian Assets as a Non-resident

If you intend to continue holding certain assets after leaving Canada, it is important to understand the tax consequences associated with future potential income from Canadian sources.

For example, dividend income, interest income, pension income and rental income from Canadian sources may be subject to Canadian withholding tax when received by a non-resident.

There will also be penalties associated with respect to the omission or incomplete information in Schedule 15 as part of the T3 Return.

In addition, if you own shares in a group of Canadian private companies or have an interest in a trust, it is important to review the structure of the group to determine whether any restructuring may be necessary, considering potential cross-border tax implications. Certain restructuring steps may need to be undertaken while you are still a Canadian resident to ensure the most favourable tax outcome.

Holding certain Canadian assets may also create significant disclosure or reporting complications in your new country of residence. If the accrued gain on such an asset is not significant, you may wish to consider liquidating it prior to departure to simplify future reporting requirements.

Collaboration with tax advisors in your new country of residence is also important to help optimize your overall tax outcome.

Deferring the departure tax liability

To lessen the tax burden arising from the deemed disposition of assets owned at the time of departure, the Canada Revenue Agency (“CRA”) allows individual taxpayers to elect to defer the tax on their deemed disposition until the asset is disposed, without additional interest. However, the CRA may require adequate security be provided to cover the amount. The acceptable security the CRA may accept include a letter of credit from a financial institution, a lien/mortgage on assets subject to the deemed disposition, or real property in Canada.

Registered Accounts: Registered Retirement Savings Plan (“RRSP”) & Tax-Free Savings Account (“TFSA”)

If you hold an RRSP or a TFSA account, you can continue to hold these accounts while being a non-resident of Canada. Any withdrawal from an RRSP account may be subject to withholding taxes. On the other hand, withdrawals from TFSA accounts will continue to be tax-free in Canada but may be subject to tax in the new country of residence. It is important to review the Tax Treaty between Canada and the new country of residence to identify the correct tax treatment for these registered accounts.

Returning to Canada

If an individual taxpayer decides to return to Canada and become a resident of Canada for Income tax purposes, the taxes that would have been paid on the deemed disposition of assets upon their departure can be recouped. The CRA allows you to elect to unwind the occurrence of a deemed disposition if you still own some or all the property that was reported on the Departure tax return. This is called an “unwinding election” and can be complex measure to utilize.

GG Observations

As a Canadian resident transitioning to non-resident status, you will need to navigate departure tax rules carefully, including potential deemed dispositions of assets and related filing obligations, to avoid unexpected tax consequences. It is important to plan ahead and allow for sufficient time to address the tax implications, obtain necessary valuations, and implement any restructuring that may be required. This can feel overwhelming, but rest assured, our team at GG specializes in making this process straightforward and stress-free. We can assist you throughout the process, including developing an appropriate tax planning strategy, and performing valuations for privately held companies to understand and minimize the tax burden.

As part of the UHY international network, we also work closely with advisors in other jurisdictions to help develop a coordinated cross-border tax plan for your transition after leaving Canada.

Contact us for more details.

Since 2022, there have been significant revisions to the reporting obligations for trusts in Canada. This article summarizes information on the filing and disclosure requirements, changes to tax calculations, and filing deadlines and penalties.

Bare Trusts Generally Not Required to File 2025 T3 Returns

Canada Revenue Agency (“CRA”) has previously announced on December 16, 2025 that it “does not expect” bare trusts to be required to file a T3 Income tax and Information return (“T3 Return”) and Schedule 15 – Beneficial Ownership Information of a Trust (“Schedule 15”) for the 2025 tax year, unless specifically directed by CRA to do so. For 2026 and subsequent years, it is expected that additional clarifications and guidance will be provided later in the year regarding the types of bare trusts that will be subject to filing requirements.

Disclosure of Trustee and Beneficiary Information

On November 18, 2025, the Government of Canada tabled Bill C-15 with proposed amendments to the trust reporting requirements as outlined in the Income Tax Act (“ITA”).

