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Does Canada have a Tax Treaty with the US?

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Does Canada have a Tax Treaty with the US? So, what do you do when both Canada and the United States claim you as a taxpayer?  Maybe you are a U.S. citizen who moved to Canada, but all of your income comes from the U.S.  Maybe you are a Canadian who stayed too long at your winter home in Arizona for a few more rounds of golf and have now surpassed 183 days in the U.S.  Perhaps you are a U.S. person who inherited a cottage in New Brunswick, but you do not see yourself going there anytime soon and want to sell it.

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Summary and Takeaways

Canada and the United States do honor a mutually agreed upon Tax Treaty. Generally its intention is to help dual citizens, or those who live in one country and earn income in other, to avoid or reduce double taxation. The way that is done is by applying foreign tax credits that effectively offset your taxable income – up to the amount of taxes you are liable for in your home country of primary residence.

Key Takeaways

  • One of the keys to understanding whether the Treaty applies to you is to identify your country of residence. That usually refers to the country where you spend the majority of your time.
  • But both countries have the first right of taxation on income derived from real property in their country, regardless of where the property owner lives.
  • The Treaty also outlines tie-breaker rules applied for people who exceed the number of days they may live in a country without being deemed a resident, even though they don’t regard that nation as their home country.
  • Under the Treaty you may also be eligible for less stringent reporting requirements and tax filings, and there are additional provisions of the Treaty applicable to estate and death taxes.

Tax Treaties U.S. citizens – and in most cases U.S. green card holders – are considered to be U.S. persons for U.S. income tax purposes.  As a U.S. person, you are required to annually file U.S. income tax returns and to pay U.S. tax on your worldwide income. This is irrespective of where you live, earn income, hold assets, or ultimately die. If you are a U.S. citizen who also lives and works in Canada, Canada wants you to pay tax on your worldwide income as well. This can present quite the conundrum.

Like most countries in the OECD (The Organization for Economic Co-operation and Development), Canada and the United States have an income tax treaty.  The primary purpose of The Canada-United States Tax Convention (1980) (the Treaty) is to help to resolve these types of conflicts.

To determine if the Treaty can help you, the first step to take is to understand how your situation is treated under domestic law.  By ‘domestic,’ we simply mean the law of the country you physically spend most of your time in.

Canada imposes income tax on its residents regardless of citizenship or legal immigration status in the country.

Alternatively, and as we indicated above, the United States imposes income tax on its residents, regardless of status. This then requires the filing of an annual income tax return and additional reporting and filing compliance requirements from U.S. persons regardless of their country of physical residence.

Both countries have the first right of taxation on income derived from real property in their country – through rental income or the sale of the real property – no matter where the beneficiary or owner of that income is resident.

Both countries also have the first right of taxation to income earned or sourced in the specific country. De minimis rules allow taxpayers to earn small amounts other than from real property that are only taxed in your country of residence.  We consider whether the income is effectively connected to a U.S. trade or business or if the cost is borne by a permanent establishment in the other country.  Under the Tax Treaty, a “permanent establishment” includes a fixed place of business (i.e., office) through which one would carry on business to generate income or activities.  For example, if you physically reside in Canada, but your income is earned in the U.S. and you are a U.S. person, then you report even de minimis earned income on both your Canadian and U.S. income tax returns.

So, what is a ‘resident’?  A ‘U.S. person’?  Income ‘derived from real property’?  “Effectively connected” taxable income’?  A ‘permanent establishment’?  These terms are all defined.  Understanding when they apply to you matters.  They are defined for each country’s purposes under that country’s domestic tax law.  In Canada, tax laws and definitions are in the Income Tax Act (the Act).  U.S. income tax legislation is found under Title 26 of the Internal Revenue Code (the Code).

Beyond the protection of certain provisions of the Treaty, as a means to avoid or reduce a taxpayer’s exposure to double taxation on income subject to tax in both countries, taxpayers are entitled to take a foreign tax credit.  This credit can be taken on foreign income up to the amount of domestic tax payable on the same reported income.  Not all of the taxpayer’s income can be offset by these foreign tax credits (FTCs).  However, the general scheme is for taxpayers to only pay tax, to both countries combined, like they would pay in their country of residence. It does not always work perfectly but the objective is to eliminate the taxpayer’s exposure to tax in both countries on the same income.

