Canadian Taxation: Tax Residency
by George Gonzalez
Are you a Canadian considering a move to another country? If so, there are important elements of Canada’s tax system relating to international activities that should be aware of. One is tax residency.
Canada’s taxation system is based on residency (unlike that of the U.S., for example, which is primarily based on citizenship). This means that: (1) if you are resident for tax purposes you will pay tax on your worldwide income from all sources, and (2) if you are a non-resident you will pay tax on your Canadian sourced income only. Depending on one’s individual circumstances, the difference between being taxed as a resident versus being taxed as non-resident could be very little difference or it could be significant.
If most or all of your income is from Canadian sources and you have relatively few deductions and credits, then you may end up paying about the same amount of tax regardless of whether you file a tax return as a resident or a non-resident. On the other hand, if a substantial portion of your income is from outside of Canada, and you reside in a country with personal income tax rates that are lower than Canada’s, then you could pay considerably less tax as a Canadian non-resident than as a resident.
Moving to a low-tax foreign country and subsequently being taxed as a Canadian non-resident may be seen as a way to significantly reduce one’s total tax bill. If you are considering this aspect of an overseas move, it may be worthwhile to do some “what if” calculations under both residency scenarios.
The aim of this article is to lay out the fundamental Canadian tax residency rules to inform you and help you define and achieve your goals and objectives.
Taxation of Residents versus Non-Residents – In General
A Canadian tax resident pays tax on worldwide income from all sources, while a non-resident’s tax is based on Canadian sourced income only. An important point to keep in mind in this discussion is that residency is determined on a year-by-year basis. Someone may be resident one year then a non-resident the next year, and vice versa.
Furthermore, in transitioning between resident and non-resident, inevitably, there will be that one transition year in which an individual goes from being a resident to being a non-resident, or the reverse. That transition year will result in a tax return that includes taxation on worldwide income one part of the year (during residency) and taxation on Canadian-source income only for the other part of the year (during non-residency). For example, assume a situation in which a Canadian resident moves overseas and becomes a non-resident on April 1. This individual will calculate their tax for the year based on (1) being a resident for the first three months of the year (and therefore including their worldwide income from all sources, for the period January 1 through March 31) and (2) being a non-resident for the other nine months of the year (and including Canadian sourced income only, for the period April 1 through December 31). Procedurally, in the tax return preparation this will usually involve the calculation of allocations, which can be somewhat complex at times but nevertheless necessary.
A key item of importance in situations where a Canadian resident plans to transition to non-resident status is the deemed disposition rules that are collectively referred to as the departure tax. Under these rules, the individual is deemed to have sold their assets for fair market value on their last of Canadian residency and repurchased those assets the next day (the first day as a non-resident) at the same fair market value. The resulting add-on tax is the departure tax (the topic of another article in these web pages). The deemed disposition rules, if not properly planned for, can result in unfavourable tax consequences when a Canadian taxpayer transitions to non-resident status. The good news is that, with residency being determined on a year-by-year basis, there is opportunity for tax planning to minimize the potentially onerous tax effects of a move to a foreign country with change in residency if action is taken early.
While the above sets forth, in very general terms, how Canadian residents are taxed in comparison to non-residents, it is important to mention the potential impact of tax treaties. Canada has tax treaties with about 95 countries. Bi-lateral tax treaties are conventions, agreements, and arrangements between two countries designed to prevent double taxation on individuals who would otherwise have to pay tax twice, i.e, to two different countries, on the same income. A tax treaty will address specific types of income such as employment compensation, dividends, interest, rental income, pensions, etc. (See a separate article in these web pages on tax treaties.)
A feature of tax treaties that is crucial to bear in mind is that they override a country’s tax laws when there is a contradiction between those laws and the tax treaty’s provisions. As an example, assume that a Canadian corporation pays a dividend to a Canadian who is a tax resident of Thailand. Under the general rule of Canadian tax law, this dividend recipient, a Canadian non-resident, would be liable for a 25% tax on that dividend income. However, under the Canada-Thailand tax treaty, the tax rate on dividends paid by a Canadian corporation to a resident of Thailand is 15%. Hence, the Canadian non-resident would pay a tax of 15%, rather than 25%, to Canada.
