The governments of Canada are facing increased scrutiny and criticism in respect of the growing deficits that have been accumulated at both the federal and provincial levels. Increasing taxation or cutting spending are the basic ways in which governments attempt to deal with budgetary shortfalls. While both options are unpopular with voters, it is suggested that the provincial governments will have no other option but to rely on increased taxation as the primary tool as they are responsible for funding increasingly expensive programs, such as health care, education and the administration of justice. Despite equalization payments amongst the provinces, it appears that the provinces are not able to provide equivalent services to their residents at similar levels of taxation; this has lead to significant variation amongst provincial taxation rates. Revenues from taxation can be increased by simply increasing the tax rate, or alternatively, increasing the scope of the tax base. Thus, it is likely that provinces with higher rates of personal income tax will be pressuring the Canada Revenue Agency (the "CRA") to closely examine the residency claims of individuals who have recently filed as residents of a province with a lower rate of personal income tax as to prevent leakage from their tax base.2
Traditionally tax planning focuses on reducing taxes payable by altering the timing of tax payments, altering the tax character of receipts or expenditures, and/or altering the jurisdiction of taxation so as to subject income to as low a rate of tax as possible.3 Due to the increasing mobility of capital and labour in Canada and the varying tax rates amongst the provinces, there has been an increased focus in recent years on inter-provincial tax planning to lower an individual's overall rate of taxation.
This paper begins with an overview of the legislative framework under which provincial income taxes for individuals are levied. The definition of "residence" is then discussed and a number of current cases with respect to provincial residency are reviewed. Finally, dispute resolution mechanisms for individuals who wish to challenge an assessment related to provincial residency are canvassed.
II. LEGISLATIVE BASIS
1. The Constitution
The governments of Canada (including the provinces and territories (collectively referred to as the "provinces")) can impose taxes only on the authority of legislation pursuant to the Constitution Act, 18674(the "Constitution"). The Constitution, pursuant to subsection 91(3), allows the federal government to raise money by any mode or system of taxation. The only jurisdictional limit on a province's right to impose taxation is found in subsection 92(2) of the Constitution which states that a province is limited to direct taxation imposed within the province to raise revenues for provincial purposes. In other words, the provinces have the power to tax individuals based on residence, domicile, employment, or carrying on business in the province as long as the connection to the province is substantial.5
The Supreme Court of Canada in Dunne c. Quebec (Sous-ministre du Revenu)6discusses what connection to the province is required for the province to be able to levy provincial income tax. The Court noted that subsection 92(2) of the Constitution is construed broadly and with flexibility to include the "power to tax residents of the province...[and also to] tax property, businesses and transactions within the province"7. Mr. Dunne was a chartered accountant and retired partner of Ernst & Young. Mr. Dunne was resident in Ontario and had never carried on business in Quebec, however he was assessed for provincial income tax under the Taxation Act8(the "Quebec Act"). The Court held that the partnership agreement established that Mr. Dunne received a share of the profits of the partnership which carried on business in Quebec and that the Quebec Act's deeming provisions operated to determine the proportion of the individual's income that could be allocated to Quebec activities and thus validly taxed under the Quebec Act. The Court held that the Quebec Act did not improperly expand the scope of the provincial taxing power.
2. The Income Tax Act
The Act,9 and the regulations made thereunder, are the primary source of income tax law with respect to levying taxes. Canadian residents are liable for tax on their worldwide income pursuant to subsection 2(1) of the Act. The occurrence of residence in Canada provides the basis for jurisdiction to tax and thus creates the liability for taxation of a person.10 Individuals, including trusts11, are thus liable for both federal and provincial tax. The specifics of what constitutes "residence" will be discussed in a later section of this paper.
