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Moving to Canada? Know the Tax Residency Rules

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If you are contemplating a move to Canada, note that you should consider tax implications well ahead of your actual move date. Your tax liability in Canada is dependent on your tax residency status:

  • Canadian resident taxpayers are taxed on their worldwide income
  • Canadian non-resident taxpayers are taxed on their Canadian source income

This presents opportunities to structure your financial affairs before being subject to the full Canadian tax system.

Move to Canada

Summary and Takeaways

As part of your preparation for a move to Canada, it’s prudent to factor in the tax residency rules, to understand your potential tax liability. Resident taxpayers are subject to taxes on their worldwide income, while non-resident taxpayers are only taxed on income sourced within Canada. But there is no strict legal definition of what the term “resident” means under the Income Tax Act of Canada. That complicates tax planning, but there are four different main things to consider, explained in this article, that can help you determine your tax residency status. Then you may be able to structure your finances in a way that minimizes tax liability.

Key Takeaways

  • Statutory provisions in the Income Tax Act of Canada and principles established by Canada’s courts may determine tax residency.
  • So can administrative decisions handed down by the Canada Revenue Agency
  • But there are more than 90 international income tax treaties in place that can override a deemed or factual residency.
  • Interpreting the rather subjective residency definitions and the complex rules can be challenge, so give yourself as much time as possible to make tax plans.
  • Is it recommended that you take advantage of the services of an expert cross-border tax planner.

How Canadian Tax Residency is Determined

The term “resident” is not defined in the Income Tax Act of Canada. Instead, Canadian tax residence is a question of fact and somewhat subjective. It depends largely on the nature and quality of the ties you establish in Canada compared to those retained in your previous jurisdiction. In determining whether you are a Canadian tax resident or not, there are four different sources to consider:

  • Statutory provisions as stated in the Income Tax Act of Canada
  • Common law principles established by the Canadian courts
  • The Canada Revenue Agency’s (CRA’s) administrative pronouncements
  • The use of an income tax treaty to override Canadian factual or deemed residency

Each of these is discussed in detail below in addition to Canadian provincial/territorial tax residency and the deemed acquisition of property when you become a Canadian tax resident.

Statutory Provisions (Income Tax Act of Canada)

Generally, you are considered a factual tax resident of Canada if you are living in Canada, and the nature and quality of the ties you establish in Canada are greater than those retained in your previous jurisdiction. Factual tax residents of Canada are taxed on their worldwide income starting with the date they become factual tax residents of Canada.

You can also be deemed to be a tax resident of Canada if you sojourn in Canada for a period of, or periods the total of which are, 183 days or more in a calendar year. This rule is outlined in the Income Tax Act of Canada. A sojourn implies a temporary stay in Canada, and you cannot already be a factual tax resident of Canada – you must be a tax resident of another country. You are said to sojourn in Canada if you are physically present in Canada for any part of a day.

Deemed tax residents of Canada are taxed in Canada on their worldwide income (the same as factual tax residents of Canada) as of January 1, even if their first day in Canada is any other day of the year. In comparison, factual tax residents of Canada are taxed on their worldwide income as of their first day of factual residency (eg. June 1, not January 1). If you are deemed to be a tax resident of Canada, but also reside in a country that has a tax treaty with Canada, it is likely that the tax treaty will remove you from the provisions of being a deemed tax resident of Canada.

Most individuals do not move and become Canadian tax residents on January 1. If your unique facts determine that you have become a factual Canadian tax resident during the year, you will be considered a “part-year” resident of Canada. For the part of the year in which you are a tax resident of Canada, you are taxed on your worldwide income in Canada. For the part of the year in which you are a non-resident of Canada, you are only taxed on your Canadian source income. Tax credits will need to be prorated based on period of tax residency in Canada.