Dividend income is one type of income that is typically covered under a tax treaty. Other types include interest income, royalty income, pensions, and annuities. While the general rule under Canadian tax law is that the recipient of these types of income is subject to a flat 25% tax, a treaty typically reduces that percentage to some lesser percentage, depending on the type of income. Returning to the Thailand example above, under the Canada-Thailand treaty the tax rates on dividend income, interest income, royalty income, and pensions/annuities are, respectively, 15%, 15%, 5% or 15% depending on royalty type, and 25%.
Tax treaties are important not only because they define how much each country is entitled to tax various types of income, but also because they often define residency. An individual could be considered a resident of Canada under Canada’s general tax laws, yet under a specific tax treaty it would be possible for that individual to be designated a resident of the other country, notwithstanding the provisions under general Canadian tax laws. This would result in a “tie-breaker” such that the treaty will override the general tax laws, and the individual will be designated a resident of the other country rather than Canada.
The tax treaties between Canada and other countries tend to share many things in common, but they each also have their own unique provisions. It is important to investigate whether Canada has a tax treaty with the country(ies) you are considering for investing or relocation, and understand how the provisions of any applicable treaty would apply to your own personal situation.
Tax Residency Rules
Let’s now discuss the specific rules that determine whether an individual is a resident or a non-resident for Canadian tax purposes. These rules would have their greatest applicability in situations in which (1) there is no tax treaty between Canada and the other country in question, and (2) tax treaty provisions are not applicable because the individual has not yet established residency in the foreign country.
Canadian tax residency laws, regulations and rules can get complex at times. There are a multitude of rules, exceptions to the rules, exceptions to the exceptions, and even exceptions to the exceptions to the exceptions. This presents both opportunities and pitfalls.
Many people believe that tax residency is a simple six-month test: if you spend more than six months in Canada during the year, then you are a Canadian resident for that year; and if you spend more than six months outside of Canada during the year, then you are a non-resident for that year. While a “six-month rule” does apply under certain circumstances (most notably in the case of “sojourners” as discussed later), it is not the main rule for Canadian tax residency that Canadian courts and the Canadian Revenue Agency (CRA) follow. It would be entirely possible, for example, to spend more than six months outside of Canada during the year, yet still be considered a resident for tax purposes.
Under Canadian tax law the determination of one’s residency status is based on one of two definitions: factual residency and deemed residency, taken in that order. These two categories are discussed next.
Factual resident: A factual resident is someone who has a set of residential ties to Canada that are sufficiently strong that they would be considered “ordinarily resident” in Canada. It is a question of fact, i.e., one that would be based on all relevant facts and circumstances. The CRA has published an Income Tax Folio (S5-F1-C1) that lists three significant residential ties and several secondary residential ties. CRA’s position is that if you meet one or more of the significant residential ties, then you would automatically be considered a tax resident in most cases, while secondary residential ties are to be examined collectively, rather than individually, in arriving at a determination of factual residency.
The significant residential ties are: (1) dwelling place (or places); (2) spouse or common-law partner; and (3) dependents. This means that if you have any of these three in Canada, you would usually be considered a resident. A dwelling place in Canada could be either owned or leased, the key is whether it is available for occupation any time. If it is, then it will be considered a significant residential tie with Canada. Similarly, having a spouse, common-law partner, or dependent who lives in Canada would also be considered a significant residential tie.
The secondary residential ties listed by the CRA are:
- personal property in Canada, such as furniture, clothing, automobiles, etc.;
- social ties such as memberships in Canadian recreational or religious organizations;
- economic ties with Canada such as employment with a Canadian employer and active involvement in a Canadian business, as well as Canadian bank accounts, retirement savings plans, credit cards, and securities accounts;
- landed immigrant status or appropriate work permits in Canada;
- Canadian hospitalization and medical insurance coverage;
- a Canadian driver’s license;
- a vehicle registered in a province or territory of Canada;
- a seasonal dwelling place in Canada or a leased dwelling place;
- a Canadian passport;
- memberships in Canadian unions or professional organizations
The above information essentially provides a roadmap: if you want to be considered (or continue to be considered) a Canadian tax resident, maintain as many of the ties listed above as is practicable. On the other hand, if you do not want to be considered a tax resident, then you should plan to sever all of the significant residential ties and as many of the secondary residential ties as possible.
