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Canadian Taxation of Nonresidents

Now that you are living in the US and have exited Canada, you are subject to Canada’s nonresident tax rules, which is Part XIII of the Income Tax Act (ITA). The Income Tax Act of Canada is divided into 17 parts that consist of tax laws related to the reporting of income, the calculation of taxes as well as collection and enforcement procedures. We will only be concerned with two of those parts, Part I having to do with income tax, and Part XIII having to do with the taxation of income of Canadian nonresidents.

As Canadians, you are most familiar with Part I of the Income Tax Act, which is the authority for requiring the filing of income tax returns, the computation, the calculation of income tax, and its enforcement. Since this book is not on the taxation of Canadians in Canada, but is instead a book on the taxation of Canadians in the US, we will not be discussing Part I of the act but will instead focus on Part XIII of the Income Tax Act of Canada, titled, “Taxation of Income from Canada of Nonresident Persons.” Canadians living in the US will almost always be nonresidents of Canada and therefore subject to Part XIII for income earned in Canada.

Part XIII imposes a withholding tax on income paid to non-residents of Canada. These amounts include pensions, annuities, management fees, interest, dividends, rents, royalties, estate or trust income, and film or acting services. The default withholding percentage is 25 percent unless the amount is reduced by the Treaty. The current Treaty came into force in 1984 and there have been numerous changes since that time which are referred to as Protocols (amendments). The Treaty provides withholding rates for all types of income. The withholding rates range from 0 percent (not taxable) to 25 percent (no reduction in the default withholding rate).

The Canada Revenue Agency (CRA) provides an online calculator for determining the correct withholding. The problem we found with it is that it assumes you know the meaning of the terms used. For example, the drop down menu asks if the income item is a lump-sum or a periodic payment. These items have specific definitions and if you choose the wrong item, you will get the wrong answer. Here is the site www.cra.gc.ca/partxiii-calculator.

1. Who Is Considered a Nonresident of Canada?

Section 250 of the Income Tax Act (ITA) provides the definitions of resident and nonresident. You are a nonresident of Canada if you reside in another country (the US) or do not have residential ties to Canada and you live outside of Canada throughout the year or you stay in Canada for less than 183 days in a year. The exception to this would be if you live outside of Canada because you are an employee of the government of Canada. For example, an employee of the Ministry of Foreign Affairs who works at a Canadian consulate outside of Canada would be classified as a resident of Canada along with his or her spouse and family members that reside with him or her outside of Canada. Other examples would be members of the Canadian Forces or those working under a Canadian International Development Agency (CIDA) program. These types of individuals would be classified as “deemed residents” of Canada. A deemed resident of Canada also includes those who spend more than 183 days in Canada in a year and are not considered a resident of another country under a tax treaty. All these individuals would be taxed in Canada on their world income.

Note: The Treaty forces you to be a resident of one country or the other; you cannot be a resident of both countries or a nonresident of both countries, assuming you are not a resident of another country.

Residential ties refer to numerous factors that have been developed through case law over the years. These primary factors include the following:

• Home in Canada

• Spouse and dependents in Canada

• Personal property such as a vehicle or furniture in Canada

• Social ties in Canada would include items such as membership in golf clubs or membership in religious organizations

Other secondary factors would include:

• A driver’s license issued by a province or territory in Canada

• Bank accounts and/or investments accounts in Canada as well as Canadian credit cards

• Health insurance with a Canadian province or Territory

The Treaty includes provisions that determine in which country you are a resident. These include tie-breaker rules to help determine your residency. (This is discussed in more detail in Chapter 3.)

This chapter deals with persons that are specifically nonresidents of Canada and earning income from Canada. As a nonresident of Canada you will pay tax on income received from sources in Canada. The type of tax you will have to pay and the requirement to file a Canadian income tax return will depend on the type of income received.

Nonresidents of Canada are subject to tax under Part I or Part XIII of the Income Tax Act. You will be subject to Part I tax and will have to file a Canadian tax return if you receive the following types of income:

• Income from employment in Canada or carrying on a business in Canada

• Receipt of Canadian scholarships, fellowships, bursaries, and research grants

• Income from providing services in Canada other than in the course of employment

• Disposing of certain Canadian property

If you receive income from Canada that is subject to Part XIII tax, you do not need to file a Canadian income tax return. However, in some limited situations, it may be advantageous to file a Canadian return and pay tax under Part I of the ITA. There are three situations in which the nonresident can elect to file a tax return (which is discussed later in this section).

Part XIII tax is withheld (deducted) by the payer; you receive the net amount, after tax. Canadian payers, including financial institutions, must deduct Part XIII tax and remit it to the CRA. In most cases, the Part XIII tax is the final tax liability to Canada on this income and no additional reporting is required in Canada, assuming the correct amount of tax was withheld.

