Canadian Tax Considerations for Canadians Moving Permanently to the United States
The booming U.S. economy over the greater part of the 1990s, the rising U.S. standard of living and the ever-increasing number of opportunities in the U.S. have attracted many skilled Canadians. While the debate whether there really is a “brain drain” continues to rage in Canada, many Canadian physicians, computer scientists, engineers, technicians and other professionals are rushing to live and work in the U.S. in greater numbers. Many have left Canada permanently to pursue greater opportunities, higher income and lower taxes in the U.S.
There are a number of Canadian income tax implications that must be kept in mind. In some situations, it may be very expensive, from an income tax perspective, to emigrate from Canada. This paper will highlight some of the more significant Canadian tax considerations for emigrants.
Determination of Residence for Canadian Income Tax Purposes
The term resident is not defined in the Canadian Income Tax Act so we need to refer to case law. Canadian Tax Courts (the "Courts") have held that an individual is resident in Canada for tax purposes if Canada is the place where he, in his settled routine of his life regularly, normally or customarily lives. Canada Customs and Revenue Agency ("CCRA"), formerly Revenue Canada, has indicated that the determination of an individual's residence status is a question of fact and is based on a number of factors that have been set out by the Courts. These factors are discussed below:
Permanence and Purpose
CCRA considers the degree of permanence. For example, if the individual has been absent for less than 2 years, it is presumed that he or she has retained Canadian residence unless all ties to Canada have been severed. If the emigrating individual's return to Canada is foreseen before his or her departure, CCRA will conclude that the individual never ceased to be a resident of Canada.
Residential Ties to CanadaResidential ties to Canada may include the following:
- A home which may be kept vacant or leased to a non-arm's length person or for a short term period;
Residential Ties Elsewhere
The Courts have indicated that an individual must be resident somewhere, but they can also have more than one residence at the same time. Therefore, the fact that the individual is considered a resident of some other country does not preclude a finding that he or she is still resident in Canada.
Regularity and Length of Visits to Canada
An individual can make the occasional return visits for business or personal reasons but if visits are on a regular basis then this may indicate that the individual continues to be a resident of Canada.
If the individual leaves Canada for two years or less, CCRA’s administrative policy is that the individual is presumed to have retained their Canadian residence during their absence, unless he or she can establish that the return to Canada was unforeseen at the time of departure. Any evidence of intent to return to Canada within two years of departure, will cause CCRA to conclude that the individual was a continuing resident of Canada, for tax purposes, during the two years that he or she was absent. This two-year rule is only an administrative policy of the CCRA and has no basis in law.
CCRA has centralized the determination of residence in its International Tax Services Office in Ottawa, and has established procedures to allow the determination of non-residence in advance of an emigrant’s departure. An emigrant is not required to obtain this prior determination, but it may be advantageous if he or she requires residence status to be clarified prior to departure. Form NR73 should be completed to request a determination of residence status.
Some of the steps that an emigrant should take in order to be considered a non-resident of Canada are:
- Close all Canadian bank accounts if possible or inform the banks of the change in residence.
Termination of Canadian Residence
Date of Departure
The date of departure is generally considered to have occurred on the latest of:
- The date the individual leaves Canada;
An individual can be a dual resident if he or she creates residential ties in the United States but does not sever all ties in Canada. In such a situation an individual could be subject to double taxation. Relief from this situation is provided by the Canada–U.S. Income Tax Convention. This Convention for the most part will provide a determinacy of residence between Canada and the United States that will override domestic tax law. When an individual is considered a resident of both countries by virtue of domestic law, an individual's residence status is determined by considering which country to which the individual has a closer connection. This is determined by considering the following factors in the following order:
- Whether the individual maintains a permanent home in the country;
Canadian Income Tax Implications of Ceasing to be a Canadian Resident
Canada's taxation system is based on residence. Residents of Canada are subject to taxation on their worldwide income while non-residents are only subject to taxation on certain types of Canadian source income. When an individual ceases to be a resident, the provisions of the Canadian Income Tax Act attempts to tax the individual on all his or her income earned up to the date that residence terminates (date of departure), especially the income that will not be taxable once the individual becomes a non-resident. This tax is referred to as the "departure tax".
Departure Tax and Deemed Dispositions
Canadian tax rules deem an individual who ceases to be a Canadian resident for tax purposes to have disposed of all property immediately prior to his or her departure. On October 2, 1996, the government brought in changes to the departure tax rules with respect to assets held by an emigrant at the time of departure. The changes brought by the new rules are mainly that "taxable Canadian property" ("TCP") will no longer be excluded from the departure tax, subject only to a few exceptions. As a result, virtually all property held at the time of departure will now be subject to the deemed disposition rules. Previously, gains on the disposition of TCP were subject to tax only at the time they were actually disposed of.