As part of the proposed amendments, certain trusts may not be required to file a T3 return for taxation years ending on or after December 31, 2025, if all the specific conditions are met.

If all of the specific conditions listed below are met, the Trust will be required to file a T3 return but will not be required to file Schedule 15 with their T3 return.

• Trust holds assets that have a total fair market value (“FMV”) not exceeding $50,000 throughout the taxation year (with no restrictions on the type of assets that can be held).
• Trust that holds assets such as cash, bonds and guaranteed investment certificates (“GICs”) with a FMV that does not exceed $250,000 at any point during the year.
• Specific accounts held by lawyers and other professionals in trust on behalf of their clients. The assets held in trust throughout the year include cash, bonds and GICs that do not exceed $250,000 at any point during the year.
• Trust that were created to comply with the statute of Canada or another province requiring the trustee to hold the property within the trust for a specified purpose, such as those of bankruptcy trustees.

Alternative Minimum Tax (“AMT”)

Legislative updates on the AMT regime that took effect on January 1, 2024, remain applicable in 2025 and could result in AMT payable in certain types of trusts. For example, under the revised AMT rules, certain carrying charges such as interest and financing expenses on money borrowed would not be fully deductible against income.

As a result, a trust that has allocated all its income to its beneficiaries and paid no tax under the regular tax regime in the past, could be liable for AMT in 2025 due to additional adjustments for AMT purposes.

While the AMT regime covers most trusts, graduated rate estates are exempt from AMT.

Filing Deadline and Penalties

The deadline for filing the T3 Return, along with any related T3 slips and summaries, is no later than 90 days after the trust’s tax year-end. Therefore, trusts with a calendar year-end must file their 2025 T3 Returns no later than March 31, 2026. Any balance owing should also be paid no later than 90 days after the trust’s tax year-end.

Failure to file a T3 Return by the due date will result in a late-filing penalty of $25 per day, with a minimum of $100 and a maximum penalty of $2,500.

There will also be penalties associated with respect to the omission or incomplete information in Schedule 15 as part of the T3 Return.

Any tax balances not paid by March 31, 2026 will be assessed penalties of 5% of the balance owing plus 1% per month late for a maximum of twelve months.

For offences due to gross negligence, knowingly failing to file, or false statements/omissions on a T3 Return, the penalty is the greater of $2,500 or 5% of the maximum value of the property held during the tax year by the trust.

GG Observations

With many updates and uncertainties on the horizon, it is important to be prepared for the changes and stay focused on the filing requirements that have been enacted. Your GG advisors can help assess the impact of the ever-changing tax legislation and filing requirements. This will ensure you stay informed regarding updates, and remain compliant with tax authorities. Contact us for more details.

Welcome to tax season! It's time to prepare for filing your 2025 personal tax return. To help you get organized, we've put together a checklist to assist in gathering all necessary information.

In this article, we outline the key deadlines related to your filing obligations and highlight changes implemented to personal tax filings for 2025.

2025 Personal Tax Deadlines

Other Tax Tips

GG Observations

These changes reflect updates to tax policies and regulations aimed at addressing various aspects of taxation, including housing affordability, support for workers, and the taxation of certain income streams. It is important to stay informed about these changes and file your personal tax on time. Please feel free to reach out to us if you need any assistance on your personal tax return for 2025.

With the new year behind us, it is crucial to be cognizant of the upcoming tax deadlines in early 2026. In this article, we will discuss a few important deadlines that you should be aware of.

Deadlines: End of February / Throughout March

RRSP

The deadline for contributing to an RRSP for the 2025 tax year is March 2nd, 2026.

The annual RRSP deduction limit is calculated as 18% of your prior year’s earned income (i.e., employment income), up to a predetermined maximum per year. For 2025, the predetermined maximum was $32,490 (18% of $180,500 of earned income). Any undeducted RRSP contributions and unused RRSP deduction room can be carried forward to subsequent years. Both your contribution limit and any carry-forward contribution room should be available on your annual notice of assessment from the CRA if you filed your taxes in the previous year. Be mindful that over contribution to a RRSP may result in unwanted penalties and interest.