It is your responsibility to notify your financial institutions and the government that you are a nonresident of Canada so that they can withhold the correct amount of tax. If you fail to notify them and no tax is withheld (or not enough tax is withheld), you are responsible for the extra tax, but more importantly, you will be subject to penalties and interest for underpayment of tax. We recommend sending a letter or email stating that you are a nonresident rather than simply calling. If there is a dispute, you will have proof that you told the institution and it now becomes the institution’s responsibility if the tax is not withheld.

The most common types of Canadian source income that is subject to Part XIII tax include:

• Dividends

• Rental and royalty payments

• Pension payments

• Retiring allowances

• Registered Retirement Savings Plan payments

• Registered Retirement Income Fund payments

• Annuity payments

• Management fees

It should be noted that interest income received or credited to a nonresident is exempt from Canadian Part XIII tax as long as the payer is unrelated to the nonresident; this is referred to as an arm’s length transaction. Canada Pension Plan (CPP), Quebec Pension Plan (QPP), and Old Age Security (OAS) are also exempt from withholding per the Treaty.

Part XIII tax is not refundable. You do not file an income tax return unless you are in one of the three situations you can elect to file a return. You can obtain a refund of Part XIII tax, only if an incorrect amount was withheld. An example of a situation where this happens is when a financial institution withholds 30 percent on a RRIF payment instead of 15 percent. If a situation like this happens, you will need to file Form NR7-R (Application for Refund of Part XIII Tax Withheld) to obtain a refund. Filing the NR7-R is a long procedure and it can take CRA in excess of a year to process the NR7-R and issue the refund. It is wise to be in contact with the payer ahead of time to ensure that the payer is indeed withholding the correct amount of Part XIII tax.

The first of the three exceptions to filing a Canadian tax return under Part XIII relates to the receipt of rental income earned from a property situated in Canada. Under Part XIII the tenant or manager of the property should remit 25 percent of the gross rental received or credited to the nonresident. This tax is due by the 15th of the month following the date the rent was received or credited to the nonresident. Any late payments of the Part XIII tax will incur interest charges. Under the usual rules of Part XIII the payment of this tax would end your tax obligation to Canada. An annual reporting form NR4 (Statement of Amounts Paid or Credited to Nonresidents of Canada) would be issued to the nonresident indicating the gross rents earned and the Part XIII tax that was remitted to the CRA on behalf of the nonresident.

However, you can elect to file under Section 216 of the Income Tax Act to pay tax on the net rental income (after deducting rental expenses) rather than the gross rents. When you elect under section 216, you are electing to file a “special” return that is known as a “216 return.” The return is due by June 30 of the following year. A late-filed 216 return may invalidate the election and thus you would owe Part XIII tax of 25 percent of the gross rental income instead of paying Part I tax on the net rental income.

In order to have Part XIII tax withheld on your net rental income, you must have an agent who could be any Canadian resident who acts on your behalf regarding the rental property. The NR6 (Undertaking to File an Income Tax Return by a Nonresident Receiving Rent from Real Property or Receiving a Timber Royalty) is due on or before January of each year or before the first rental payment is due. The NR6 would include an estimate of the upcoming year’s gross rental income and an estimate of the upcoming year’s rental expenses. The NR6 must be signed by the nonresident as well as by his or her agent prior to sending it to the CRA. After it’s approved, you must file the Income Tax Return for Electing Under Section 216 (Form T1159) return to report your rental income and pay any tax due; the return must be filed by June 30 of the following year.

The second exception is for actors. If you are an actor living in the US and working in Canada, Part XIII says any nonresident individual or a foreign corporation related to that individual that provides acting services in Canada for a film or video shall have 23 percent of any amount paid withheld and that amount will be the final tax liability to Canada for those acting services. The withholding applies to fees for acting services, per diem payments for days in Canada, and similar benefits. This withholding is not required for reasonable travel expenses paid directly to third parties such as hotels and airlines and reasonable travel expenses reimbursed to the actor as long as they are supported by receipts.

As an actor, you can elect to file a return on a net Canadian source acting income at graduated individual or corporate rates instead of paying 23 percent tax on the gross income. In other words, you will be allowed to deduct acting expenses from your gross acting income and pay tax on the net income earned from your acting while in Canada. The amount withheld will be credited so that you or the corporation can receive a refund of any excess tax withheld.

The return is called a 216.1 return and is due by April 30 for individuals, or if you are self-employed, by June 15. However, if there is any tax due, it is due by April 30 even though the return does not have to be filed until later. If the entity is a corporation, the return is six months from the fiscal year end. If this return is filed late, then the election is invalid and the tax of 23 percent on the gross income from acting would be due.

