Due to its proximity to the United States, Canada is the United States' largest trading partner. In addition, Canada is a signatory to the North American Free Trade Agreement ("NAFTA") with the United States and Mexico. As a result of these very close economic and cultural ties between Canada and the United States, many citizens and residents of one country often move to the other country to work, to invest, to conduct business and even to retire.
Canada and the United States each have very unique systems of taxation. However, these two countries have signed a Tax Treaty in order to avoid double taxation and to prevent fiscal evasion with respect to taxes on income and on capital. The Canada-United States Income Tax Treaty ensures that a resident of one country is not taxed by each of the two countries on the same income in the same year. (referred to as "double taxation"). This is particularly important if a person lives in one country and either commutes to work in the other country every day or moves to the other country temporarily to work for a limited period of time.
The discussion below will outline general Canadian and United States principles concerning the taxation of individuals. It is of a summary nature only, and should not be acted upon without professional advice.
Canadian Tax Information
Unlike the United States, (which taxes individuals based on their citizenship) Canada taxes individuals based on their residency. Therefore all residents of Canada are required to pay tax on worldwide income earned in a particular calendar year. For income tax purposes, residents of Canada include individuals who permanently reside in Canada, whether as citizens or landed immigrants of Canada. A Canadian resident who leaves Canada on a temporary basis, with the intention to return to Canada in the near future, continues to be considered a resident of Canada for income tax purposes. As a resident of Canada, he or she is required to file an income tax return in Canada every year and is required to report worldwide income earned and pay Canadian taxes on this worldwide income.
Canada also taxes non-residents on certain Canadian source income under certain circumstances, which may include withholding tax on interest, dividends, royalties, etc. paid to a non-resident. In addition, non-residents who "sojourn" (visit and stay in Canada) for greater than 183 days in a given year are deemed to be Canadian residents for income tax purposes and are subject to Canadian tax on their worldwide income.
As long as the individual remains a resident of Canada for income tax purposes, Canadian taxes are due even though the individual may be working in the United States and already paying tax on United States employment or business income. Under United States tax law, Canadian citizens living in the United States (referred to as non-resident aliens for United States income tax purposes) are required to pay tax on all United States source income (and perhaps on worldwide income), despite the fact that they may be residents of Canada for Canadian income tax purposes and therefore be required to pay Canadian tax as well on the same United States employment or business income. Canadian domestic tax law as well as the Canada-United States Income Tax Treaty would generally allow United States taxes paid on United States employment or business income to be offset against Canadian taxes calculated on the same United States employment or business income, as a "foreign tax credit". Of course, there are certain restrictions regarding the amount of foreign tax credits that may be claimed for Canadian income tax purposes.
Usually the combined United States Federal and State personal income tax rates are lower than the combined Canadian Federal and provincial personal income tax rates. As a result, it is generally desirable to pay income tax only in the United States and not in Canada. By remaining a resident of Canada for income tax purposes all United States source personal income is subject to Canadian tax, which may be partially or wholly offset by foreign tax credits. However, the total tax paid in the United States plus the tax paid in Canada (net of foreign tax credits) usually equals the tax that would be paid in Canada, at least on the United States source income.
The determination of residency is important for Canadian income tax purposes. As discussed above, residents of Canada are subject to Canadian tax on their worldwide income. Certain onerous income tax rules come into play that could result in a large tax liability (generally referred to a "Departure tax") when an individual leaves Canada and moves to the United States permanently.
The term "residency" is not defined in the Income Tax Act (Canada). However the Federal Government's Department of National Revenue, Revenue Canada, in its Interpretation Bulletin IT-221R2 - Determination of an Individual's Residence Status, provides certain guidelines to assist taxpayers in determining residency for income tax purposes. In the Interpretation Bulletin, Revenue Canada states the following:
Where an individual leaves Canada, the following factors will be taken into consideration in determining whether or not the individual will remain a resident of Canada for tax purposes while abroad:
- permanence and purpose of stay abroad,
- residential ties within Canada,
- residential ties elsewhere, and
- regularity and length of visits to Canada
Revenue Canada has stated that when an individual leaves Canada for a period of less than 2 years, that person will be presumed to be a continuing resident of Canada for income tax purposes. However, if the individual can establish that he or she has severed all residential ties on leaving Canada, that individual will be considered to have become a non-resident of Canada on departure, even if they do return within 2 years. If there is evidence that his or her return to Canada was foreseen at the time of departure (e.g. a contract for employment upon return to Canada), Revenue Canada will presume that he or she did not sever all residential ties with Canada.