T4 and T5 Slips

T4 Summary and Slips should be filed for salaries paid to individuals during 2025. Similarly, T5 Summary and Slips should be filed for dividends paid during the year.

The deadline to file 2025 T4 and T5 Summary and Slips is February 28th, 2026*.

Final payments of corporate income taxes

Final payments of corporate income taxes are required within two months of each taxation year-end (Note: eligible Canadian-controlled private corporations may qualify for a three month final payment due date). For a corporation that does not qualify for the three-month due date and that has a December 31, 2025 year-end, the final payment due date is February 28th, 2026*.

Trust returns

T3 Trust income tax and information return should be filed 90 days after the trust’s tax year-end. For a Trust that has a December 31, 2025 year-end, the deadline to file is March 31st, 2026.

With the new year behind us, it is crucial to be cognizant of the upcoming tax deadlines in early 2026. In this article, we will discuss a few important deadlines that you should be aware of.

Deadlines: End of April / June

Final payments of personal income taxes

Final payments for personal income taxes are required to be paid by April 30th, 2026. This payment deadline also applies to individuals with self-employment income, who have a personal tax filing deadline of June 15th, 2026.

Vacant Home Tax ("VHT") Declaration

The Toronto VHT is a tax on residential properties in Toronto that are considered vacant. To avoid assessment of VHT, Toronto homeowners are required to declare occupancy status of their property every year.

VHT is calculated at 3% of the property’s current value assessment ("CVA") for the year in which the home is vacant.

The deadline to complete the VHT Declaration is April 30th, 2026.

https://www.toronto.ca/services-payments/property-taxes-utilities/vacant-home-tax/

* When a due date falls on a Saturday, Sunday or public holiday recognized by the Canada Revenue Agency (CRA), the return is considered filed and the payment is considered to be made on time if the CRA receives the filing—or the payment or filing is postmarked—on or before the next business day. In these instances, since the due date falls on a weekend or a federal holiday, the filing or payment deadline is the first working day that follows.

GG Observations

Individuals and businesses alike should be aware of their tax filing obligations and be proactive to meet the filing deadlines. Taxpayers should plan to determine the most tax efficient way to minimize tax liabilities and keep more in their pockets. Grewal Guyatt LLP has extensive experience in assisting clients with tax planning strategies and meeting tax filing obligations. If you have queries about prior and current tax filing obligations, please contact us.

If you have a prescribed rate loan as an income-splitting arrangement, with either a family member or with a family trust, the deadline to pay the 2025 interest on the loan is January 30, 2026. It is vital that the interest is paid in cash, since failure to do so would cause the loss of the exemption from the attribution rules for not only that year, but all subsequent years. With the prescribed rate of 3% as of 2026 Q1, individuals that were able to ‘lock-in’ a low prescribed rate need to preserve the tax beneficial arrangement by ensuring the interest is paid before the deadline.

What is a Prescribed Rate Loan Family Trust?

A prescribed rate loan family trust is a structure that can be used to implement an income-splitting strategy to help reduce your family’s combined tax liability. If structured properly, this strategy will allow a high-income parent to split income with their low-income family members through a prescribed rate loan lent to a family trust. The beneficiaries of the family trust could include your spouse, children, and grandchildren. The investment income earned in the family trust from the prescribed rate loan can be shared among the lower-income family members to achieve overall tax savings for the family. The income allocated to children can be used to pay for private school tuition, camp fees and other expenses.

Attribution Rules

The Income Tax Act contains certain income “attribution” rules to prevent family income splitting in various scenarios. If applicable, these rules will attribute taxable income back to the family member that provided cash for the investment, eliminating the benefits of income splitting. The attribution rules can generally be avoided if the funds advanced to the family member or a family trust are through a loan with an interest rate not less than the prescribed rate set by the CRA.