The Act in Canada and the Code in the United States are not identical.  They define residence, income sources, and many other items without regard to the other country’s tax laws.  Situations arise where both countries may claim first right of taxation on an item of income, or more commonly, that a taxpayer is resident in both countries under their domestic tax laws.

That is where the Treaty comes in.  The Canada-United States Tax Convention (1980) was entered into force on August 16, 1984 and has been updated with five protocols. The most recent update was the Fifth Protocol, which was entered into force on December 15, 2008.  If an additional form of income tax –for example, like the U.S. Net Investment Income Tax (U.S. NIIT) passed by the Obama Administration—is created after the Treaty’s last Protocol, then it is not covered and cannot be eliminated using FTCs.

The Treaty has thirty-one articles dealing with a variety of topics.  Article IV covers residence and provides tie-breaker tax residency rules for people who over-stay “their tax welcome” in the country they don’t consider “home.” Article XIII covers gains, including gains from real property (the cottage in New Brunswick, for example).  Article XXIV is titled Elimination of Double Taxation and is particularly helpful for the U.S. citizen living in Canada who is required to report worldwide income to both countries.

Let us walk through a simple example.
George and Ida are U.S. citizens who moved to Toronto for work when they were in their 40’s.  They liked it, ending up staying in Canada, and ultimately chose to retire to a winterized cottage in the Muskoka’s – Ontario’s Cabin Country.  George and Ida would be considered Canadian tax residents under Canadian domestic law.  They did not renounce their U.S. citizenship and do not intend to, which means that there are also considered U.S. residents for U.S. tax purposes.   Their income includes U.S. Social Security, Canada Pension Plan (CPP), and Old Age Security (OAS) benefits along with distributions from their U.S Individual Retirement Accounts (IRA) and Canadian Registered Retirement Income Funds (RRIF).  George and Ida also have various forms of investment income from a variety of taxable accounts in various countries.  As required, they file Canadian income tax returns annually reporting their worldwide income to Canada and then take a foreign tax credit for taxes withheld at source on their U.S. IRA and foreign investment income including the 15% withheld in the U.S. from U.S. sourced dividend income.  Their U.S. Social Security income is only 85% taxable under Article XVIII of the Treaty in Canada and No longer taxable on their U.S. return.

Being U.S. citizens, George and Ida also must file a U.S. tax return annually reporting their worldwide income.  Since their income is all retirement and investment income, it is all sourced to Canada, except their U.S. dividend income.  However, this source of income has to be recalculated and reported under principals in the U.S. Code.  On their U.S tax return, they can take a foreign tax credit for income taxes paid to Canada on most of their income and for taxes paid to other countries for their global investments.  These foreign tax credits can eliminate everything except tax on the U.S. dividends and the U.S. NIIT, which tax is referred to as ‘latter-in-time’ under the Treaty.  Further, there is also Article XXIV, which will apply in their case and provides for an additional foreign tax credit to bring the amount of tax paid to the United States on U.S. dividends down to 15%.  Fun math but doable if you know the rules and have the right software!

We hope your key take-away thus far is to recognize that there is a Tax Treaty is in place between Canada and the United States.  The Tax Treaty can be utilized to relieve some of the unique filing and reporting requirements for those of you who might have filing and reporting obligations on the same level of income to both countries.  Traditionally, this often relates to U.S. citizens resident in Canada and dual citizens.  But it also has implications for snowbirds or those individuals who might have worked in one country in the past and are now receiving pension or retirement income in their “home” country.

As this article is focused on the income tax issues under the Treaty, it is important to note that the Treaty also covers other issues that relate to the death and taxation of assets in either country of citizens/residents and the application of the income at death (Canada) or Estate Tax issues (U.S.). Maybe now you understand the answer to the question of Does Canada have a Tax Treaty with the US.

