Articles

TAX CONSIDERATIONS - RELOCATING EMPLOYEES FROM CANADA TO THE U.S.

By Wayne Bewick CA, CFP, CPA (II)
Trowbridge Professional Corporation
Chartered Accountants | Tax Advisors

Author’s note: The purpose of this article is merely to assist in identifying some of the tax issues
that a Canadian individual may face while working in the U.S. Since the tax implications of
Canadians working in the U.S. will vary based on an individual’s specific circumstances,
professional tax advice should be sought before acting on any information provided in this
article.

With the continued increase in globalization comes the need for an internationally transportable
workforce. The mobility of key talent is crucial for keeping global companies ahead of their
competitors. 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 them self and their family
as well as 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 company?

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 U.S. The tax
implications of a relocation should be considered well in advance of the employee commencing
work in the U.S. 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 U.S., 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 U.S.: 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 U.S. but either
returns home on the weekends or only stays in the U.S. for a few weeks at a time. This type of
business traveler tends to keep their personal belongings, permanent residence and family in
Canada and generally maintain their 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 6 months or two years, it will usually involve the transferee being in the U.S. for extended
periods of time, with infrequent returns to Canada. They may or may not keep their 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 their Canadian
residential ties since there is an expectation that the individual will not return to Canada. In this
instance, the individual ceases their Canadian residency status for tax purposes.

There are various tax issues involved for each of the three situations discussed. 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 U.S. 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
they maintain their home in Canada and have the majority of their economic, personal and social
ties in Canada. Even if an individual moves to the U.S, they may still be considered a Canadian
resident for tax purposes if they maintain any of their primary residential ties.

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

U.S residency

Unlike the Canadian residency rules, the U.S rules for determining an individual’s residency
status are clearly stated under U.S. law. Under U.S. 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 U.S immigration status is the determinant for the first residency test. For an
individual who is a “green card” holder or permanent resident, they are deemed to be a U.S.
resident from the first day they are present in the U.S. with a valid green card. The consequences
for employees with green cards are that they have to file U.S. returns on which they must include
their worldwide income on a yearly basis. Even if an employee who worked in the U.S. and
obtained a green card returns to Canada, they will still have to file U.S. returns on an annual basis unless they rescind their 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 U.S. for 183 days or more during a calendar year will be regarded as a U.S. resident for part of the year.  This test is to be applied on a cumulative basis. An individual who is present in the U.S. 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 U.S. 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 U.S. and Canada for tax purposes.  This may lead to the individual having to file both Canadian and U.S tax returns, including their worldwide income on both, unless treaty protection is available under the Canada-U.S. Tax Convention. Although there are provisions in the Canada-U.S 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 their Canadian residency, (some short-term assignee
individuals and permanent transfers) they are deemed to have disposed of all their 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 RRSP’s, RRIF’s, DPSP’s, and RESP’s, 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 30th 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 30th filing deadline. If the tax arising on the deemed disposition is in excess of $25,000, adequate security must be provided to the CCRA. 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 their departure from Canada if the property is sold prior to their 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, they are 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 their 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 their home during their absence from Canada which should also
be addressed by the employee, but is beyond the scope of this article.

RRSP issues

Under the Canada-U.S. tax treaty, RRSP accounts can continue to grow tax free in both the U.S.
and Canada until disposed. A beneficiary of a Canadian RRSP may elect to defer the U.S.
taxation of income earned in the RRSP until such time as a distribution is made from the plan. As
previously discussed, RRSP’s 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 U.S. 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
U.S., 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 U.S. 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 U.S. 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.

Wayne is a Tax Advisor with Trowbridge Professional Corporation, Chartered Accountants | Tax Advisors, and specializes in both Canadian and U.S. taxation. The firm focuses on international tax services for Canadians and Amricans around the world. For further information on their firm and the services they provide, you can contact them at their Toronto office at (416) 214-7833, visit their website at www.trowbridgepc.ca , or email Wayne at wayne.bewick@trowbridgepc.ca

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