(a) Income of an Individual
The Act itself does not in fact impose a provincial tax. The phrase "income earned in the year in a province" is defined in subsection 120(4) of the Act to mean an amount determined under rules prescribed for the purpose by regulations made on the recommendation of the Minister. Regulation 2601(1) states that if an individual resides in a particular province on the last day of the taxation year and has no income for the taxation year from a business with a permanent establishment outside the province, the individual's income earned in the taxation year in the particular province is the individual's income for the taxation year. Generally speaking an individual's taxation year will end on the last day of the calendar year. In other words, for purposes of simplicity, the provinces have agreed to tax individuals, excepting business income of an individual, on the basis of an arbitrary provision which assumes residence on the last day of the taxation year is indicative of residence throughout the taxation year.12 By way of example, the CRA considered a situation in a recent technical interpretation13 where an individual was a US citizen who earned employment income in Quebec in the year but resided in Alberta on the last day of the taxation year and was considered a part year resident of Canada. The CRA opined that the individual would be taxable under regulation 2601(1) and that all of theindividual's employment income from Quebec would be considered to be earned in Alberta.14
In a December 18, 2003 letter,15 the Minister states that the provinces took the current approach to provincial taxation in an attempt to simplify the determination of tax payable and to avoid unnecessarily complex allocation calculations. The Minister went on to state that any possible increase in revenue from creating, implementing, monitoring and enforcing potential allocation calculations amongst provinces would be negligible.16
A simple, but not particularly practical, tax planning strategy exists if an individual wants to lower their overall rate of taxation – move to a province with a lower rate of taxation. This strategy may be attractive to individuals who expect to receive a large capital gain or dividend, as provincial residency for the taxation of all passive forms of income (interest, dividends and capital gains) is determined by the province of residence of the individual on the last day of the taxation year. For this strategy to be effective, it will be imperative for the individual to sever their residential ties with the old province and establish new residential ties in the lower rate province before the end of the taxation year. The meaning of residence and the relevant provincial residential ties are discussed later in the paper.
(b) Business Income
With respect to business income derived from a permanent establishment (a "PE") outside of the particular province (i.e. the province of residence as determined on the last day of the taxation year), a taxpayer's provincial income tax will be calculated in accordance with Regulation 2601(2) which states that the individual's income earned in the taxation year in the particular province is the amount by which the individual's income exceeds the amounts that can be attributed to carrying on business that is earned in a province other than the particular province. The phrase "PE" is defined in Regulation 2600(2) for purposes of this Part of the Act to mean a fixed place of business of the individual including an office, farm or warehouse; the place where an employee or agent is located if this person has the general authority to contract or if the person has a stock of merchandise owned by the principal or employer from which he regularly fills orders; or the place where substantial machinery or equipment is used.
The CRA recently stated17 that they would be prepared to reconsider their view on the meaning of the word "agent" for purposes of regulation 2600(2). Previously, the CRA ascribed the ordinary meaning to the word "agent", being one who is authorized to act for or in the place of another. The Federal Court of Appeal looked to the common law in Canada v. Merchant Law Group18 to define the word "agent" as a person who is "able to affect the principal's legal position with third parties by entering into contracts on the principal's behalf or by disposing of the principal's property"19. As a result of the slightly more narrow legal definition, that the agent is must not simply undertake acts for the principal but must be able to affect the principal's legal position, the CRA stated that "sufficient support exists for using the legal meaning of the word 'agent' in situations involving allocation for provincial income tax purposes".20 The CRA's position is effective prospectively for taxation years ending in 2012.
For greater certainty, regulation 2603(1) states that where an individual had a PE in a particular province in the taxation year and had no PE outside of the province, then all income from carrying on business is deemed to be earned in the particular province. If apportionment between two or more PEs is necessary then regulation 2603 requires a taxpayer to first apportion the total business income in the ratio of gross revenue reasonably attributable to each PE, then to apportion the total business income in the ratio of salaries and wages paid to employees at each PE, and then finally to average the two amounts derived from the previous two calculations in respect of each PE.
If an individual is not resident in Canada, regulation 2602 will impute income from an office or employment, which is brought into tax liability pursuant to section 115 of the Act to the provinces in which the duties thereof were performed. In a recent technical interpretation,21 the CRA was asked to consider the situation of a hockey player who is a US-resident (i.e. a non-resident of Canada) who plays for an National Hockey League team based in Ontario. The description of the facts indicated that the individual's T4 slip stated his place of employment as Ontario, however the individual performed his employment duties in several different provinces. The CRA opined that the individual would be required, pursuant to regulation 2602, to allocate his employment income to the provinces in which he played hockey on a reasonable basis.
(d) Dual Residency
Regulation 2607 of the Act is of particular importance as it addresses the issue of dual provincial residency meaning that it applies where individuals can said to be resident in more than one province on the last day of the taxation year. This provision will deem the individual to have resided on that day only in that province which may reasonably be regarded as his or her principal place of residence. Therefore, for provincial purposes an individual can only have one place of residence.
In a scenario not unfamiliar to many individuals employed in the Alberta oil patch, the CRA was asked to provide some guidance as to the place of an individual's residence where the individual's spouse and children live in British Columbia but the individual's permanent job and day-to-day activities were in Alberta. The individual had moved to Alberta three years prior and planned to stay indefinitely, however he and his spouse still considered themselves married. The CRA opined22 that the individual was a resident of both British Columbia based on his family ties and a resident of Alberta based on the fact that he had a permanent full-time job, a house, and this was where his day-to-day activities occurred. The CRA noted that regulation 2607 applies in these situations and concluded that the individual likely had his principal place of residence in Alberta based on the strength and the number of ties with Alberta.