Deemed resident: An individual may fail to meet the conditions for factual residency but still be considered a tax resident if they fall under one of the deemed resident categories. The CRA lists the following categories of deemed residents:
- Sojourner in Canada (more on this below);
- members of the Canadian Forces at any time in the year stationed outside of Canada;
- officers or servants of Canada or a province, at any time in the year, who received representation allowances or who were factually or deemed resident in Canada immediately prior to appointment or employment;
- individuals who performed services, at any time in the year, outside of Canada under an international development assistance program of the Canadian International Development Agency, provided they were either factually or deemed resident in Canada at any time in the three month period prior to the day the services commenced;
- members of the overseas Canadian Forces school staff who have filed their returns for the year on the basis that they were resident in Canada throughout the period during which they were such members;
- a child of someone described in the preceding four categories (2 through 5), and whose income for the year did not exceed the basic personal amount for the year;
- individuals who at any time in the year were, under an agreement or a convention between Canada and another country, entitled to an exemption from an income tax that would otherwise be payable in that other country in respect of income from any source, and (1) the exemption under the agreement or convention applies to all or substantially all of their income from all sources and (2) the individuals were entitled to the exemption because they were related to, or a member of the family of, an individual (other than a trust) who was resident (including deemed resident) in Canada at the particular time.
Regarding the first category above: to sojourn is to stay temporarily in a place. An individual who does not have sufficient residential ties to Canada (as discussed above) may avoid being considered a factual resident, however if that individual sojourns in Canada for a total of 183 days or more in any calendar year, they would be a deemed resident.
Furthermore, and this is critical, a sojourner would be deemed to be resident in Canada for the entire year. This means that they will be subject to Canadian income tax on their worldwide income from all sources for the whole year. This is a much different result from that of being taxed as a resident for part of the year and a non-resident for the other part of the year (such as would occur in a transition year, as previously mentioned, when an individual transitions from resident status to non-resident status). A sojourner is taxed as if they were a resident of Canada for the whole year, regardless of how many days they were actually physically present in Canada.
The upshot of this is: if you move overseas and want to continue being treated as a tax resident by Canada, then simply ensure you are considered a factual resident by maintaining residential ties; you need not worry about the sojourner rule. On the other hand, if you move overseas with the intention of becoming a non-resident for Canadian tax purposes and take proper steps to make this change in tax status happen, you need to worry about the sojourner rule. You want to ensure that you spend less than 183 days in Canada in a calendar year to avoid meeting the definition of sojourner and consequently be deemed a tax resident for the whole year.
An additional aspect of deemed residency that is important to note is that a deemed resident is, by definition, not a factual resident and therefore not a resident of any particular province for provincial tax purposes. Provincial tax rates are not insignificant; the top rate across provinces and territories currently ranges from 11.5% to 25.75%. The tax law has therefore anticipated the inequity of a deemed resident paying federal tax but no provincial tax. To address this, the rules provide that a deemed resident will be required to pay a federal surtax in addition to the regular federal tax. This surtax may be higher or lower than what the individual would have paid as provincial tax if he or she were resident in a particular province.
One of the most important tax issues for an expatriate minded Canadian who has moved, or is planning to move, to a foreign country, is that of tax residency. This article briefly introduced the general principle of taxation based on residency and how a Canadian resident is taxed differently from a non-resident. The discussion of tax treaties explained how a tax treaty overrides general Canadian tax laws, and how a non-resident of Canada with Canadian source income may pay a different amount of tax under a treaty than they otherwise would under the general tax laws. That was followed by a discussion of how one’s residency status is determined by the factual residency and deemed residency rules in Canadian tax laws.
1 This is often referred to as a “withholding tax” because the Canadian payor has an obligation to withhold 25% of the payment from the non-resident and remit the 25% withholding tax to the CRA.
2 In other words, first determine if you meet the definition of a factual resident and, if you do not, then determine if you meet the definition of a deemed resident.
3 An exception to this is that under Quebec law, an individual who resided in the province of Quebec immediately prior to leaving Canada, and who is later a deemed resident, may be deemed to be a resident of Quebec while abroad.
4 Federal tax brackets start at 15% and go up to a maximum of 33%.
5 In the case of Quebec, where a deemed resident is required to pay both the Quebec provincial tax and the federal surtax, the individual may apply to the CRA for relief from the federal surtax at the time of filing his or her return.