As those issues are very important and part of the overall comprehensive financial planning that we do for our clients, we will cover those issues in a future article.

Hedging Currency in your Portfolio

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Portfolio management requires many decisions. One decision that many investors don’t give much thought to is how much of their financial net worth should be in their “home” currency. For example, if you’re living a cross border lifestyle, or have assets in two or more countries, how should you manage the different currencies you have in your portfolio? At Cardinal Point, we think about this a lot. The portfolios we manage are internationally diversified, and many of our clients invest in, and spend money in, more than one country.

Summary and Takeaways

One component of portfolio management worthy of exploration is how much foreign currency exposure is helpful. That is also a key question to ask if you live a cross-border lifestyle where you often rely on access to more than one currency. Nevertheless, the goal of currency hedging is the same – to try to achieve financial stability and avoid volatility.

Key Takeaways

  • For Canadian investors, holding U.S. stock positions that are not hedged can benefit from a strong U.S. dollar.
  • But when the Canadian dollar is strong, a hedged position can be advantageous.
  • Timing the movement of any currency ahead of time is difficult, so a good strategy may be to partially hedge stocks, based on the objectives of the portfolio.
  • Keep in mind that compared to equity investments, a bond portfolio invested for fixed income will have significantly lower volatility.
  • In that case, additional exposure to underlying currency through hedging may actually increase unwanted volatility.
  • When thinking about currency exposure, consider your future needs for a particular currency – and the implications of doing a currency exchange in order to access the preferred currency.

When buying foreign stocks and bonds, you are really making two investment decisions. First, you are deciding to make the investment. Second, you are deciding to buy the currency. Or you can make the investment but “hedge” the currency. If you like the company but not the currency, then a professional manager would buy the company but hedge the currency risk. Hedging can be done in several ways though the concept is always the same. The end goal is to immunize the currency movement so that you are only exposed to the movement of the investment and not that of the currency as well.

All investment managers investing outside their “home” country are faced with currency hedging decisions. Cardinal Point is unique because we invest from two different countries and have clients that live and work in both. Not only do we have to make the currency hedging decision as it relates to the foreign content in portfolios, but we also have to consider how our client’s capital will be able to maximize returns and minimize risk when they may need retirement income in the other currency.

In order to explain how Cardinal Point approaches currency hedging from our unique vantage of serving investors in the U.S. and Canada, we will start with the basics that all portfolio managers should consider when investing in foreign stocks and bonds.

A Short History of Currency Hedging in Portfolios
When international investing first started, only very sophisticated investors like huge pension funds could hedge currency. The costs of hedging were too high and the types of products that allowed for it were underdeveloped. Currency hedging became more prevalent in the 1970s with the development of publicly available options and futures. In the early 1990s, some believed that you shouldn’t hedge your stocks because not doing so resulted in greater diversification.

One of the classic studies that was done in this area was Froot 19931. Kenneth Froot did research on portfolios and found that hedging the currency of a foreign stock portfolio did not decrease the variability as was previously believed. In fact, a stock portfolio that left the currency “un-hedged” had lower volatility.

This led to the concept that currency volatility actually reduces the volatility in foreign stocks. The concept goes something like this.

  • The return path of the currency moves independently from the return path of the stock.
  • So, if you pair the time series of the return of the stock with the time series of the return on the currency, you will get a time series with lower volatility than the return of the stock by itself.

This is similar to the concept that investing in two stocks will be less volatile than one because there are some days when the stocks will move in opposite directions. For stocks, the currency exposure can act as a further diversifier. The volatility of a portfolio of two or more foreign stocks can actually be reduced if the currency is left “un-hedged” in the portfolio.

This relationship can vary over time and can also change depending on which currency is the “home” currency. For Canadian investors, holding un-hedged U.S. stock positions can benefit from the USD strength that often accompanies broad market sell offs. But in times of CAD strength, the currency hedge can boost returns. It is tough to know in advance if the hedge will help or hurt, so we look to minimize the uncertainty by partially hedging stocks depending on the goals for the portfolio.