Below is a helpful summary of the various Canadian tax residency classifications, and what each is taxed on:

Deemed Resident Part-Year Resident Non-Resident Deemed Non-Resident
Worldwide income earned from January 1 Worldwide income earned only during the period of Canadian tax residency Canadian sourced income only Canadian sourced income only

Common Law (Canadian Courts)

In the leading case of Thomson v. MNR, [1946] CTC 51 (SCC), the Supreme Court of Canada considered the circumstances of a Canadian who sought to become a non-resident of Canada and established key principles regarding the meaning of “ordinarily resident in Canada,” setting the standard still referred to by courts today. The general principles established by this case are as follows:

  • For income tax purposes, an individual must reside somewhere
  • An individual does not need to have a principal residence in a country to be considered resident of that country
  • Residency is more than the simple fact of being present in one country
  • Residency does not require a constant presence in that country
  • An individual can be resident in more than one country at the same time
  • The intention of the individual is relevant, but not determinative
  • The number of days spent in a country is not a determinant factor in itself, but can become one

As tax residency in Canada is largely a question of facts, here are the criteria established by the courts and largely used to assess the facts:

  • Primary criteria:
    • Maintenance of a home in Canada which is available for occupation
    • The location of the individual’s spouse and children
    • The intention of the individual in regard to return to Canada
    • The frequency and duration of visits to Canada
  • Secondary criteria:
    • Citizenship
    • The location of other family members
    • The relative strength of social and economic ties, if any, to Canada vs. those established in another country
    • History of fiscal compliance (or non-compliance) with the other country (e.g., have you routinely filed resident tax returns in the other country you claim is your tax home?)

CRA’s Administrative Pronouncements

The CRA issued Income Tax Interpretation Bulletin IT-221R3, which does not have the force of law, but outlines their interpretation of the factors considered in determining Canadian tax residency. The CRA’s interpretation places an emphasis on residential ties in Canada as an indicator of residency:

  • Primary residential ties
    • The location of the individual’s dwelling place (or places)
    • Where the individual’s spouse or common-law partner resides
    • Where the individual’s dependants reside
  • Secondary residential ties
    • Personal property
    • Social and economic ties
    • Landed immigrant status or appropriate work permits
    • Medical insurance coverage from a province or territory of Canada
    • Driver’s license
    • Vehicle registered in a province or territory
    • Seasonal dwelling place in Canada or a leased dwelling place
    • Canadian passport
    • Memberships in Canadian unions or professional organizations

Income Tax Treaty

At the time of this writing, Canada has a tax treaty in force with 94 countries.  If you are arriving from one of these countries to Canada, it is likely that the residency article of the respective tax treaty will help determine your Canadian tax residence status. As an example, the Canada-U.S. Tax Treaty Article IV states:

  • Paragraph 1 – A “resident of a Contracting State” is defined to mean a person who, under the laws of that state, is liable to tax by virtue of their domicile, residence, citizenship, or other criterion. This basically outlines that tax residency is first determined under each country’s tax rules.
  • Paragraph 2 – By virtue of paragraph 1, an individual may be a resident of two contracting states at the same time – a “dual resident.” When this occurs, the Canada-U.S. Tax Treaty provides tie-breaker rules for determining the country in which you are a tax resident. The tax residency tie-breaker rules look at the following, in order:
    • The country in which you have a permanent home available to you
    • The country where your centre of vital interests is strongest. Your centre of vital interests is defined as your personal and economic ties, such as the location of your family and social relations; your occupations; your political, cultural, or other activities; your place of business; the place from which you administer your property; etc.
    • The country in which you spend the greatest amount of time (habitual abode)
    • The country of your citizenship (note that a U.S. Green Card holder is not a U.S. citizen)
    • Competent authorities of both countries will settle the question of your tax residency by mutual agreement

Canadian Provincial/Territorial Residency

In general, you are subject to a province’s/territory’s tax rates for the entire tax year if you are a resident of that province on December 31 of that year. Your provincial/territorial tax residency is determined in the same manner as your Canadian tax residency. If you reside in more than one province/territory on December 31, you are considered resident in the province/territory where you have the most significant residential ties.

Deemed Acquisition of Property

When you commence or recommence Canadian tax residency, you are deemed to dispose of and immediately reacquire, at fair market value, most properties (except for certain specified property, such as Canadian real estate and stock options) owned immediately before becoming a tax resident of Canada. If the properties are then subsequently disposed of during the period of Canadian residency, only the gain or loss accrued since the commencement of Canadian tax residency is taxable in Canada.

Conclusion

As you likely gathered from this article, Canadian tax residency is not exactly black-and-white. It is best to review your unique situation with a qualified cross-border tax advisor and financial planner well ahead of your actual move date. There may be opportunities to structure your financial affairs before being subject to the full Canadian tax system and the deemed acquisition of property. For more information, please contact Cardinal Point.

