Under the Income Tax Act (the "ITA") of Canada, Canadian residents are subject to income tax on all worldwide income. On the other hand, non-residents are only subject to tax on income tied to Canadian sources. Although this may sound straightforward, determining your liability and extent of liability can be complicated and the consequences for failing to comply can be significant. Here is a list of some important considerations:
(1) Are you a “Canadian resident” for the purposes of taxation? Determining residency goes beyond looking at your passport or immigration status. In some cases, persons who are living in Canada but are citizens of another country may be considered to be Canadian residents for income tax purposes. Similarly, persons who work outside of Canada or live outside Canada but retain connections to Canada may still be considered to be “Canadian residents” for income tax purposes.
(2) What is “worldwide income”? The definition of “worldwide income” encompasses all income and capital gains regardless of its source. This would include all Canadian income, plus all foreign income such as employment income earned outside of Canada, rental income from property outside of Canada and investment income from foreign accounts. This applies even if the money is reinvested outside of Canada or is never brought to Canada, and even if the country where the income is earned has taxed it too.
(3) Will I be subject to “double taxation”? A Canadian resident may be required to report and pay Canadian tax on foreign income that is already being taxed in the source country. To avoid double taxation, the ITA allows for a tax credit for foreign income tax paid. In addition, there are tax treaties between Canada and other countries which may contain relieving rules. Such rules might minimize the impact of being taxed in two countries.
(4) Immigration and the “deemed disposition rules”. On the date that a person becomes a resident of Canada, that person is deemed to have disposed of and immediately re-acquired all of their property and investments for an amount equal to the fair market value of that property and those investments (subject to certain exceptions). This creates a new “cost base” on the date that the person becomes a resident of Canada; and therefore, the person is not taxed on gains that arose before the person was a resident of Canada. As a result, the person is only subject to Canadian tax on the appreciation in that value that occurs after the person is a resident of Canada.
(5) Emigration and the “deemed disposition rules”. Similar to the rule above, on the date that a person ceases to be a resident of Canada, that person is deemed to have disposed of and immediately re-acquired all of their property and investments for an amount equal to the fair market value of that property and those investments (subject to certain exceptions). This results in a “deemed disposition” for Canadian income tax purposes on the date that the person ceases to be a resident of Canada triggering Canadian tax on gains that arose while the person was a resident of Canada. As a result, a person may have a significant liability for Canadian tax (a departure tax) when they cease to be a resident of Canada even though they haven’t sold anything. Therefore, it is very important to know if a person has ceased to be a resident of Canada and exactly when a person has ceased to be a resident of Canada in order to avoid an unexpected tax bill. The main exception to this rule arises where the property will continue to be subject to Canadian taxation when the non-resident sells such property (e.g. real estate in Canada).
(6) Foreign investment property reporting requirements. If a person owns foreign investments or foreign investment property and the total cost of all of those foreign investments and properties is more than $100,000 (in Canadian dollars), a special form (T1134, T1135) must be filed with the Canada Revenue Agency each year and ownership of those investments and properties must be reported. The reporting of ownership of foreign assets is separate from the reporting of income arising from such foreign assets. This is not well understood and is often missed. As a result it is possible for a person to believe they have complied with all tax rules because they have reported the income received from foreign assets on their tax return. However, they also have to report the ownership of those foreign assets on a separate form. Additionally, the obligation to report the ownership of foreign assets on a separate form exists regardless of whether or not any income is earned from such foreign assets. The consequence of failing to report such ownership is not income tax but rather steep penalties for failing to report ownership – and those penalties apply for each year that the reporting of ownership was not made. This reporting requirement extends to all foreign bank accounts, shares in foreign companies, interests in non-resident trusts, real estate investments outside Canada, and generally all holdings outside of Canada (e.g. gold coins, bars, etc.). It is important to note that reporting income earned from foreign assets does not automatically report ownership of the foreign assets themselves.
(7) Potential liability in penalties for failure to report. Taxation in Canada is based on self-reporting and depends on full disclosure. Therefore, failing to file or making false statements or omissions in tax returns can lead to significant penalties. Penalties are increased significantly where the conduct is deliberate or negligent. The most shocking aspect of the penalty rules is that the penalties for a mere failure to report arise regardless of whether the person owes tax. Consider the impact on a couple who may owe tens of thousands of dollars in penalties for failure to report the ownership of foreign assets even though that couple may have had no income from those assets! Consider further the impact on the couple if they did receive income from the assets, had reported such income each year and paid the proper amount of Canadian tax on those foreign investments, but they still owe large penalties for failure to report ownership of the assets themselves! If you are in that situation, you should seriously consider contacting me to see if you qualify under the voluntary disclosure program (amnesty program) before you are caught.
Part two of this article, Determining Residency for Canadian Taxation Purposes, will explore how residency is determined and how the law defines a “Canadian resident” for taxation purposes. You can find it in next month’s issue of Legal Alert.
Tom Fellhauer heads up the Tax Group at Pushor Mitchell LLP. You can contact Tom at (250)869-1165, or at [email protected]
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