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As we move from warm cottage weather to the colder gusts of wind and eventual snowfalls that are non-negotiable staples of the Canadian climate, many retirees gear up to migrate temporarily across the border to escape the cold.
These retirees, informally known as "snowbirds", are individuals who reside in Canada for the majority of the year, and then reside temporarily in places like the southern United States for the rest of the year.
As such, it is crucial that snowbirds (and other temporary relocators) consider the impact of the Income Tax Act (the "ITA") on questions of residency and taxation of income.
Different Types of Residents and Non-Residents
Under Canadian tax law, you can be a factual resident, a deemed resident, or a common law resident.
A factual resident is someone who has significant residential ties with Canada, which, among other things, includes having a residence in Canada, a spouse in Canada, and/or dependants in Canada.
A deemed resident, per section 250(1)(a) of the ITA, is someone who lived in Canada during the tax year for 183 days or more in a calendar year.
When an individual has connections both inside and outside Canada, and the deemed residency rules fail to provide a clear answer, the common law can be used to determine whether an individual can be considered a resident of Canada for tax purposes. This is referred to as being a "common law resident."
The leading common law guidance on questions of residency is Thomson v. Ministry of National Revenue, which stands for the proposition that residency is determined by examining whether an individual maintains a "settled connection" or "continuing state of relationship" with Canada.
Common law residency is also supported by the Canada Revenue Agency's ("CRA") Income Tax Folio S5-F1-C1, which outlines key factual indicators that can be used to establish common law residency.
For snowbirds, the categorization is mostly clear: snowbirds are, by and larg,e residents of Canada and therefore will have Canadian tax rules apply to their worldwide income. However, it is not out of the realm of possibility that snowbirds may sometimes be non-residents.
Non-residents are normally, customarily or routinely living in another country and not considered residents of Canada. They lack significant residential ties to Canada because they lived outside the country throughout the tax year or stayed in Canada for less than 183 days. Non-residents of Canada are only taxed on Canadian-source income.
Taxation of income becomes more intricate for both residents and non-residents once passive income is involved.
Taxation of Passive Income
Passive income refers to any income that a person earns without actively participating in the business or activity that generates it. This can include investment income, rental income, capital gains, dividends, and pensions.
For residents, taxation of passive income earned in Canada is straightforward: all of it is reported on the Canadian tax return. This includes income earned abroad, for example, when snowbirds rent out a property they own in Florida, when they are not occupying the premises.
For non-residents, taxation of passive income becomes more nuanced in that it then follows the procedures set out under Part XIII of the ITA. All passive income earned by non-residents is subject to a 25% withholding tax, per section 212(1). This means that as a non-resident, 25% of your Canadian passive income is withheld and sent to the CRA before you receive it. Other countries use the same mechanism; for example, the United States has a withholding tax rate of 30%.
Treaty with the United States to Reduce Withholding Tax
Recognizing that withholding tax rates can be excessive when applied on top of regular individual progressive tax rates, the Canadian government entered into bilateral tax treaties with other countries, including the United States, to reduce overall tax liability owed for cross-border residents.
For example, if you are a Canadian resident who owns property in Florida that earns rental income, not only will you owe taxes to the Canadian government based on your individual progressive rate, but also to the United States at its 30% withholding tax rate. This exposes you to unreasonable double taxation.
The bilateral treaty steps in to address and eliminate this problem.
Article XXIV of the United States bilateral treaty applies to ensure that Canada provides you with a foreign tax credit for the 30% tax paid to the United States. As a result, you will only be liable for Athe merican tax rate.
Following our previous example, this would mean that your rental income earned will be taxed by the United States at 30%, but the individual progressive rate taxes you owe Canada will be offset by the foreign tax credit, effectively cancelling out your Canadian tax liability.
You can also make certain elections to the CRA or Internal Revenue Service in the United States to reduce your tax liability even further, depending on your circumstances.
Understanding your Canadian tax residency status and the protections afforded by bi-lateral tax treaties is essential for snowbirds and other individuals with cross-border ties. With strategic tax planning, you can minimize the risk of double taxation, ensure compliance on both sides of the border, and make the most of your retirement or investment income abroad.
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.
