Tax Considerations in Canada-US Relocation

With the continued increase in globalization comes the need for an internationally mobile workforce. The mobility of key talent is crucial for keeping ahead of the competition. Unfortunately, finding talented individuals that are able and willing to relocate is a difficult task, due to the numerous issues that both the employee and the company face. Among the most important questions: Is the employee willing to relocate both self and family, as well as to adapt to a new environment for the foreseeable future? How much immigration difficulty will be faced in sending an employee to another country? What costs are involved? Given that expatriates can cost as much as three times (or more) the rate of local hires, is the return on the investment worthwhile for the employer?

Although these are all significant issues, there are also vital tax concerns faced by both the employee and the company when contemplating having the employee work in the US. The tax implications of relocation should be considered well in advance of the employee commencing work in the US as a part of the initial strategy in determining whether a particular employee is a good fit for a transfer. In reality, the tax issues are often not considered far enough in advance, if at all, and this invariably leads to problems. Where the tax issues are not properly managed before the employee begins work in the US, both the employee and the company can incur significant additional tax costs.

In order to meet the needs of the company and the employee, there are typically three scenarios under which Canadians work in the US: the intermittent or frequent business traveler, the temporary assignee, and the employee who permanently relocates. Each situation can have varying tax implications and understanding the diverse consequences can be quite complex.

The intermittent or frequent business traveler is an individual that works in the US, but either returns home on the weekends or only stays in the US for a few weeks at a time. This type of business traveler tends to keep her personal belongings, permanent residence, and family in Canada, and generally maintains her Canadian residency status for tax purposes.

The temporary assignee is typically an individual that relocates for a specified time or project, but generally intends to return to Canada when the time period or project is complete. Whether it is for six months or two years, it will usually involve the transferee being in the US for extended periods of time, with infrequent returns to Canada. He may or may not keep his family, residence, and belongings in Canada. In this situation, the employee may or may not continue to be a Canadian resident for tax purposes. There is often significant tax planning opportunities for the temporary assignee, especially if ceasing residency is an option.

The permanent relocation scenario is somewhat self-explanatory. It generally involves the individual obtaining a permanent residence abroad, as well as breaking most of her Canadian residential ties, since there is an expectation that the individual will not return to Canada. In this instance, the individual ceases her Canadian residency status for tax purposes.

There are various tax issues involved for each of the three situations mentioned above. However, the most common issues to be considered and the ones to be addressed here are:

1. Determining residency status from both a Canadian and US perspective;
2. The tax implications of selling or renting their principal residence;
3. Deemed dispositions and the related departure tax; and
4. Registered Retirement Savings Plan (RRSP) issues.

Canadian Residency

For Canadian tax purposes, the concept of residency is an important one, since Canada imposes tax on the worldwide income of its residents. Therefore, whether an individual is a resident of Canada or a non-resident of Canada is central to determining the overall tax liability of the individual. The disparity in the individual's tax liability is greater when the individual is relocating to a lower tax jurisdiction.

Canadian residency is a difficult concept, in that it is a question of fact, and is largely based on an individual's demonstrated intentions. An individual is considered to be a resident of Canada if he maintains his home in Canada and has the majority of his economic, personal, and social ties in Canada. Even if an individual moves to the US, he may still be considered a Canadian resident for tax purposes if he maintains any of his primary residential ties.

If the employee is in a position to cease Canadian residency for tax purposes, depending on the facts of the situation, the person may be able to lower her worldwide tax liability, depending on what state and tax rate she is subject to in the US. In these situations, the employee should have a discussion with a tax professional who deals with expatriate tax issues to determine if it is possible for her to become a non-resident for tax purposes and if so, to outline the necessary steps to be taken to achieve this.

US Residency

Unlike the Canadian residency rules, the US rules for determining an individual's residency status are clearly stated under US law. Under US law, there are two objective tests that are used for determining if an individual is considered to be a resident for income tax purposes. An individual's US immigration status is the determinant for the first residency test. For an individual who is a "green card" holder or permanent resident, he is deemed to be a US resident from the first day he is present in the US with a valid green card. The consequences for employees with green cards are that they have to file US returns on which they must include their worldwide income on a yearly basis. Even if an employee who worked in the US and obtained a green card returns to Canada, he will still have to file US returns on an annual basis unless he rescinds his green card, which is another tax implication that should not be taken lightly. This annual filing requirement can be quite costly to the employee.

The second test is called the "substantial presence test." Generally, an individual who is present in the US for 183 days or more during a calendar year will be regarded as a US resident for part of the year. This test is to be applied on a cumulative basis. An individual who is present in the US during the current year and the two preceding years for a weighted average of 183 days or more, will be regarded as a resident. An individual must be physically present in the US for any part of at least the 31 days during the current calendar year and 183 days during the current and two preceding calendar years, counting the sum of all the days of physical presence in the current year, one-third of the number of days of presence in the first preceding year, and one-sixth of the number of days of presence in the second preceding year.

