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Working abroad but living in Canada? Have Foreign Investments? – This is for you
A client once came to us with the idea of forming a company in some faraway land to save on taxes. They assumed that by registering a company offshore, they could reduce or even eliminate their Canadian tax liabilities even though all their operations would continue to take place in Canada. Unfortunately, we had to explain why this strategy would not work as intended.
The story doesn’t stop there. We have also seen many cases of Canadian-resident doctors working in the States or the Emirates, only to face questions from the Canada Revenue Agency (CRA) regarding their residency status and Canadian tax obligations. This also applies to Canadians who make investments in foreign countries. The CRA’s assessments of residency for individuals and corporations follow complex rules, requiring careful consideration of each person’s or company’s connection to Canada.
Canada’s tax system is rooted in both corporate and personal residency, and Canadian residents, whether individuals or corporations, are taxed on their worldwide income. The case brought to light the importance of understanding how Canada defines residency for tax purposes and why creating a foreign company or moving away doesn’t necessarily exempt one from Canadian taxes.
Let’s explore Canada’s personal and corporate residency rules, how the CRA determines residency, and why tax treaties play a crucial role in these cases.
Canadian Personal Tax Residency: Four Categories of Residency Status
Determining individual residency is equally nuanced, as it affects where a person is taxed and on what income. Canada’s tax residency rules, outlined in Subsection 250(1-3) and Interpretation Bulletin IT-221R3, classify individuals into four main categories:
Ordinarily Residents
Individuals with significant residential ties to Canada, such as a home, family, or social connections, are considered ordinarily residents. Ordinarily residents are taxed on worldwide income, even if they spend much of their time abroad.
Deemed Residents
Individuals who spend 183 days or more in Canada within a calendar year are “deemed residents” for tax purposes under ITA Subsection 250(1), even if they lack significant residential ties. Deemed residents are also taxed on global income.
Part-Year Residents
This situation occurs in one of two situations: If a Person immigrates to Canada part-way through the year or if a person emigrates out of Canada part-way through the year. In these situations, the individual is considered a resident only for the portion of the year that they were actually in Canada (regardless of how long; the 183-day sojourner rule does not apply)
The Impact is that the individual must pay tax in Canada on worldwide income earned during the portion of the year they were resident in Canada and will be treated as a "non-resident" for the rest of the year
4. Non-Residents
Non-residents are taxed only on Canadian-sourced income, including income from Canadian employment, property rentals, or businesses, and typically don’t pay Canadian tax on foreign income.
Primary and Secondary Ties for Determining Personal Residency
The CRA assesses both primary and secondary residential ties to determine an individual’s residency status. For one to be a non-resident they must have no primary ties and minimal secondary ties:
Primary Ties: Maintaining a permanent home in Canada, having a spouse or common-law partner, and dependent children in Canada are considered primary indicators of Canadian residency.
Secondary Ties: Additional factors like owning personal property, maintaining Canadian bank accounts, holding memberships in Canadian clubs or professional organizations, and having Canadian health insurance coverage contribute to an individual’s connection to Canada.
Canadian Corporate Tax Residency: Three Main Types
In Canada, a corporation’s residency status is primarily determined by where it is managed and controlled or, in some cases, by where it was incorporated. Here are the three main residency types:
Deemed Residency (Incorporation)
Under the Income Tax Act (ITA) Subsection 250(4), a corporation incorporated in Canada after April 26, 1965, is deemed resident in Canada for tax purposes. This means it is taxed on its worldwide income, not just Canadian-sourced income, regardless of its management location.
Common Law Residency (Central Management and Control)
If a corporation is incorporated abroad but has its central management and control in Canada, it may be considered a Canadian resident under common law principles. The CRA determines this based on where key decisions are made, often where the board of directors operates and conducts meetings. This principle is supported by case law and is a pivotal factor in establishing corporate residency.
Non-Residence
In cases where a corporation does not fall under the previous two categories, this corporation will be considered a non-resident. As a result the corporation will only pay tax on income from carrying on business in Canada and the Sale of “Taxable Canadian Property”.
Most tax treaties restrict the taxation of a non-resident corporation's business income in Canada to situations where the income is generated through a "permanent establishment" within the country.
How Tax Treaties Help
Tax treaties are essential tools that help avoid double taxation for individuals and corporations that qualify as residents in multiple jurisdictions. Canada has established tax treaties with numerous countries, and these treaties include tie-breaker rules that prioritize residency based on factors like the individual’s permanent home location, and primary business activities.
In cases like those of Canadian-resident doctors working in Florida, tax treaties are vital to claim foreign taxes paid to avoid double taxation. It is also important to note which countries do and do not have tax treaties with Canada, as this may mean double taxation for some who do not prove a “Clean Break” from Canada
Departure from Canada
In a future blog, we will explore the concept of deemed dispositions, which occurs in various situations, one of which includes leaving Canada. When an individual decides to leave Canada, they must establish a “clean break” by severing primary residential ties, such as home ownership, financial assets, and family ties, to be recognized as a non-resident for tax purposes. This separation is essential, as the Canada Revenue Agency (CRA) will otherwise continue to view the individual as a resident and tax them on their worldwide income.