For bonds, the standard theory is different. The volatility in fixed income is much lower than equities. In fixed income, the addition of currency exposure may add greater volatility. The actual direction or return of the currency in any given year may far exceed the return of the underlying fixed income asset (bond or bond fund). Therefore, it is generally recommended that you hedge out your currency exposure of your fixed income. It has been the case over long periods of time that currency volatility can both help and hinder your portfolio returns. The rationale for currency hedging fixed income is because the currency volatility can swamp the income returns. Fixed income is supposed to reduce portfolio volatility, so we should not have currency exposure in bonds.

Cardinal Point’s Philosophy on Currency Hedging in Portfolios
Because we have investors in both Canada and the U.S., we had to rethink the conventional wisdom about hedging to your “home” currency. Many of our clients have spending needs in both countries. We believe it is important to think about the future portfolio cash outflows when developing a hedging strategy.

Literature on currency management is surprisingly thin on whether to hedge or not based on future cash outflows from portfolios. The idea of tying investment decisions to future cash outflows is known as an Asset Liability Management (ALM). There is a whole body of literature about managing with an ALM framework for pension plans. But very little of that relates to hedging currency with the specific intent that the income you earn matches the currency of future cash outflows. All literature on hedging or not hedging looks at risk vs. return of the decision and does not relate to the currency of future cash outflows.

We talk to clients about currency needs as part of their investment policy statement and portfolio construction process. Where appropriate, we encourage clients to keep their portfolio denominated in a manner that balances their future income needs. If currency exchange is needed, we have resources to help them convert their currency at more competitive exchange rates. We do not receive any financial compensation from recommending currency exchange providers, and we have negotiated competitive currency exchange rates with custodians on behalf of clients.

We deploy some currency hedging in most portfolios. Most of the bond exposure is hedged back to the currency of the portfolio, and some of the stock exposure is typically hedged. Currency management is one of the many ways we provide additional value to our clients. By taking a systematic approach to currency management, we believe our clients are more likely to have successful investment outcomes.

1 Froot, Kenneth A., 1993, Currency hedging over long horizons, NBER Working Paper No. 4355.

Terry Ritchie on Unraveling Cross-Border Financial Planning

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Terry Ritchie

Snap Projections, a financial planning software company, recently featured Cardinal Point’s Partner and Director of Cross Border Wealth Services, Terry Ritchie, on their Growing Your Financial Advisory Practice podcast. Given Terry’s more than 30 years of experience in cross-border financial, investment, tax, and estate planning, it’s no surprise that Snap Projections chose to tap into his insight for this primer directed at financial planners who want to serve US-Canada clients.

From the factors driving clients to move between Canada and the US (hint: politics, healthcare, family, and lifestyle all play a role) to the intricacies of visas, green cards, and US income tax, the podcast highlights Terry’s wealth of knowledge and passion for cross-border work.

Here’s everything discussed in the one-hour episode:

  • Why people move between Canada and the US.
  • Why Terry thinks cross-border work matters.
  • What you MUST know about visas and green cards.
  • Important elements of US income tax.
  • Limitations on Canadians who invest in the US.
  • Estate planning for cross-border clients.
  • The biggest cross-border planning mistake advisors make.
  • How to grow a financial planning career you really love.

Residents of Canada: Tax Ramifications of being forced to liquidate a U.S. retirement account

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As mentioned in a previous article, many banks and brokerage firms are informing U.S. non-resident clients that they are no longer able to service their accounts and that their accounts have been restricted or even closed.  In that same article, we outlined the following:

U.S. citizens and Green Card holders who reside in Canada or anywhere else abroad would be considered to be non-residents for the purposes of these regulations.
These regulations are not new, but were not generally monitored or enforced.
Financial institutions have started to enforce these regulations much more diligently.
The options available to an individual for their taxable brokerage accounts once they have received notification that they are required to find another service provider were addressed in the above mentioned article. Individuals with tax-deferred accounts, such as an IRA or 401K, are being told much the same thing.  The account holder will generally be told that if they are not able to transfer the account to another service provider within a set period of time, the assets within the account will be liquidated and a distribution will be sent.  If a distribution from an IRA/SEP IRA/Roth IRA is received, you have 60 days to deposit the funds into another retirement account with a U.S. custodian or the distribution will become fully taxable.  Distributions from an inherited IRA/Roth/SEP IRA do not have a 60 day window.