(e) Tax Policy Considerations
From the perspective of fairness, a key tax policy consideration, it is illogical that an individual is taxed on wages and salary in the particular province of which they are found to be resident on December 31st and not the province in which the wages or salary was earned. The stated policy of using a common residence is simplicity of the tax system, also a key tax policy consideration. It is suggested that taxing wages and salary on a basis similar to business income would not require significant complications to the tax system as employers could easily be asked to provide a provincial allocation of the wages and salaries of their employees since this is already done for purposes of workers' compensation premiums and related coverage. Further, the provinces that are creating jobs, such as Alberta, should arguably benefit from this job creation (and analogous increases to infrastructure costs) by having wages and salaries from these jobs liable to taxation in the province. This change would be particularly significant to several provinces as many individuals live in another province (for example Newfoundland) and regularly commute to a job in a second province (Fort McMurray, Alberta) on a rotational basis.
It is further suggested that passive investment income, other than a capital gain from the sale of real property, continue to be taxed in the province of residency on the last day of the calendar year as it would be cumbersome, and perhaps impossible, given the mobility of capital to allocate it to the provinces in which it was derived. A capital gain or loss arising on the sale of real property should be taxed in the province in which the real property is situated as there is a direct connection between the income (or loss) amount and the province. This method of taxation would be consistent with many of Canada's bi-lateral treaties.
3. Provincial Legislation and the Federal-Provincial Fiscal Arrangements Act
(a) Provincial Legislation
Section 3 of the Alberta Personal Income Tax Act23 (the "Alberta Act") gives the province of Alberta the legislative authority to levy the personal income tax. This provision states that an individual who was resident in Alberta on the last day of the calendar year24 or who had business income in Alberta during the calendar year is liable for tax in Alberta. Section 5 of the Alberta Act equates an individual's taxable income for purposes of the Act with an individual's taxable income under Part I of the Act, thus creating an identical taxation basis. Section 4 of the Alberta Act specifies that personal tax will be levied at a flat rate of 10 percent. Sections 2, 4, and 4.1, respectively, of the Income Tax Act (British Columbia)25 (the "BC Act") impose almost identical provisions to the Alberta Act except that the rate of taxation is progressive from 5.06 percent to 14.70 percent. Sections 2, and 4, respectively, of the Income Tax Act (Ontario)26 (the "Ontario Act") also mirror the Alberta Act with the exception of progressive rates of taxation ranging from 6.05 percent to 13.16 percent. See the following table for complete information on provincial income tax rates currently in effect:
(b) Federal-Provincial Fiscal Arrangements Act
The federal and provincial income tax arrangements are governed by the Federal-Provincial Fiscal Arrangements Act27("FPFAA"). Specifically, the federal government levies tax on behalf of the provinces through a series of tax collection agreements ("TCA")28 which are provided for under the FPFAA. The federal government has TCA with all of the provinces, except Quebec,29 for the collection of personal income taxes. For ease of administration, the TCA requires that provincial income taxes to be levied on the same basis as federal income taxes meaning that the provinces are required to use the federal definition of "taxable income". However, the provincial income tax may be calculated using a tax on income method which calculates provincial income tax payable by individuals as a percentage of their taxable income.30 This method of calculating provincial taxes payable allows the provinces to set their own tax rates and determine which non-refundable tax credits they will offer.
The federal government currently gives an abatement of 16.5 percentage points to allow room for the provinces to impose taxation.31 Specifically, subsection 120(2) of the Act gives an abatement of 3 percentage points and section 27 of the FPFAA gives an abatement of 13.5 percentage points. Technically speaking, a tax abatement is deemed to be a payment of tax made on prescribed dates and such dates are prescribed in regulation 6401.
The legality of the TCA was challenged in Gendis Inc. v. Canada32where the corporation, Gendis, undertook a corporate reorganization that allowed the corporate group to utilize the differences between section 85 of the Act and a parallel rollover provision in the Quebec Act to avoid provincial tax liability in respect of a sale of property which resulted in a capital gain (the "Quebec Shuffle"). Subsequent to the Quebec Shuffle, Gendis was assessed under the Manitoba provincial tax legislation that was passed retroactively to target such transactions. Gendis argued, not that the legislation was invalid, but that the application of the legislation to the transaction in question was invalid on the basis that the specific provision in the Manitoba legislation33 could not be enforced as it was not a tax collected on the federal income basis as stipulated by the TCA. The Manitoba Court of Appeal held that the CRA's ability to collect and transmit taxes was not strictly limited to the terms of the TCA as there was an ongoing agency relationship of consensual administrative delegation, thus the Minister could validly levy an assessment under the Manitoba legislation in this circumstance against the corporation.