American Taxpayers Immigrating to Canada: Maximizing the Roth Conversion Strategy

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Starting a new chapter in your life by relocating north of the border can be exciting. However, there are many financial and tax implications to take into consideration before you embark on this path. Whether you are an American citizen, a Green Card holder, or otherwise a U.S. resident taxpayer, you may have built up a significant amount of tax deferred investments via IRAs, 401ks, and other types of employer sponsored plans. Once a Canadian tax resident, distributions from most of the plans will be taxable in Canada. In general, the tax rates in Canada for individuals are higher than those in the U.S., and the highest marginal tax brackets are reached at lower levels of income. As such, it is possible that future withdrawals from these U.S. investment vehicles will result in a significantly higher income tax liability than would have been paid had you remained in the U.S. With proper counsel, there is an opportunity to mitigate this situation with some proactive planning.

With the advent of the Tax Increase Prevention and Reconciliation Act, the shackles of income restrictions on Roth conversions were removed. This presents a tax planning opportunity for many Americans, especially those who are considering a move to Canada.

A Roth conversion allows investments held in Traditional/Rollover IRAs, SEPs, and Simple IRAs to convert to a tax-free Roth IRA. The fair market value of the converted amount would be included as ordinary income for the year in which the conversion takes place. Although markets cannot be timed, in theory, the optimal window to convert is when the values of the stocks within the accounts are down, as less tax would be paid on the conversion. The rationale on this strategy includes: diversification of account types to manage future tax liabilities, paying tax at marginal tax rates today in order to avoid paying tax at potentially higher rates in the future, and blessing loved ones with tax free assets as part of your estate plan.

For the American taxpayer planning to relocate to Canada, this presents a golden opportunity. As part of the 5th protocol to the Convention between Canada and the United States (“the Treaty”), Roth IRAs are considered pensions and as such, both the U.S. and Canadian governments recognize the tax-free status of Roth IRAs. This means that if one were to convert a traditional IRA to a Roth IRA prior to moving to Canada, one would completely avoid further taxation on the account basis and any subsequent growth. For many individuals, this minimizes the combined tax liability for the two countries and maximizes what you are able to pass on to your heirs.

To get more granular, let’s view this strategy within a specific context. Let’s say you were approached by your employer regarding an opportunity to transfer from Houston to Calgary. You ponder the move since you always wanted to experience life with the Rockies at your doorstep. You have a 401k in the U.S. that is eligible for rollover to a traditional IRA, with $300,000 currently invested. Since your employer’s offer dictates a move during the spring of the following year, you essentially have two tax years to exploit the Roth conversion opportunity by converting $150,000 prior to the completion of the current tax year, followed by the final $150,000 conversion in the new tax year prior to your spring transition date. This strategy would split the tax liability over two tax years and potentially keep you in a lower tax bracket for each year. Let’s assume that, your federal marginal tax rate is 24% on each conversion ($36,000). Since Texas has no state income tax, as a resident, you would have no state tax your total tax liability to the United States would be 72,000, spread over two tax years, and you would pay nothing to Canada when you take distributions.

Let’s compare this strategy to what would take place if you were to move to Canada and maintain the $300,000 in the 401K. As a resident of Alberta, the 401K would eventually be transferred to a rollover IRA, and you would take distributions later in life. Since the highest tax brackets are reached at much lower income levels in Canada, in this particular example, the distributions from the unconverted 401K, assuming the same income level, would be taxed at around 48% in Alberta (current combined federal/provincial rate). This is double the 24% tax rate of the conversion. Converting the 401K to a Roth IRA prior to becoming a Canadian tax resident would have resulted in effective tax savings of 50% on the $300,000 in question. As well, the growth within the Roth IRA on the original $300,000 would have been free from taxation from either country.

As outlined by the above example, employing a Roth conversion strategy prior to establishing Canadian tax residency could result in substantial tax savings for many individuals. It is important to note that the amount of tax savings that would result from this strategy are highly dependent upon the specific facts and circumstances of each individual as well as future tax and exchange rates. In addition, this strategy is also dependent upon filing the proper Treaty-based election with the filing of your first Canadian resident income tax return. As a result, it is paramount that you seek the guidance of qualified Canada-US Cross-Border financial advisors and tax professionals  prior to making any decision regarding this strategy. Feel free to contact Cardinal Point if you have further questions.