For many, it is difficult to find an alternate service provider that allows a non-resident to maintain a retirement account in the U.S. Even if a new service provider can be found, it is possible that the new provider will restrict activity within the account, effectively freezing the account.  Because of these complications, Canadian residents may feel compelled to liquidate their U.S. retirement accounts.

For the majority of U.S. retirement accounts, a liquidation would have U.S. and Canadian tax implications for both U.S. citizens residing in Canada and Canadian citizens living in Canada.  A couple of common scenarios include the following:

A U.S. citizen owning a U.S. retirement account moved to Canada and became a tax resident of Canada.
A Canadian citizen who lived in the U.S. for a period of time on a work permit, and who contributed to a U.S. retirement account while living in the U.S., moved back to Canada and once again became a Canadian tax resident.
We will discuss each scenario separately, since the tax implications of the liquidation of the retirement account will be different for each scenario.

U.S. Citizen Becomes a Tax Resident of Canada

As mentioned in our previous article, when you establish income tax residency in Canada, for Canadian income tax purposes, you are deemed to have disposed of all of your property immediately beforehand, with some exceptions, for proceeds equal to the fair market value of that property at that time. You are then deemed to have acquired such property at a cost equal to such fair market value.  U.S. retirement accounts are one of the exceptions to this rule. As such, the retirement assets would retain their historical cost basis for both U.S. and Canadian tax purposes.

As a U.S. tax resident, a distribution from most types of U.S. retirement accounts would be taxed as ordinary income subject to taxation at marginal tax rates.  Distributions from Roth IRAs are not  taxable.  The maximum marginal tax rate is currently 37% (2018).  Depending upon circumstances such as the age of the recipient, there could potentially be early withdrawal penalties as well.

Canada will also tax the entire distribution from most U.S. retirement accounts.  The entire distribution is taxable even though an individual in this scenario did not previously receive a deduction on a Canadian tax return related to the contributions.  Distributions from Roth IRAs are not taxable in Canada.  The marginal tax rate would depend upon the province of residency. For example, a resident of Ontario would currently have a maximum rate of 53.53% (2018).  A foreign tax credit can be claimed in Canada in relation to the U.S. tax payable on the distribution.  Early withdrawal penalties are not eligible for a foreign tax credit.

Individuals in this scenario are generally subject to an overall tax rate upon liquidation equal to the Canadian tax rate.  The tax payable to the U.S., which is subsequently claimed as a foreign tax credit in Canada, is usually not sufficient to completely eliminate the Canadian tax liability.

Canadian Citizen Resumes Canadian Tax Residency

The second scenario is of a Canadian citizen previously living in the U.S. who moves back to Canada and resumes Canadian tax residency.

In this scenario, the U.S. requires a 30% non-resident withholding tax.  Due to the tax treaty between the U.S. and Canada, that rate can be dropped to 15% for periodic payments, but there is some debate about whether or not that applies to a liquidation event, and recently, service providers have been less inclinded to agree to the lower rate.  Because of this, we advise our clients to expect a 30% withholding rate from most providers.  In order to recuperate the other 15%, the filing of a U.S. non-resident income tax return would be required.  Note that recuperating the other 15% would not be required if the entire 30% withholding tax is claimed as a foreign tax credit on the Canadian tax return.  In the case of an early withdrawal, the penalty normally imposed would be included in the 15% or 30% tax, which is considered a final tax for U.S. tax purposes.

Canada will also tax the entire distribution from taxable U.S. retirement accounts in the same manner as was discussed in the earlier scenario.  A foreign tax credit can be claimed in Canada in relation to the U.S. withholding tax.