When a person becomes a non-resident, Canada treats most of their assets as if they were sold at fair market value, resulting in immediate taxation on any accrued capital gains. However, there are exceptions: assets like Canadian real estate or interests in Canadian businesses are not deemed disposed of, so no immediate capital gains tax applies to these. For those keeping property in Canada, further requirements exist. Rental properties, for instance, must be transferred to a non-resident tax account, and any income generated will be subject to a 25% withholding tax, remitted by the Canadian payer to the CRA. Non-residents can also opt to file a Canadian tax return to apply for deductions and potentially lower the withholding tax. These steps are crucial to ensure compliance and avoid penalties, making it essential to address all tax obligations properly before departing Canada.
FAQs:
What determines corporate residency for tax purposes in Canada?
Corporate residency is determined through three main types:
Deemed Residency: A corporation incorporated in Canada after April 26, 1965, is deemed resident for tax purposes under ITA Subsection 250(4).
Common Law Residency: A corporation managed and controlled in Canada may be deemed a resident, even if incorporated abroad.
Deemed Non-Residency (Tax Treaties): Tax treaties include tie-breaker rules to resolve dual residency issues, often favouring the place of effective management.
What are the categories of personal tax residency in Canada?
Personal residency falls into four categories:
Ordinarily Residents: Those with significant residential ties to Canada.
Deemed Residents: Those present in Canada for 183 days or more in a calendar year.
Part-Year Residents: Individuals immigrating to or emigrating from Canada during the year are taxed on worldwide income earned while resident.
Non-Residents: Taxed only on Canadian-sourced income.
How does the CRA assess personal residency status?
The CRA examines:
Primary Ties: Permanent home, spouse/common-law partner, and dependent children in Canada.
Secondary Ties: Bank accounts, personal property, memberships in Canadian organizations, and health insurance coverage.
What role do tax treaties play in residency determination?
Tax treaties prevent double taxation by defining residency using tie-breaker rules based on factors like permanent home location, habitual abode, and the primary site of business activities.
What is a "deemed disposition" and when does it apply?
A deemed disposition occurs when an individual becomes a non-resident, treating most assets as sold at fair market value for tax purposes. Exceptions include Canadian real estate and business interests.
What tax obligations remain for non-residents with Canadian property?
Non-residents must transfer rental properties to a non-resident tax account and remit a 25% withholding tax on rental income. Filing a Canadian tax return can help apply for deductions to reduce this withholding tax.
Why doesn’t forming a company in a low-tax Country eliminate Canadian tax liabilities?
Canadian residents (individuals and corporations) are taxed on worldwide income. Establishing an offshore company does not exempt a Canadian resident from this obligation.
What steps are needed to establish a “clean break” from Canada for tax purposes?
To establish non-residency, sever primary residential ties by:
Disposing of a Canadian primary residence.
Closing Canadian financial accounts.
Relocating family members.
Failure to do so may result in continued worldwide taxation by the CRA.
Relevant ITA & Case Citations (Cross References Included)
ITA Subsection 250(4): Defines corporate deemed residency based on incorporation in Canada.
ITA Subsection 250(1): Establishes deemed residency for individuals spending 183 days or more in Canada.
Interpretation Bulletin IT-221R3: Guides on determining individual tax residency.
4. Income Tax Folio: S5-F1-C1: Determining an Individual’s Residence Status
Case Law on Common Law Residency:
De Beers Consolidated Mines Ltd. v. Howe (1906): Foundation for the "central management and control" test.
Fundy Settlement v. Canada (2012): Reinforces principles of residency based on decision-making authority.
Thomson v. M.N.R. (1946): This landmark case established that an individual's residency is determined by their "settled routine of life," emphasizing the importance of personal ties and habitual residence in Canada.
Tax Treaty Articles: Tie-breaker rules under OECD Model Tax Convention.
CRA Guidelines on Residential Ties: Detailed in CRA publications for evaluating primary and secondary ties.
Useful Forms for Emigrants
• Form NR73, “Determination of Residency Status (Leaving Canada)
• Form T1161, List of Properties by an Emigrant of Canada.
• T2061A Election by an Emigrant to Report Deemed Dispositions of Property and any Resulting Capital Gain or Loss
o To Recognize the Deemed disposition
• Form T1243, Deemed Disposition of Property by an Emigrant of Canada.
• Form T1244
o Election, under Subsection 220(4.5) of the Income Tax Act, to Defer the Payment of Tax on Income Relating to the Deemed Disposition of Property.
o Adequate security to cover the amount of the tax that is being deferred is needed
· NR4 - Statement of Amounts Paid or Credited to Non-Residents of Canada
· NR6 Undertaking to File an Income Tax Return by a Non-Resident Receiving Rent from Real or Immovable Property or Receiving a Timber Royalty
o Will Allow for Withholding tax based off of Net income rather than gross
· T1159 Income Tax Return for Electing Under Section 216
Contact us
Residency and taxation is stressful, so leave it to the team at Elkhanagry Accounting. Our experts specialize in navigating the complexities of Canadian tax residency and cross-border tax issues, ensuring that you are fully compliant while minimizing your tax burden.
Whether you’re considering offshore holdings, spending extended time abroad, leaving Canada or working in multiple jurisdictions, we’ll guide you through the regulatory landscape, leveraging our deep understanding of the Income Tax Act, tax treaties, and CRA guidelines. Contact us today to secure reliable, strategic tax advice tailored to your unique needs and circumstances. Let us handle the intricacies so you can focus on your financial goals with confidence.
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