The rules state that all individuals who cease to be Canadian residents and who own property, with a total fair market value of more than $25,000CAD, at the time of departure must file a listing of all the properties owned at that time. There are exceptions for items such as personal-use property, including clothing and household goods with a value of less than $10,000CAD. CCRA has issued a draft form T1161, which is an information return that requires the emigrant to list all of the required properties owned at the time of departure. The return is to be filed with the ordinary T1 – Canadian Individual Income Tax Return for the year of departure.
The Federal Income Tax Act provides other exceptions to the deemed disposition rules that apply on departure, including:
- Real property situated in Canada;
There is a provision in the rules that allow an individual to post security rather than pay the tax on a deemed disposition, since the individual may not have the cash to pay the tax arising on departure as the assets may not be sold at that time.
It should be noted that capital property that ceases to be used in a business after departure, and that had its deemed disposal deferred at the time of departure, would be deemed to be disposed of at the time it ceases to be used in the business.
Taxable Canadian Property
Gains on actual dispositions of taxable Canadian property can be taxed again even though they were taxed at the time of departure. If the property loses value and is disposed of more than three years after departure, the loss may not be carried back to offset the previous gain. If the individual moves to the U.S. and sells the property after several years, there will be U.S. tax on the full gain calculated as the difference between the property’s proceeds of disposition less it’s original cost. In this situation, no foreign tax credit would be available to recognize Canadian tax already paid at the time of departure.
Taxable Canadian Property includes:
- Real property situated in Canada;
At the time of departure, individuals leaving Canada may rent their principal residence or continue to own existing rental properties. There are special rules for the taxation of rental income earned in Canada by non-residents. Non-residents will be subject to a 25% withholding tax on gross rental income. The tenant or rental agent will be required to withhold and remit this 25% withholding tax to the Government.
The non-resident may file Form NR6 called an "Undertaking to File an Income Tax Return by a Non-Resident Receiving Rent from Real Property", which is an election to reduce the withholding tax on rental income. This election allows the non-resident to file an income tax return as if he or she were a Canadian resident earning only rental income from a property situated in Canada. This section 216 tax return calculates the income tax on net rental income rather than gross rent. The tenant or agent is required to withhold tax based on the estimated net rental income. A Canadian income tax return reporting net rental income for the year must be filed within six months after the end of the year if Form NR6 is filed. A non-resident who chooses to file an income tax return reporting net rental income will be taxed on his or her net rental income at the tax rate that generally applies to Canadian residents.
Income earned on investments within an RRSP is not taxed annually and the accumulated income can continue to grow on a tax-deferred basis. The individual has until the end of the year in which he or she reaches age 69 to maintain the RRSP. However, if the emigrant collapses the RRSP in the year of departure, the entire amount withdrawn will be taxable in that year. If the RRSP is instead collapsed after the emigrant becomes a non-resident, the amount withdrawn will attract a 25% non-resident withholding tax.
The non-resident can choose to make a section 217 election, which could reduce the tax on amounts withdrawn from the RRSP by the non-resident. This election is beneficial if the individual's pension income from the RRSP is equal to at least 50% of his or her worldwide income and is reported on the special section 217 tax return, where personal credits can be claimed.
Home Buyer's Plan
Amounts withdrawn from an RRSP under the Home Buyers' Plan are not taxable as long as the funds are used to acquire a Canadian home. However, if the individual withdraws these funds from an RRSP and becomes a non-resident before acquiring a Canadian home, the withdrawals will be added to the individual's income in the year of withdrawal. However, the individual may choose to refund the withdrawal and then cancel his or her participation in the Home Buyer's Plan. Form T1037 must be filed but as long as the repayment is made before the individual files the final income tax return for the year of departure, the amounts withdrawn will not be taxable.
If an individual withdraws funds from an RRSP under the Home Buyers' Plan and becomes a non-resident after acquiring a Canadian home, he or she must put an equivalent amount back in the RRSP or include the amount in income within 60 days of becoming a non-resident and prior to filing a tax return for that year.
Old Age Security and Canada Pension Plan
Commencing in 1996, payments of Old Age Security ("OAS") benefits, CPP benefits, and Quebec Pension Plan ("QPP") benefits to non-residents became subject to Canadian withholding tax.
Part-Year Resident in
the Year of Emigration
Individuals who leave Canada permanently and move to the U.S. are considered to be part year residents of Canada in the year this change occurs. The following general rules apply to this year:
Income Included While a Resident
The emigrant must include world income that is subject to Canadian tax for that portion of the year of departure that he or she was a resident of Canada. The income for this period is computed as if the residence portion of the year was a whole year, and all allowable deductions are taken in computing net income for this period.