Individuals in this scenario are also generally subject to an overall tax rate upon liquidation equal to the Canadian tax rate.  The U.S. foreign tax credit is generally not sufficient to completely eliminate the Canadian tax liability.

A relatively common tax planning technique for individuals in this scenario is to roll funds from their IRA into a RRSP in an effort to defer taxation of the IRA income.  This strategy is now less attractive due to the application of the higher 30% U.S. non-resident withholding tax.  We would also point out that this strategy is generally recommended by service providers that do not have the ability to actively manage U.S. retirement accounts.  A more effective solution would be to find a service provider, such as Cardinal Point, that can actively manage the IRA and eliminate the need for a liquidation altogether.

The Cardinal Point Advantage

These examples highlight the complicated and negative tax implications involved with an unexpected liquidation of U.S. retirement accounts.  The main negative tax implication being that the full value of most retirement accounts becomes taxable upon liquidation.  We recommend that you avoid these unnecessary tax consequences by finding a custodian who is able to manage U.S. retirement accounts for non-residents of the U.S.  Cardinal Point has the unique registrations and ability to manage investment portfolios that include accounts in Canada and the United States.  As such, we have the ability to actively manage U.S. retirement accounts for our Canadian resident clients.

Cardinal Point has the cross-border financial planning, investment management, and tax expertise to ensure that our clients are able to maintain retirement assets in their country of origin, and to transition other assets from one country to another in a tax-efficient manner. Our clients receive tax planning as a part of their overall financial plan.

Residents of Canada: What are the Canadian and U.S. Tax Ramifications when being forced to liquidate a U.S. brokerage account.

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As noted by several articles that have been published, many banks and brokerage firms, including Wells Fargo, Morgan Stanley, Fidelity, and others, are informing U.S. non-resident clients that they are no longer able to service their accounts and that their accounts have been restricted or even closed. In this case, the term “non-resident” is not based on the U.S. income or estate tax definitions, but loosely refers to the location of the principal or primary residence. This means that U.S. citizens and Green Card holders who reside in Canada or anywhere else abroad would be considered to be non-residents for the purposes of these regulations. These regulations are not new, but were not generally monitored or enforced. However, with the passage of the Foreign Accounts Tax Compliance Act (FACTA) in 2010 and the accompanying reporting requirements of that law, financial institutions also began enforcing those older regulations. More information about FACTA and why these restrictions are being enforced can be found in our article.

The options available to an individual once they have received notification that they are required to find another service provider depend upon whether the account is a tax-deferred account (such as an IRA or 401K), or a taxable brokerage account. Options for tax deferred accounts will be addressed in a separate article and we will focus only on taxable brokerage account here. For those accounts, the account holder will generally be told that if they are not able to transfer assets to another service provider within a set period of time, the assets will be sold. Once the assets are sold, the account holder would receive a check for the proceeds of the sale. In many cases, it not possible to find an alternate service provider that allows a non-resident to maintain a brokerage account in the U.S. Even if a new service provider can be found, it is likely that not all of the assets in a U.S. brokerage account can be transferred to a Canadian or other foreign brokerage account. For example, U.S. mutual funds cannot be held in a Canadian brokerage account. Because of these complications, many individuals are forced to liquidate either their entire U.S. brokerage account, or a sizeable portion.

Liquidating any part of a taxable brokerage account usually brings with it tax implications. For Canadian tax residents who are not also U.S. tax residents, this liquidation would only have Canadian tax implications, but for U.S. citizens who are also Canadian tax residents, a liquidation would have tax implications in both the U.S. and Canada. Some common scenarios include the following:

  • A U.S. citizen owning a U.S. brokerage account could move to Canada and become a tax resident of Canada.
  • A Canadian citizen who lived in the U.S. for a period of time on a work permit, and who now owns a U.S. brokerage account as a result, could move back to Canada and once again become a Canadian tax resident.
  • A U.S. citizen has been a long-term resident of Canada and has been a Canadian tax resident the entire period of ownership of U.S. brokerage accounts.

We will discuss each of these three scenarios separately, since the Canadian and U.S. tax implications of the sale of the assets contained within the brokerage account will be different for each scenario.