Revenue Canada considers the following factors in determining an individual's residential and other ties with Canada:
- dwelling place (or places)
- spouse and dependents
- personal property
- social ties
- provincial hospitalization and medical insurance coverage
- a seasonal residence in Canada
- professional or other memberships in Canada (on a non-resident basis)
- family allowance payments
The greater the number of ties an individual has with Canada, the greater the chance that the individual is a resident of Canada.
Canadian courts have held that:
- everyone must be resident somewhere, and
- it is quite possible for an individual to be resident in more than one place at the same time for tax purposes.
A departing Canadian resident must establish a residence elsewhere, otherwise the presumption is that he or she is a continuing resident of Canada for income tax purposes. Where under the domestic tax laws of Canada and another country (e.g. the United States), an individual is a resident of both countries at the same time, the applicable Income Tax Treaty must be examined to determine how the conflict will be resolved. The Canada-United States Income Tax Treaty contains such "Tie-Breaker" rules.
United States Tax Information
To assist in the understanding of certain United States income tax terminology, consider the following definitions:
- Resident aliens - individuals who are not United States citizens who have moved to the United States on a temporary basis to either work or attend school. Resident aliens are taxed in the United States on worldwide income.
- Non-resident aliens - individuals who are not United States citizens and who do not reside in the United States. Non-resident aliens are only taxed on United States source income, such as employment income, interest, dividends, royalties and income effectively connected with a United States trade or business.
As indicated above, the United States tax laws require all United States citizens to pay Federal income tax on worldwide income, no matter where they reside in the world. This means that United States citizens have to file annual United States Federal income tax returns even if they are currently residents of other countries and have been for years. The United States does allow its citizens to claim an annual $70,000USD foreign earned income exclusion, where certain criteria are met. In addition, the United States allows foreign tax credits, being income taxes paid to other foreign countries and jurisdictions, to offset Federal income taxes payable.
Canadians, who are not also United States citizens who move to the United States on a temporary basis, may be considered to be resident aliens for income tax purposes. Canadian citizens, either working or conducting a business in the United States, will be required to pay Federal, state (if applicable) and city (if applicable) income taxes.
Generally, a foreign citizen is treated as a non-resident for United States tax purposes, unless he or she meets one of the statutory tests for residency. These tests are: (a) the Lawful Permanent Resident test, and the Substantial Presence Test. The lawful permanent resident test would not apply to Canadians who are in the United States temporarily. However, most Canadians in temporary status would probably meet the Substantial Presence Test, which is based on physical presence in the United States.
A foreign national will meet the Substantial Presence Test if he or she is present in the United States for 31 days in the current year and the sum of the following:
- sum of the days present in the United States in the current year,
- one-third of the number of days present in the first preceding year,
- one sixth of the days present in the second preceding year equals or exceeds 183 days.
There are limited exceptions for foreign government employees and professional athletes.
Canadians who regularly visit the United States for business or pleasure and meet the Substantial Presence Test, will be treated as residents for United States tax purposes. However, a "Closer Connection Exception" is available if all of the following apply:
- the alien has been present in the United States for less than 183 days in the current year;
- the alien has maintained a permanent place of residence in Canada throughout the current year; and
- the alien files Form 8840 by the due date, usually June 15th of the following year.
If a Canadian meets the Substantial Presence Test but is ineligible to meet the Closer Connection Exception (i.e. since he or she is present in the United States for more than 183 days in the current year), he or she will be considered to be a resident alien of the United States. Resident aliens are taxed on worldwide income in the same manner as United States citizens.
Unlike Canada, United States tax laws allow a husband and wife to file a joint income tax return, in which worldwide income earned in a current calendar year by both individuals is reported. However, to be eligible to file a joint income tax return, both individuals must be United States residents on the last day of the tax year and they must make a special election.
As noted above, United States taxes paid by a Canadian, who is residing and working in the United States temporarily, can be claimed as foreign tax credits against Canadian taxes payable on the same income which has to be reported in Canada, as the individual is considered to be a resident for Canadian tax purposes as well.
Non-resident aliens are not subject to state or city taxation as they do not reside in the United States. However, resident aliens are subject to state and perhaps city taxation (only certain major cities in the United States assess income tax on their residents) since they actually reside in a particular city and state. State and city income tax is generally calculated as a percentage of Federal Adjusted Gross Income ("AGI"). State and city income tax is generally deductible for Federal income tax purposes.
This is a joint page of Chang and Boos and McCarney, Greenwood, LLP. The article was provided courtesy of Mr. Roy Ohm, C.A., C.P.A.
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