Income Included While a Non-Resident
The emigrant must include only income from Canadian sources for that portion of the year of departure that they were a non-resident. Only those amounts that are generally allowable to non-residents in computing taxable income, and which relate to that portion of the year of departure that the individual was a non-resident, may be deducted from income.
Deductions Allowed While a Resident of Canada
Non-capital losses and net capital losses incurred in Canada in other years may be deducted subject to limitations. While a resident of Canada, if the emigrant incurred net capital losses from dispositions of property or non-capital losses from employment, property, or a business, such losses may be carried over to other years within normal carryover period limits. However, the amounts of the above mentioned losses that are applicable to employment outside Canada, to property outside Canada or to a business carried on outside Canada, as well as all net capital losses incurred while the taxpayer's income is computed as that of a resident, may not be carried to any years, or parts of years, where the taxpayer's income is computed as that of a non-resident.
Losses from a business carried on in Canada can be carried over into periods of non-residence. Residence appears to be immaterial in determining loss carryovers. Similarly, allowable business investment losses and employment losses arising in a period of residence, may be carried back or forward to other years or periods of residence. When calculating losses as a part year resident, the emigrant cannot carry over losses incurred in the resident portion of the year to the period of non-residence of the same year, even though the calculations are made for each of the residence and non-residence periods.
Deductions from net income to arrive at taxable income may be taken in the normal way if they may be considered wholly applicable to the period of residence. However, in order to arrive at taxable income for the period of residence, any deductions from net income, which are not wholly applicable thereto, must be pro rated.
The Capital gains exemption is available for the period of residence, provided the emigrant was a resident of Canada throughout the immediately preceding year. Deductions used to arrive at taxable income for a part-year resident may not exceed the amounts that could have been deducted had the individual been resident in Canada throughout the year.
Election by a Non-Resident to file a Canadian Tax Return under Section 217
A section 217 election is available to non-resident individuals (including that portion of the year of departure that the emigrant was a non-resident of Canada) who receive pension benefits, employment insurance benefits, sundry government assistance, retiring allowances, or amounts out of RRSPs, RRIFs or Deferred Profit Sharing Plans ("DPSPs"). These amounts are normally subject to Canadian non-resident withholding tax and must be withheld by the Canadian payer.
Generally these amounts are subject to a flat withholding tax rate of 15% based on the Canada–U.S. Tax Treaty. It will be advantageous to the non-resident to make a section 217 election if the non-resident's effective Canadian tax on these amounts, after applying allowable deductions and tax credits, is less than the flat rate tax already withheld.
The election consists of a Canadian tax return reporting all the amounts listed above, and taxing them as if they were earned by a resident. Alimony and maintenance are no longer eligible for this election because the withholding tax on those items was discontinued after 1997.
The amounts eligible for the section 217 election consist of the total of all amounts paid or credited to the non-resident in the year, which would normally be subject to non-resident withholding tax. These typically including:
- Pension benefits;
Generally, these items are subject to withholding tax only to the extent they would be taxable if received by a Canadian resident and not subject to a tax-free rollover or offsetting deduction. Presumably, receipts not subject to withholding are not Canadian benefits, but neither are they income for any other purpose under these rules.
The emigrant must file a Canadian income tax return under the rules applicable to residents within six months of the end of the taxation year for which he or she is making the election. This does not extend the normal filing and payment deadlines for returns claiming a section 217 election to June 30th. Rather, it requires them to file by June 30th or they lose the right to make the election. In other words, the emigrant has no right to make a late-filed election after June 30th of the following taxation year.
The emigrant can request CCRA to make a determination regarding whether, on the basis of his or her estimated Canadian and world tax liability, he or she will benefit from a section 217 election for the current or coming year. If CCRA determines that the emigrant will benefit, it will authorize the payers of their Canadian benefits to reduce or eliminate withholding to match their estimated liability under the election. Form NR5 is designated for this purpose.
Personal Amounts Allowed While a Resident
The emigrant is required to make a notional computation of the personal amounts generally available to non-residents and a separate computation of the amounts available generally to part-year residents for the period of residence then add the two amounts together. This is subject to the overriding limitation that the total for each specific personal amount may not exceed the amount that would have been available had the individual been resident throughout the year.
Period of Non-Residence
The following personal amounts are wholly available for the period of non-residence to the extent they are related to that period:
- Charitable donations;
All other personal amounts may be deducted if at least 90% of world income for the calendar year is included on the return, no matter how long the period of non-residence.
Period of Residence
In determining each personal tax credit for the period of residence, only the following personal credit amounts may be claimed to the extent they are considered applicable to the period of residence. As a practical matter, CCRA interprets this to mean they are pro rated for the period of residence. These amounts include:
- Basic personal amount;
All other applicable personal amounts may be claimed in whole, without being pro rated, if they are related to the period of residence. There is an overriding limitation that the total for each specific personal amount may not exceed the amount that would have been available had the individual been resident throughout the year.