U.S. Citizen Becomes a Tax Resident of Canada

When you establish income tax residency in Canada, for Canadian income tax purposes, you are deemed to have disposed of all of your property immediately beforehand, with some exceptions, for proceeds equal to the fair market value of that property at that time. You are then deemed to have acquired such property at a cost equal to such fair market value. In effect, at the date of establishing Canadian residency, you would be entitled to a “step-up” in the Canadian tax cost of all property (with some exceptions) owned by you for the purposes of determining the capital gain or tax loss implications upon a future sale, the settling of a trust, or at death. To summarize, the assets contained within the U.S. brokerage account would have a Canadian cost basis equal to their fair market value on the date that you became a Canadian tax resident. For U.S. tax purposes, the assets would retain their historical cost basis. As such, the cost basis of the assets owned on immigration to Canada would be different for Canadian and U.S. income tax purposes.

Canada taxes 50% of the realized gain as income, and the marginal tax rate would depend upon the province of residency. For example, a resident of Ontario would currently have a maximum rate of 53.53%. Since Canada taxes only 50% of the gain, that is the same as a 26.76% tax on the entire gain, and we will use this method when calculating taxes below. As mentioned above, only the growth since the move to Canada would be taxed.

The U.S. capital gains rate depends on how long the investment has been held and how much income has been earned. For investments held one year or less, capital gains are taxed as ordinary income. For investments held greater than one year, rates range from 0% to 20%. A 3.8% Medicare surtax is levied on investment income when AGI exceeds certain thresholds, so the maximum U.S. rate on long-term capital gains is 23.8%. The U.S. does allow for a foreign tax credit for the Canadian tax payable on the capital gains, however, the 3.8% Medicare Surtax is calculated after foreign tax credits, so will not be eliminated.

For example, assume that an Ontario resident has income from various sources that would put her in the top tax brackets in both countries. Let’s also assume that the U.S. brokerage account contained long-term securities with a historical cost basis of $500,000. The securities were worth $750,000 upon immigration to Canada, and were worth $1,000,000 when she was required to liquidate the account. Let’s also assume that the U.S. dollar was at par when the assets were originally purchased, was worth 1.15 Canadian dollars on immigration, and that the exchange rate at liquidation was 1.3.  In this situation, the Canadian tax on the disposition would be (($1,000,000 * 1.3) less ($750,000*1.15)) multiplied by 26.76%. This comes to a Canadian income tax liability of CAD $117,075. Converted to U.S. dollars (at 1.3), this would equate to USD $90,058.

The U.S. income tax on the transaction would simply be 23.8% of the difference between $1,000,000 and $500,000, which comes to USD $119,000.  The foreign tax credit from the Canadian taxes would eliminate USD $90,058, leaving a final U.S. tax liability of USD $28,942.

In this scenario, because of the bump-up in cost basis that limits the amount of Canadian tax paid, the overall tax rate upon liquidation is essentially equal to the U.S. tax rate. This scenario only covers assets that were owned upon immigration. Any assets purchased after immigration would be treated differently and will be dealt with in the third scenario.

Canadian Citizen Resumes Canadian Tax Residency

The second scenario is of a Canadian citizen previously living in the U.S. who moves back to Canada and resumes Canadian tax residency. In this case there would also be a deemed acquisition in the same manner as discussed above. Assets contained within the U.S. brokerage account would have a Canadian cost basis equal to their fair market value on the date the account owner became a Canadian tax resident.

This article will not go into details of the rules for U.S. income tax residency, but for the purposes of this discussion, we will assume that U.S. tax residency will terminate on the same date that Canadian income tax residency began. This should be possible through the application of either the Closer Connection exemption, or through the application of the income tax treaty that is in place between Canada and the U.S. Since the U.S. does not tax non-citizen non-residents of the U.S. on the sale of stocks, mutual funds, and EFTs found in taxable brokerage accounts, the liquidation of the U.S. brokerage account will not be taxable in the U.S.

