Foreign Income: A Highly Underreported Type of Income
Foreign income is one of the most underreported types of income for Canadian tax purposes. Many taxpayers believe, at least until an experienced Canadian tax lawyer or a friend who has faced penalties and interest as a result of not reporting foreign income inform them otherwise, that if income is not earned in Canada, or not Canadian sourced, it is not required to be reported for tax purposes. Nothing can be further from the truth.
Reporting Foreign Income to the Canada Revenue Agency
There are various ways that foreign income earned in prior years which was not reported for tax purposes is ultimately reported to the Canada Revenue Agency (CRA). They include the CRA conducting a tax audit on foreign funds received by the taxpayer (for example, through a bank transfer), the taxpayer filing amended tax returns, and the taxpayer filing amended tax returns with a Voluntary Disclosure application. Of these three, filing amended tax returns with a Voluntary Disclosure application is most recommended for minimizing tax liabilities (i.e. penalties & interest) and for the taxpayer's protection overall. For more information review our firm's articles addressing the benefits of filing a Voluntary Disclosure application. (https://www.canadiantaxamnesty.ca/voluntary-disclosure-program/ & https://taxpage.com/voluntary-disclosure/)
A Potential Consequence for Pensioners Disclosing Historical Foreign Income: Repayment of the Guaranteed Income Supplement and Allowance
The Guaranteed Income Supplement
The Guaranteed Income Supplement is a monthly non-taxable benefit paid to recipients of Old Age Security pension who have low income and are living in Canada. The amount of Guaranteed Income Supplement paid to individuals monthly can change based on the cost of living, the amount of prior year income of the individual pensioner, and the combined prior year income of the individual and his/her spouse or common-law partner.
In order to apply for the Guaranteed Income Supplement, a pensioner must report certain personal income and deduction information to the Old Age Security program of Service Canada. Most of the income and deduction information Service Canada's Old Age Security program requests is also required to be reported on each individual's tax return. Some examples include CPP benefits; all other pension income including private and foreign pension income; interest and investment income; capital gains and taxable Canadian dividends; and rental income.
However, most Canadian pensioners are automatically enrolled to receive Guaranteed Income Supplement payments if they qualify based on the relevant income and deductions they reported to the CRA on their prior years tax returns. Thus, the CRA reports income and deduction information of taxpayers to the Old Age Security Program of Service Canada.
Yearly Review of Individual Pension Income to Determine Eligibility of the Guaranteed Income Supplement
The prior year income of pensioners is reviewed on an annual basis to determine their annual eligibility for the Guaranteed Income Supplement. Therefore, Guaranteed Income Supplement payments can increase, decrease and cease according to a pensioner's reported changes in annual net income. If a pensioner has a spouse or common-law partner, their combined income is considered for purposes of determining the pensioner's eligibility for the Guaranteed Income Supplement. In addition, the spouse or common-law partner of a pensioner eligible for the Guaranteed Income Supplement could be eligible for an Allowance if he/she is Canadian, between 60 and 64 years old, and is below the maximum income threshold.
Repayment of the Guaranteed Income Supplement and Allowance
In the case where a Canadian pensioner received income from foreign sources which financially sustains his/her retirement, yet these amounts were not reported on his/her historical tax returns, disclosing this information to the CRA could lead to surpassing historical maximum income thresholds for eligibility of Guaranteed Income Supplement payments. Since the Old Age Security program bases its assessment for its benefits on information received from the CRA, the revision of historical taxable income will eventually be reported to the Old Age Security program, which will be obligated to adjust any benefits accordingly.
In these cases, the taxpayer will receive a letter from Service Canada's Old Age Security program providing the amount of historical overpayment, and indicating the taxpayer has to pay the entire amount back within 30 days or have it deducted from future Old Age Security payments. If the taxpayer chooses to deduct the amount from future payments, 25% is normally the portion deducted. However, this could be reduced to as low as 10% if the taxpayer appeals the normative percentage deducted and provides the Old Age Security Program with a Statement of Income & Expenses which proves difficulty in repaying the benefit at the 25% garnishment rate.
The Old Age Security Act entails legal provisions which could apply interest and penalties to Old Age Security benefits that were paid out historically and have to be repaid. However, the Old Age Security Program does not actually charge any interest or penalties on funds that were paid out as Guaranteed Income Supplements to an ineligible pensioner which are later determined to have to be paid back.
The reported changes to a pensioner's income could affect future Guaranteed Income Supplement payments as well. For instance, if a pensioner originally failed to report foreign pension income for tax purposes, this income could likely also affect his/her eligibility for current and future Guaranteed Income Supplement payments. As a result, Service Canada requests pensioners in these scenarios to inform the Old Age Security program of the unreported income as soon as possible (rather than waiting for the CRA to inform the program, as this could take some time), to avoid future overpayments of the Guaranteed Income Supplement. This can be accomplished by sending the Old Age Security Program's service centre of the pensioner's district a letter indicating such or simply informing the Program over the phone.
If the Old Age Security Program has not calculated the repayment required accurately, or the pensioner does not agree with the decision for a different reason, a letter of reconsideration may be written to the Old Age Security Program. There is also an appeals process which is subsequently available through the Social Security Tribunal. Each submission to these administrative processes is evaluated on a case-by-case basis.
The process for paying back an Allowance which has been granted to a spouse or common-law partner of an individual who has received payments of the Guaranteed Income Supplement is the same.
Tax Tips: Report Foreign Income for Tax Purposes & Consult with a Tax Lawyer regarding the Disclosure of Historical Unreported Income
Canadian pensioners should ensure to report all foreign income earned on their tax return(s). This includes reporting foreign pension income which is tax exempt due to a tax treaty. To ensure that a tax liability is not calculated on these types of income, a corresponding deduction should be taken on line 256 of the tax return. Further, if you paid foreign taxes on your pension, you may be able to claim a foreign tax credit when you calculate your Canadian federal and provincial taxes (see line 405 on the tax return).
Foreign pension income and any corresponding deductions must be reported in Canadian dollars using the Bank of Canada exchange rate in effect on the day the pension is received. The average annual rate may be used if the pension is received at different times of the year.
If you are a Canadian pensioner who has unreported foreign income, you should speak with a Canadian tax lawyer regarding formally and professionally disclosing this income to the CRA through the voluntary disclosure program (VDP). You could otherwise face extensive penalties and interest on the tax liability associated with this income. You should also be aware that if you were granted the Guaranteed Income Supplement during a period in which you also received foreign income, it is likely the case that you will have to pay some or all of these payments received back to the Old Age Security program.
However, the good news is disclosure of the income through a Voluntary Disclosure can help you save on interest and penalties incurred on the revised tax liability. In addition, you won't have to pay interest and penalties on any Old Age Security Guaranteed Income Supplement and Allowance benefits which have to be paid back.