Transfers from Spouse
The emigrant can claim a transfer from their spouse in calculating their personal amounts. The spouse's basic personal amount, age amount, and disability amount for the period of time that the emigrant’s spouse was resident in Canada during the year of departure must be pro rated.
Only medical expenses paid while the emigrant was resident in Canada are available as a deduction. Medical expenses paid in any twelve month period ending between January 1 and the date of non-residence may be claimed, except expenses already deducted in the previous year may not be claimed. The claim cannot include medical expenses paid after the date of non-residence, even if they were incurred prior to that date. The $1,614 and 3% of net income thresholds seem to apply to all net income from all sources for the period of residence only.
CCRA’s view is that charitable donations are subject to the rule that the contributions which may be claimed for the periods of residence and non-residence are each limited to 75% of the net income for that period. Note that under the Canada-U.S. Tax Treaty provisions the emigrant may be able to deduct donations made to U.S. charities while resident in Canada.
Issues related to the Canada-U.S. Income Tax Treaty
The Canada U.S. Tax Treaty or Convention provides a detailed definition of the term "resident of a Contracting State". The definition begins with a person's liability to pay tax as a resident under the respective taxation laws of the Contracting States. The Treaty definition is also designed to assign residence to one State or the other for purposes of the Convention in circumstances where each of the Contracting States believes a person to be its resident of that State. The Treaty definition is, of course, exclusively for purposes of the Convention.
The term “resident of a Contracting State” means any person who, under the laws of that State, is liable for tax therein by reason of his or her domicile, residence, place of management, place of incorporation, or any other criterion of a similar nature. The phrase “any other criterion of a similar nature” includes, for U.S. purposes, an election under the Code to be treated as a U.S. resident.
A “dual resident” individual is initially deemed to be a resident of the Contracting State in which he has a permanent home available to him. If the individual has a permanent home available to him in both States or in neither, he or she is deemed to be a resident of the Contracting State with which his or her personal and economic relations are closer. If the personal and economic relations of an individual are not closer to either Contracting State, the individual is deemed to be a resident of the Contracting State in which he or she has a habitual abode. If he or she has such an abode in both States or in neither State, then he or she is deemed to be a resident of the Contracting State of which he or she is a citizen. If the individual is a citizen of both States or of neither, the competent authorities are to settle the status of the individual by mutual agreement.
The amended Protocol states explicitly that a person will be considered a resident of a Contracting State for purposes of the Convention if he or she is liable to tax in that Contracting State by reason of citizenship. Although this applies to both Contracting States, only the United States taxes its non-resident citizens in the same manner as it taxes its residents. U.S. citizens and aliens admitted to the United States for permanent residence are taxed by the United States as residents, regardless of where they physically reside. However, U.S. citizens and green card holders who reside outside the United States may have relatively little personal or economic nexus with the United States. The Protocol adds a second provision to paragraph 1 that acknowledges this fact by limiting the circumstances under which such persons are to be treated, for purposes of the Convention, as U.S. residents.
RRSPs and Other Deferral Plans
A U.S. citizen who was a resident of Canada and a beneficiary of a Canadian RRSP could elect, under rules established by the competent authority of the United States, to defer U.S. taxation with respect to any income accrued in the plan but not distributed by the plan, until such time as a distribution was made from such plan.
The new paragraph makes reciprocal the rule that it replaced and expands its scope, so that it no longer applies only to residents and citizens of the United States who are beneficiaries of Canadian RRSPs. As amended, paragraph 7 applies to an individual who is a citizen or resident of a Contracting State and a beneficiary of a trust, company, organization, or other arrangement that is a resident of the other Contracting State and that is both generally exempt from income taxation in its State of residence and operated exclusively to provide pension, retirement, or employee benefits. Under this rule, the beneficiary may elect to defer taxation in his State of residence on income accrued in the plan until it is distributed or rolled over into another plan. The new rule also broadens the types of arrangements covered by this paragraph in a manner consistent with other pension-related provisions of the Protocol.
December 1999 Revised Taxpayer Migration Proposals
On December 17, 1999, the Federal government released certain revised proposals that apply to emigrants of Canada. These proposals revise certain provisions previously announced on December 23, 1998 and further modify certain provisions announced on September 10, 1999. This article does not deal with these recently released proposals but there appear to be no major conceptual modifications contained therein. Rather these proposals appear to clarify the existing proposals and in some cases provide additional relief.
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.
McCarney Greenwood, LLP
900 - 10 Bay Street
Attention: Mr. Roy Ohm. C.A. C.P.A. (Illinois)