(c) Payment Mechanism
Section 228 of the Act is the mechanism under which the provincial income tax gets allocated to the provinces and this section states that Minister is to apply any payments made a taxpayer in accordance with the TCA notwithstanding that the taxpayer may have directed that the allocation of payments be made in some other manner.34 Generally, TCA specify that an amount collected in respect of tax payable be allocated first to the provincial portion of tax payable and then to the federal portion of tax payable. Where two or more provinces are to share the provincial tax payable, an amount paid is to be allocated pro rata to each province under the TCA.
1 The author would like to thank Lisa Handfield for her significant contributions to this paper. Gregory J. Gartner is a partner at Moodys Gartner Tax Law LLP which is affiliated with Moodys LLP and Moodys US Tax Advisors.
2 With respect to the provincial corporate tax base, an 18 month pilot project known as the Provincial Income Allocation Audit Plan was announced in 2005 by the CRA. The focus of the plan was said to be the identification of permanent establishments and corporate reorganizations that affect the provincial tax base.
3 For more information on inter-provincial tax planning see Sian M. Matthews, "Water Runs Downhill: Interprovincial Tax Planning," in Report of Proceedings of the Fifty-Sixth Tax Conference, 2004 Conference Report (Toronto: Canadian Tax Foundation, 2005), 25:1-45.
4 30 & 31 Vict., c. 3.
5 Supra, note 3 at 25:10.
6 2007 SCC 19.
7 Ibid., at para. 12.
8 R.S.Q., c. I-3.
9 All references are to the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.), as amended, unless otherwise stated.
10 Subsection 248(1) defines a person to include an individual.
11 See Provincial Residency – Trusts by H. Michael Dolson which was co-presented with this paper.
12 Interestingly, there is no mechanism in the Act to allocate tax credits amongst the provinces. In Coffey v. Minister of National Revenue,  C.T.C. 2283, the taxpayer resided in Quebec on the last day of the taxation year but had business income from eight provinces. The taxpayer allocated his deduction for alimony payments and pension plan contributions amongst the eight provinces. The Court held that the deduction should be fully borne by Quebec as regulation 2601(2) specifies that an individual's "income for the taxation year" is determined, after deductions for income allocated to permanent establishments outside the province.
13 CRA document no. 2011-0407601E5.
14 Section 114 governs the taxation of individuals who are resident in Canada for only part of the year and specifies that taxable income otherwise calculated under subsection 2(2) of the Act includes income earned while a resident in Canada plus income and losses included under paragraphs 115(1)(a) through (c) of the Act for the part of year that the individual was a non-resident of Canada.
15 CRA document no. 2003-0049244.
17 CRA document no. 2011-0426561C6(E).
18 2010 FCA 206.
19 Ibid., at para. 17.
20 Supra, note 17 at page 2.
21 CRA document no. 2012-0440381E5.
22 CRA document no. 2004-0054681I7.
23 R.S.A. 2000, c. A-30, as amended.
24 "Calendar year" is to be read as "taxation year" where a person died or became bankrupt during the calendar year pursuant to subsection 3(3) of the Alberta Act.
25 R.S.B.C. 1996, c. 215, as amended.
26 R.S.O. 1990, c. I.2, as amended.
27 R.S.C. 1985, c. F-8.
28 The TCA were implemented in 1962. The federal government assumes the cost of bad debts as well as the cost of administering the TCA and in exchange the federal government is allowed to retain interest and most penalties levied on taxpayers.
29 Residents of Quebec receive an abatement of 16.5 percent of their basic federal tax but are subject to tax at the prevailing rates set by the Quebec government. Quebec taxes its residents under the Quebec Act (see note 8).
30 Prior to 2000, the TCA required the provinces to levy income taxes through a tax on tax method of calculation where provincial income taxes payable were calculated as a percentage of federal income tax payable.
31 In 1977 the federal government lowered its tax rates to create more room for the provinces to levy their tax, thus there was minimal effect on the total amount of income tax payable by an individual.
32 2006 MBCA 58 affirming 2004 MBQB 180.
33 Section 53.2 of The Income Tax Act, CCSM c I10.
34 Section 228 also assists the Minister with collecting taxes as it will confine the process to a single court where an amount received is sufficient to discharge fully the taxpayer's provincial tax liability.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.