Canadian Residence and Canadian Source Income
Canadian residents are taxed on their worldwide income and non-residents are taxed on income from Canadian sources. The underlying policy is that a resident Canadian is utilizing the social benefits taxation enables (healthcare, roads, etc.) therefore they should pay their share on income they derive, regardless of the jurisdiction of origin. In the same manner, a non-resident who earns Canadian-source income has done so utilizing Canada’s economic system which is supported and comprised of taxpayer funded entities. Tax liability is based on residence and source.
Double Taxation & Tax Treaties
Canadian policy is to avoid double taxation. So, if tax is paid in a foreign jurisdiction, while a resident of Canada for tax purposes, in most cases a Foreign Tax Credit (“FTC”) can be claimed to avoid double taxation. Foreign tax exemptions also serve to provide relief.
The taxation relationships between Canadian and foreign jurisdictions are normally governed by tax treaties. These treaties helpfully outline “tiebreaker” rules to determine which jurisdiction receives the tax. International taxation also involves the distinctive treatment of “active” versus “passive” and “direct” versus “indirect” income and “inbound” versus “outbound” transactions.
Active income refers to income from business activity and personal services. For instance, income from employment or business. Passive income includes, for example, rental or investment income such as dividends. Non-residents must file a Canadian tax return for active income. For non-residents, tax for passive income must be withheld at the source. FTCs for active income are more generous than for passive income.
Thomson v. Minister of National Revenue, 1946 CanLII 1 (SCC), [1946] SCR 209
The seminal case on residency was before the Supreme Court of Canada in Thomson v. Minister of National Revenue, 1946 CanLII 1 (SCC), [1946] SCR 209. The SCC defined residence as “a matter of the degree to which a person in mind and fact settles into or maintains or centralizes his ordinary mode of living with its accessories in social relations, interests and conveniences at or in the place in question.”
In Thomson, a New Brunswicker sold his home and claimed to have moved to Bermuda where he leased another. He did not stay there for a long period but travelled to the United States and built a home. During his time in the US he visited Canada. Then he rented a home in New Brunswick. He resided there in the summer for multiple years and then built a home. His wife accompanied him at all times. Ultimately, he spent 159 days in Canada in 1940. Based on those facts, the Canadian government considered him to be a Canadian resident for tax purposes and requested that he file a Canadian tax return for 1940.
So, was he a resident of Canada for tax purposes in 1940 or otherwise? The court considered various factors and found him to be resident. Many of the factors the court referred to have long been incorporated into CRA residence policy. For instance, are there significant primary and secondary residential ties to Canada? Primary ties include a Canadian home, a spouse and dependants such as children. Secondary ties include items such as a Canadian driver’s license, passport or even a bank account and car.
Even if a person does not maintain residential ties with Canada, they can be deemed a resident through the sojourner rule. Essentially, if you “sojourned” in Canada for 183 days or greater in a year you can be considered a resident of Canada for tax purposes.
Similar concepts exist for the residence of Corporations. Resident corporations are taxed on worldwide income and non-resident Corporations are taxed on income from Canadian sources. A corporation can be found to be a Canadian resident if it was incorporated in Canada or its “central management and control” exists in Canada.
CRA Residence Determination
There are many areas of tax dispute that can arise based on the issue of residence. Canada Revenue Agency (“CRA”) may question a taxpayer’s residence through a CRA audit and in turn modify a tax assessment. In most cases the modification leads to an increase in taxable income. There are also certain tax withholding requirements based on residence that taxpayers may not be aware of. For example, if a person resides in a foreign jurisdiction but owns property in Canada and receives rental income, a Canadian resident must withhold a 25% non-resident tax to be submitted to the CRA on behalf of that person. Missing withholding requirements can lead to penalties and drawn out disputes with the CRA.
An application can be made to CRA for an official residence determination. If CRA issues an incorrect determination a second review can be requested. If CRA fails to change its position the tax liability will be based on their determination. At that point the residence determination and respective tax assessment can be disputed by filing a Notice of Objection and/or appealing to the Tax Court of Canada.
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