Using the same assumption from the first scenario, the Canadian income tax liability associated with the disposition would be CAD $117,075.  Converted to U.S. dollars (at 1.3), this would equate to USD $90,058.

Since the individual is no longer a tax resident of the U.S., the disposition will not be taxable in the U.S. As such, in this scenario, the individual will avoid paying the additional USD $28,942 associated with the U.S. taxation of the account.

This highlights a planning consideration for Canadians who are not U.S. citizens or Green Card holders who plan on repatriating back to Canada from the U.S. If they have assets in taxable brokerage accounts with unrealized gains, they should generally wait to liquidate these assets until after they have become U.S. non-residents. By doing so, they will pay little to no Canadian tax due to the bump-up in Canadian cost basis that they will receive, and the disposition will no longer be taxable in the U.S.

By extension, some Green Card holders may consider whether the benefits of expatriating and subsequently selling their assets as a non-resident of the U.S. outweigh the costs of losing Green Card status. A full discussion of the tax implications of expatriation is outside the scope of this memo, and undertaking any actions that could result in expatriation should not be pursued without discussing your unique facts and circumstances with tax and immigration professionals. However, for certain individuals, this represents an opportunity for significant tax savings.

U.S. Citizen as a Long-Term Tax Resident of Canada

In this case, since the U.S. brokerage account was opened while the individual was a tax resident of both countries, the bump-up in Canadian cost basis would not be applicable. The Canadian and U.S. cost basis would be the same, or similar. For the purposes of this discussion, we will ignore the differences in the calculation of cost basis when multiple units of the same stock are purchased over time (FIFO versus average cost etc.) Under these assumptions, the only significant difference in the two cost bases would be that the Canadian basis would be adjusted for the foreign exchange rate on the date of purchase.

For this scenario, let’s also assume that the historical cost basis of the assets within the U.S. brokerage account was $500,000 and that the assets were worth $1,000,000 when account liquidation was required. Let’s also assume that the U.S. dollar was at par when the assets were purchased and that the exchange rate upon liquidation was 1.3.  In this situation, the Canadian tax on the disposition would be (($1,000,000 * 1.3) less $500,000 multiplied by 26.76%. This comes to a Canadian income tax liability of CAD $214,080. Converted to U.S. dollars (at 1.3), this would equate to USD $164,677.

The U.S. income tax on the transaction would remain 23.8% of the difference between $1,000,000 and $500,000, which comes to USD $119,000.  The foreign tax credit from Canadian taxes would completely eliminate the regular U.S. income tax, but as mentioned above would not eliminate the 3.8% surtax.  As such, a USD $19,000 tax liability would remain. The excess Canadian tax that was payable would be carried forward as a foreign tax credit carry-forward and can be used to reduce future U.S tax liability. In contrast to the first scenario, where the cost basis bump up reduced the overall tax rate, in this case, the higher Canadian tax rates dominate and the overall rate would be even higher because of the 3.8% surtax.

This example highlights the difference in income tax rates between the two countries, but also highlights the significant impact that foreign exchange rates can have on the amount of tax that is payable. By being forced to liquidate the account when the U.S. rate was at 1.3, the Canadian capital gain that was realized was much larger than the gain that was realized in the U.S.

The Cardinal Point Advantage

These examples highlight how even a relatively simple concept such as the liquidation of an account can be more complicated than it initially appears.  It is important to look at the situation from a tax perspective to ensure that the potential capital gain is properly calculated, and to determine whether any planning can be implemented to reduce the combined U.S./Canada tax liability. The last example also shows how variations in foreign exchange rates can significantly impact future tax liabilities.

Cardinal Point has the cross-border financial planning, investment management, and tax expertise to ensure that our clients are able to transition assets from one country to another in a tax-efficient manner. Our clients receive tax planning as a part of their overall financial plan. We also have the ability to maintain U.S. denominated brokerage accounts in Canada. For example, U.S. citizens who ultimately plan on retiring in the U.S., and who want to eliminate the risk of future fluctuations in exchange rates, are able to own Canadian mutual funds and ETFs in a U.S. denominated account.