It is not uncommon for individuals to have more than one country in which they are considered a resident for tax purposes ("dual resident" or "dual residence"). In Canada, high-net-worth individuals with a second home in a warmer jurisdiction, individuals who have obtained permanent residence status ("landed immigrants") yet maintained residential ties in their country of origin, as well as employees who are on extended foreign job assignments, can all find themselves as dual residents. As a consequence of the pandemic, there is now a new group of individuals who are dual residents, resulting from decisions they had to make to extend their stay in Canada or abroad due to travel restrictions or health and safety factors. Although tax administrations around the world, including the Canada Revenue Agency ("CRA"), introduced administrative guidelines regarding the pandemic and residence issues, these guidelines are very restricted and will often not provide any relief to these individuals.
Historically, the CRA have had enhanced audit activity on high-net-worth individuals and certain landed immigrants with more than one residence. Now it can be anticipated that CRA audit activity on residence issues will even be greater as individuals unexpectedly, and without proper tax planning, spent significantly more time in Canada, as a consequence of the pandemic, during the 2020 to 2022 taxation years and now find themselves with significant Canadian tax issues.
It is vital that dual residents, regardless of what above category above they fall into, understand their Canadian tax compliance requirements before filing their Canadian tax returns or, if they are already under the scrutiny of the CRA, respond carefully to CRA enquiries, requests and demands for tax returns. While each situation is unique, the purpose of this article is to describe a few important Canadian tax considerations for dual resident individuals. Often, proactively speaking to a tax advisor on some of these issues may be prudent.
Canadian tax system – Based on residence
Canadian residents are taxable on their worldwide income. In the year of immigration or emigration, they are subject to tax on their worldwide income earned during the part of the year they were resident in Canada. There is no definition of "residence" in Canada's Income Tax Act ("ITA"). The Courts have 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 making such a determination, all the relevant facts must be considered.
In Income Tax Folio S5-F1-C1 ("Determining an Individual's Residence Status", March 28, 2013) ("Folio"), the CRA provided guidance as to what criteria will be considered in determining whether a person is factually resident in Canada. In the Folio, the CRA lists the most important factors ("primary residential ties") as well as secondary factors in determining whether an individual leaving Canada remains resident in Canada for tax purposes.
Individuals have the option of filing an NR73 form, Determination of Residency Status (Leaving Canada) or an NR74 form, Determination of Residency Status (Entering Canada), as the case may be, which would allow the CRA to give an opinion on their residence status. However, there is a risk that submitting this form could trigger a CRA review or audit or a determination of your residence status that may not necessarily be clear from doubt and in your best interest. There is no legal obligation to file an NR73 or NR74 form unless requested to do so by the CRA.
Dual resident (subsection 250(5) of the ITA)
An individual can be resident in more than one country at the same time. Where an individual is a tax resident in Canada, as well as a tax resident of another jurisdiction in which Canada has a tax treaty, the final determination of the individual's residence status for Canadian tax purposes may depend on the application of subsection 250(5) of the ITA. In brief, if subsection 250(5) applies, it deems a taxpayer who is otherwise a factual resident of Canada to be a non-resident of Canada if, pursuant to the dual residence tie-breaker rules of the applicable tax treaty, the tie is resolved in favour of the other country. A non-resident of Canada, factual or deemed, is generally only taxable in Canada on certain Canadian source income and would only be required to file a Canadian tax return in limited scenarios. The dual resident provision (i.e. subsection 250(5)) is therefore a critical consideration for individuals who have residential ties in Canada as well as another treaty country and have significant sources of income, including business, employment or investment income, earned outside Canada.
Treaty tie-breaker rules
The vast majority of Canada's tax treaties utilize a set of internationally standard tie-breaker rules, including the permanent home test, centre of vital interest test, place of habitual abode test and citizenship test. But before these treaty tie-breaker rules can even be applied, the individual has to be a resident of both contracting states for purposes of the treaty. To be a resident of a contracting state for treaty purposes, a person must be "liable to tax" in that state, by virtue of a criterion referred to in the treaty. The CRA have provided their views on the meaning of "liable to tax," in the context of Canada's tax treaties, in paragraphs 1.41 to 1.45 of the Folio. Consequently, taxpayers relying on subsection 250(5) of the ITA should expect to have to provide support to the CRA regarding their tax status in the other jurisdiction (e.g. copies of foreign tax returns and assessments).
The country in which the individual has a permanent home, either owned or rented, available to them is always the first tie-breaker test. That is why proper tax planning (e.g. ensure that you do not have a permanent home in both countries available to you at the same time) can often guarantee how the tie-breaker rules will apply. However, as often is the case with dual residents, the individual has a permanent home available to them in both states during the dual resident period and this test will therefore not resolve the tie. Consequently, the second and third tie-breaker tests, centre of vital interest and place of habitual abode, are most often the tie-breaker rules that end up determining the individual's residence status for purposes of the treaty. As both of these tests are highly subjective, it may be prudent to talk to a tax advisor to seek an opinion on the matter. Obviously, when relying on the CRA to make the determination for you (e.g. filing forms NR 73 or NR 74 - Determination of Residency Status), the CRA will tend to err on the side of caution and determine the individual to be a resident of Canada, when in fact the individual may have a valid and defensible tax filing position that they are a non-resident of Canada, due to subsection 250(5) of the ITA and the treaty tie-breaker rules.
Taxpayers not bound if they have mistakenly filed tax returns as Canadian residents
Individuals, when filing their initial Canadian tax returns, are often unaware of the dual resident provision in subsection 250(5) of the ITA and mistakenly report themselves to the CRA as Canadian residents. Regardless of the reasoning behind filing as a Canadian resident on a tax return, where an individual was a dual resident and ITA subsection 250(5) should have applied to deem them to be a non-resident, the individual should be able to amend their prior tax returns, assuming the taxation years are not statute barred and the CRA agrees with the analysis of the tie-breaker rules. There is Canadian jurisprudence that supports the proposition that taxpayers are not bound by their initial mistaken tax classification as a resident of Canada. Depending on the circumstances, this could be highly advantageous for taxpayers, particularly those who have significant non-Canadian source income and the tax rates in their other country of residence are lower than Canada's tax rates. However, on the flip side, amending tax returns to identify yourself as a non-resident can also trigger potential negative tax implications, such as departure tax. Before considering amending tax returns, it again would be prudent to discuss with a tax advisor all of the possible ramifications, in both jurisdictions, that could arise.
Every dual resident case is unique and numerous tax issues can be triggered in both countries. As a positive, if you are a resident of Canada with significant residential ties to a country with a tax treaty with Canada, you should never find yourself in a position of double tax. That is, under the treaty, there will be a tax dispute process (Mutual Agreement Procedure) available to resolve the double taxation. However, the objective of this article is to give the reader an awareness of Canada's tax system and specifically subsection 250(5) of the ITA. There are many individuals who have filed tax returns, or who are considering filing tax returns, as Canadian residents, when in fact they are really deemed non-residents of Canada. With an increase of dual residence cases as a consequence of the pandemic, hopefully this article reminds taxpayers of the rules in the Canadian tax system that might favourably impact them.