This is the test that typically catches the intermittent business traveler and short-term assignee, and results in the individual being considered a resident of both the US and Canada for tax purposes. This may lead to the individual having to file both Canadian and US tax returns, including her worldwide income on both, unless treaty protection is available under the Canada-US Tax Convention. Although there are provisions in the Canada-US treaty designed to avoid double taxation, there are still instances in which double taxation can occur. Therefore, careful planning is necessary to avoid this undesirable situation.

Deemed Dispositions and Departure Tax

In instances where an individual ceases Canadian residency (some short-term assignee individuals and permanent transfers), he is deemed to have disposed of all his capital property, other than certain specific property, for its fair market value on the date they ceased to be a Canadian resident. The intent of the deemed disposition rules (commonly referred to as "departure tax rules") is to ensure that the appreciation of the capital property owned by a Canadian while a resident of Canada is subject to Canadian capital gains tax. The property that is excluded from the departure tax rules are: real property situated in Canada, pensions and retirement savings vehicles such as RRSPs, RRIFs, DPSPs, and RESPs, employee stock options, rights to benefits under most employee benefit plans, interests in Canadian trusts that were not acquired for consideration, and life insurance policies in Canada (other than segregated fund policies). The reason for this is that Canada retains the right to tax this property even if its owner is a non-resident of Canada.

The tax owing on a deemed disposition is due by April 30 of the calendar year following the year of departure, which is the normal filing date for Canadian tax returns. The individual can elect to defer the tax owing on the deemed disposition, without interest, and pay it when the property has been sold or otherwise disposed of. The reason for the deferral is that the tax owing could be burdensome if funds are not readily available to the taxpayer. This is often the case, given that the assets on which the deemed disposition has occurred have not actually been disposed of. This deferral is possible only if an election is filed with the Canada Revenue Agency (CRA) by the April 30 filing deadline. If the tax arising on the deemed disposition is in excess of $25,000, adequate security must be provided to the CRA. Providing the security is sometimes an issue for the employee, and a determination should be made before the employee relocates as to who will be responsible for providing this security, the taxpayer or the employer.

Principal Residence

There should be no immediate tax implications with respect to an individual's principal residence as a result of her departure from Canada if the property is sold prior to her departure. However, if the principal residence is eventually sold by the relocating employee (relevant to some short-term assignee individuals and permanent transfers) as a non-resident of Canada, the person is required to file certain forms in order to notify the CRA of the disposition and request a clearance certificate. In addition, a withholding tax of 25% of the estimated taxable capital gain, if any, must be remitted along with the required forms at the time the clearance certificate is requested. Typically, the individual's lawyer or legal counsel files this form on her behalf at the time of sale.

Where no clearance certificate is obtained prior to the disposition, the purchaser is required to withhold and remit 25% of the gross house sale proceeds. Therefore, it is important to ensure a clearance certificate is obtained. There are also various issues and required tax filings when a Canadian non-resident rents out his home during his absence from Canada, which should also be addressed by the employee, but is beyond the scope of this article.

RRSP Issues

Under the Canada-US tax treaty, RRSP accounts can continue to grow tax-free in both the US and Canada until disposed. A beneficiary of a Canadian RRSP may elect to defer the US taxation of income earned in the RRSP until such time as a distribution is made from the plan. As previously discussed, RRSPs are not subject to the deemed disposition rules and, accordingly, there is no additional tax owing upon departure from Canada (relevant to some short-term assignee individuals and permanent transfers).

Funds that are withdrawn from an RRSP by a non-resident of Canada in the US will be subject to withholding tax at a rate of 25%. Since the 25% withholding tax rate can be significantly lower than the individual's marginal tax rate in Canada, some tax planning opportunities should be considered when contemplating withdrawing amounts from an RRSP. An additional concern for employees who are ceasing their Canadian residency is the loss of RRSP contribution limit room as RRSP contribution room is based on earned income and can only be created by residents of Canada.

Conclusion

Since it is impossible to cover every conceivable tax issue faced by an employee relocating to the US, we have only briefly outlined some of the more common ones. For this reason, as part of the initial process in determining whether an individual should be sent to the US to work, it is important to consider how this decision will affect the employee's personal tax situation. This should be done well before an individual commences any work in the US in order to minimize the costs to both the employee and employer. A specialized tax accountant should be consulted to assist in determining the best course of action, to minimize both the current and future tax liabilities, and to also minimize any duress that could be caused from any non-compliance with the relevant taxation authorities.

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