We recommend that if you intend to file this return and make the election so as to pay tax on the net income from acting, that you apply to the CRA prior to providing the acting service in Canada, so that you can have the withholding rate reduced.

The third exception to filing a return is by filing a 217 election. There are only certain types of income eligible for a section 217 election and they are as follows:

• Old Age Security

• Canada Pension Plan

• Quebec Pension Plan

• Most superannuation and pension benefits

• Most registered retirement savings plan payments

• Most registered retirement income fund payments

• Death benefits

• Certain retiring allowances

• Registered supplementary unemployment benefit plan payments

• Most deferred profit-sharing plan payments

• Amounts received from a retirement compensation arrangement

• Prescribed benefits under a government assistance program

• Auto Pact benefits

Note: Because the withholding on these payments are typically 15 percent, you must report it on Schedule A (Statement of World Income). While your world income is not taxed, the world income is used to determine the allowable federal nonrefundable tax credits. If your world income is too high, you will have no tax credits and you will pay more under a 217 return than the withholding tax.

If you intend to file a 217 return on income, but it is not yet time to file it, you can apply to have CRA reduce the Part XIII tax. You will need to file an Application by a Nonresident of Canada for a Reduction in the Amount of Nonresident Tax Required to be Withheld (Form NR5) on or before October 1 or before the first payment to the nonresident is due. If the NR5 is approved by the CRA then the individual must file a section 217 return for each year of the approval period.

The CRA will use the information given on the form NR5 to determine if the election will be beneficial. If it is, the CRA will authorize the Canadian payer to reduce the amount of Part XIII nonresident withholding tax.

2. Selling Property in Canada

Although not subject to Part XIII tax, the balance of this chapter will deal with nonresidents of Canada selling property in Canada or more specifically, taxable Canadian property. Taxable Canadian property includes the following:

• Canadian real or immovable property

• Life insurance policies in Canada

• Canadian resource property

• Canadian timber resource property

• Depreciable property that is taxable Canadian property

• Business property used in Canada, shares of a private corporation where more than 50 percent of the fair market value was derived from any of the above mentioned during the previous five years, and shares of a public corporation where at any time in the previous five years the taxpayer holds more than 25 percent of the issued shares and derived more than 50 percent of its fair market value from any of the above mentioned.

The sale of other types of property, most commonly securities, is only taxable in the country of residence, per the Treaty. The exception to this is that US citizens are taxable on their world income and will therefore have to report the sale of securities on their US tax returns, even if they are living in Canada.

The CRA should be notified of the sale of taxable Canadian property in advance of the sale, but they must be notified no later than ten days after the closing of the sale. This usually happens when you receive a signed agreement on the sale of your property and a request is made to the CRA for a Certificate of Compliance Related to the Disposition of Taxable Canadian Property. When making this request, you report the selling price of the property, and the adjusted cost base of the property. The adjusted cost base would be the amount paid for the property and all subsequent improvements made to the property. All of the details regarding the sale price and adjusted cost base should be sent with the request. After CRA has reviewed the request, it will then request payment of 25 percent of the estimated gain, rather than 25 percent of the gross sales price.

If the Certificate of Compliance has not been received by the time the sale is completed, the lawyer for the vendor must withhold 25 percent of the purchase price in a trust account until the Compliance Certificate is received.

You must still file a Canadian tax return under Part I of the Income Tax Act of Canada for the year in which the sale took place. When you file, include any costs of disposition such as legal fees, real estate commissions, accounting fees, etc. This would normally result in a tax refund since these items are not included in the filing for the Compliance Certificate.

It should be noted that if the property was the taxpayer’s principal residence, these procedures are still required. A principal residence is a housing unit normally inhabited by the taxpayer. A taxpayer who emigrates from Canada can designate a principal residence until he or she is no longer a resident of Canada. The effect of this is that there will be no capital gains tax on any accrued gains of a principal residence until the taxpayer emigrates from Canada; any gains accrued after his or her exit from Canada will be taxable.

If you are selling your former principal residence, you will designate that property as such in the request for the Compliance Certificate, so that a portion of the gain will be tax exempt. The problem is how will the CRA know the appreciation occurred after you emigrated from Canada? The answer is that the CRA won’t unless you have documentation as to what the property was worth on or around the time you emigrated. The easiest way to document the value is to have one, or preferably three real estate agents provide you with a broker’s opinion as the value of the home. We recommend that you do this as close to the date emigration as possible.

Note: Complications can arise when you have a typically large lot, including farms, or where you rented your home after you emigrated. Consult with a tax specialist before you sell the property so that you can estimate the tax consequences before the sale.