How Prescribed Rate Loan Family Trusts Work

A prescribed rate loan is established when funds are advanced by a family member (the lender) to a family trust (the borrower) using a formal written loan agreement at an interest rate that is at least equal to the CRA’s prescribed rate in effect at the time the loan is established. The CRA sets the prescribed interest rate every quarter and the current prescribed rate for Q1 of 2026 is 3%. Once the loan is established, the interest rate can be maintained for the life of the loan regardless of any subsequent increases to the actual prescribed rate. The family trust must pay interest to the lender at the CRA’s prescribed rate on or before January 30th of the following year. If payment is made late for any year, the prescribed rate loan family trust will lose its exemption from the attribution rules for not only that year, but all subsequent years.

The investment income earned by the trust from the advanced funds can be allocated to the beneficiaries of the family trust and taxed at their respective marginal tax rate. The lender will include the interest received as income on his or her tax return. The interest paid by the trust is deductible by the family trust as an investment expense.

GG Observations

As the CRA prescribed rate is currently at 3%, which is a decrease compared to January of last year, the prescribed rate loan can be a viable strategy depending on the rate of return you can get on the funds advanced. If you implemented the prescribed rate loan strategy previously and were able to ‘lock-in’ a lower rate, it is important that the interest on the loan is paid (in cash) by the January 30, 2026 deadline to preserve the benefits of the strategy.

If you are looking to take advantage of the prescribed rate loan strategy, Grewal Guyatt has extensive experience in assisting clients with the implementation and administration of prescribed rate loan family trusts. For more information, please contact our tax team.

As a business owner, you wear many hats — from generating sales and overseeing operations to initiating hiring and formulating strategy. Nevertheless, the one area that often doesn’t get the attention it deserves is internal controls. While controls may sound like something only large corporations worry about, internal control is essential for businesses of all sizes. Effective internal controls can protect a business, increase efficiency, and give owners peace of mind.

What are Internal Controls

Internal controls are the policies, procedures, and systems you put in place to protect your business. They consist of preventive. detective and corrective measures to help ensure that:

• Your financial information is accurate
• Assets are safeguarded from theft or misuse
• Employees are following proper processes
• Mistakes and fraud are prevented or detected early
• Your business is complying with regulations

Internal controls are not just about preventing fraud and errors — they’re about building a stronger, more reliable business.

Why Internal Controls Matter for Your Business?

1. Protecting Your Assets

Whether it’s inventory, cash, equipment, or data, your business assets need to be protected. Without proper controls, there’s a higher risk of theft, waste, or accidental loss. For example, something as simple as requiring two signatures on outgoing payments can reduce the risk of unauthorized spending.

2. Preventing Errors and Fraud

Even the most trusted employees can make mistakes — and unfortunately, in some cases, act dishonestly. Clear procedures, segregation of duties, and regular oversight can reduce both accidental errors and intentional misconduct.

3. Improving Financial Accuracy

Your decisions as a business owner rely on accurate, timely financial information. Internal controls help ensure that your accounting records are complete and correct, so you're not flying blind when making critical decisions.

4. Building Trust with Lenders and Investors

If you're seeking financing or outside investment, a strong internal control environment sends a clear message: this business is well-managed and financially responsible. Lenders and investors feel more confident when they know your financial systems are reliable.

5. Supporting Business Growth

As your business grows, so do the risks and complexities. What worked when you were a small team may not work at a larger scale. Internal controls help your company grow in a structured, sustainable way — avoiding growing pains and costly oversights.

GG Observations

Think of internal controls as your business’s immune system. When it’s strong, it quietly protects your company in the background. When it’s weak, problems can go unnoticed until it’s too late. The internal control framework can be implemented and managed in-house or outsourced to external professionals, such as a CPA firm, depending on your company’s size, resources, and complexity. Either approach can be effective—as long as the controls are properly designed, implemented, and monitored. Our team of professionals can assist you in assessing weaknesses and areas for improvement over your internal controls and providing recommendations and strategies on how to strengthen your internal controls.