Tax Residence and Tax Treaties
There are two factors that determine where a taxpayer pays taxes; where income is earned and where the taxpayer is tax resident. In determining whether an individual is a tax resident of Canada, his or her residential ties to Canada are considered. None of these factors are individually determinative but are instead weighed together to determine residence. The primary factors, those that have more weight in the determination of an individual's residence, are: home in Canada, spouse or common-law partner in Canada and dependents in Canada. Secondary factors include driver's license in Canada, economic ties to Canada, maintaining a Canadian passport, health insurance, bank accounts in Canada and social ties to Canada. Canada, in common with many countries, has entered into many tax treaties which contain "tie-breaker" rules for residence when a taxpayer is considered a tax resident of both countries. Canada taxes all residents of Canada on their worldwide income. Non-residents of Canada for tax purposes are taxed solely on their Canadian-source income.
Tax residence is separate and different from immigration residency. A taxpayer does not need to be a citizen or permanent resident or landed immigrant of Canada to be considered a tax resident of Canada. A taxpayer can also be a tax resident of more than one country. For example, a taxpayer who has homes in both Canada and France, has a spouse in Canada and dependents in France could be considered a tax resident of both France and Canada. This possibility of multiple tax residencies creates the potential issue of double taxation - where the taxpayer is determined to owe tax on the same worldwide income in multiple countries.
To minimize the possibility of double taxation, countries have entered bilateral tax treaties with other countries which contain a section on tax residence for individuals. These provisions set out a series of factors to deem the taxpayer to be resident of one of the two countries in cases where, without the tax treaty, the taxpayer would be considered a resident of both countries. Countries usually model these residence sections of their tax treaties after the OECD (Organisation for Economic Co-operation and Development) Model Convention With Respect To Taxes On Income And On Capital.
Unlike the domestic Canadian tax residence factors discussed above, the OECD (Organisation for Economic Co-operation and Development) Model Convention With Respect To Taxes On Income And On Capital residence factors are not analyzed collectively. Instead, they are dealt with like steps in a test. If a first factor does not allow for a determination of the taxpayer's residence, the second factor is analyzed. If the second factor does not determine residency, the third factor is analyzed. This is repeated until a determination is made.
The below discussion of the factors will be based on the OECD's above-mentioned model convention and its commentary of these factors. Taxpayers should be aware the tax treaty relevant to their circumstances may vary in wording from the model convention. Further, the OECD commentary is fairly high level and additional interpretation by local courts may be necessary to apply the factors. Taxpayers who have questions about the application of these factors to their own circumstances and interpretation of the relevant tax treaty should consult with one of our experienced Canadian tax lawyers.
Factor 1: Permanent Home
The taxpayer is considered resident of the country where the taxpayer has a permanent home available to him or her. The type of home (e.g. apartment or house) or whether the taxpayer owns, rents or has another allowance to stay in the home is not relevant. The consideration is whether the home is "permanent". The taxpayer must have established circumstances to use the home for permanent or continuous use instead of circumstances where it is evident the taxpayer only intends to remain in the home for a short duration.
Factor 2: Centre of Vital Interests
Where the taxpayer has a permanent home in both countries, the centre of vital interests is the country where the taxpayer's personal/social and economic ties are closer. The location of the centre of vital interests is determined based on where the taxpayer's family, work, club or organizations and other similar associations are located and similar activities are conducted.
If the taxpayer has no permanent home in either country, this factor is skipped.
Factor 3: Habitual Abode
Where a taxpayer has a permanent home in both countries and no clear centre of vital interests in either country, or the taxpayer has no permanent home in either country, the location of the taxpayer's habitual abode is considered. The determination of where the taxpayer's habitual abode is located is done based on time spent in each country over a period of time. The period of time must be sufficiently long to determine whether the residence is habitual and at what intervals the stays take place.
In the case of having a permanent home available in both countries, both stays at the permanent home and other locations in the same country must be considered for determining the habitual abode. Where there is no permanent home available to the taxpayer in either country, the reason for the taxpayer's stay in each country does not need to be ascertained to make a determination of the taxpayer's habitual abode.
Factor 5: Nationality
If the taxpayer has an habitual abode in both countries or neither country, the nationality of the taxpayer is considered. National is defined as an "individual possessing the nationality or citizenship" of the country in question.
Factor 4: Mutual Agreement
The final factor if no determination can be made on the basis of any of the above factors is mutual agreement by the competent authorities of each country to deem the individual a tax resident of one country or another. In Canada, the competent authority is the Canada Revenue Agency.
Variation to the Residency Factors in Specific Treaties - Example Canada- United States
As mentioned above, the OECD's Model Convention With Respect To Taxes On Income And On Capital effectively provides countries with a prototype for their own bilateral tax treaties. However, tax treaties are not required to include the exact provisions found in the model convention. The Convention Between Canada and the United States of America With Respect to Taxes on Income and on Capital, for example, varies from the above factors in two notable ways. The centre of vital interest test applies both where the taxpayer has a permanent home in both countries and where the taxpayer does not have a permanent home in either country. The treaty also does not use the term "national" but citizen. This example demonstrates the importance of having an experienced Canadian tax lawyer analyze the specific tax treaty applicable to the taxpayer's individual circumstances.
Pro Tax Tips: Residence Determinations and Residence Memoranda
Taxpayers attempting to determine to which country they should be paying tax can consider two different options for making such a determination. A residence determination is a form, or when carried out by our experienced Canadian tax lawyers, a form and accompanying explanatory letter, filed with the Canada Revenue Agency to receive a non-binding opinion from the Canada Revenue Agency about the taxpayer's residence. A residence memorandum is legal analysis drafted by an expert Canadian tax lawyer advising on the taxpayer's residence. The benefits of the residence memorandum are not notifying the Canada Revenue Agency of any tax filing errors and flexibility if the taxpayer is considering various options such as different timing for emigration. Our experienced Canadian tax lawyers regularly assist our clients by preparing both residence determinations and residence memoranda.
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.