Introduction
Your status as a tax resident determines the extent to which Canada taxes your income. While Canada taxes its residents on worldwide income, it taxes non-residents only on income derived from Canadian sources. Tax residence is crucial for determining your obligations. Interestingly, your tax residency does not necessarily correlate with immigration status. This article focuses on part-year residence, the tax implications of such a status, and the Canadian rules that apply when individuals change their residence.
Becoming a Canadian Tax Resident
Tax residence in Canada is determined in one of two ways: common-law residence or deemed residence. Both scenarios are important for understanding your tax obligations.
Common-Law Tax Resident (Factual Resident)
In Canada, the term "resident" isn’t explicitly defined in the Income Tax Act, but Canadian courts interpret it under common law. The Supreme Court of Canada, in its 1946 decision in Thomson v. Minister of National Revenue, outlined that tax residence is determined by where an individual regularly and customarily lives. Factors that courts examine include:
- Life habits and routines,
- Length and frequency of visits,
- The individual’s ties to Canada and elsewhere,
- The permanence of a stay abroad.
Not all jurisdictional ties hold equal weight. For example, having a dwelling, spouse, or dependents in Canada are considered strong indicators of tax residence.
Deemed Resident: The Sojourner Rule
Under the sojourner rule in paragraph 250(1)(a) of the Income Tax Act, an individual who spends 183 days or more in Canada during a tax year is deemed to be a tax resident for that entire year. This rule makes it clear that a person’s physical presence in Canada for more than half the year will result in Canadian tax residency, regardless of their regular living situation.
Ceasing Canadian Tax Residency
The rules for losing Canadian tax residence mirror the rules for becoming a resident. This can be based on common-law tests or deemed non-residence through tax treaties.
Losing Residence Under Common Law
Whether a person is still a tax resident under common law depends on their individual circumstances, including the ties they maintain to Canada. However, courts have found that the significance of ties to Canada is less when determining whether someone is no longer a resident compared to determining if someone has become a resident in the first place.
Deemed Non-Residence
Subsection 250(5) of the Income Tax Act deems a person to be a non-resident if a tax treaty between Canada and the individual’s new country of residence designates that country as their tax home. This rule allows for a part-year residence, where an individual is considered a Canadian resident for part of the year, depending on the applicable tax treaty.
Part-Year Residence in Canada
When an individual moves in or out of Canada, subsection 250(5) helps prevent them from being taxed as a resident of both Canada and another country. If a person is deemed non-resident under a tax treaty, they are treated as a part-year resident, allowing them to avoid double taxation. The sojourner rule does not apply in such cases, as subsection 250(5) overrides it, enabling part-year residence.
Tax Consequences of Part-Year Residence
Part-year residents of Canada must consider several tax consequences, including the reporting of worldwide income for the part of the year they were a Canadian tax resident.
Worldwide Income Reporting for Part-Year Residents (Section 114)
Under subsection 2(1) of the Income Tax Act, part-year residents are taxed on their worldwide income during the period they are Canadian residents. However, Section 114 provides relief by allowing part-year residents to exclude foreign income earned while they were non-residents. The sojourner rule, however, doesn’t provide this relief, meaning that if it applies, worldwide income must be reported for the entire year.
Deemed Disposition upon Change in Residence (Section 128.1)
Section 128.1 of the Income Tax Act treats a change in residence as a deemed disposition of most property. For individuals emigrating from Canada, this results in a departure tax on capital gains. However, this also allows immigrants to benefit from a tax bump on non-Canadian capital property, which is helpful in adjusting the cost of such assets for Canadian tax purposes.
Foreign Reporting Rules (Sections 233.1 to 233.6)
When a person becomes a Canadian resident, they must report certain foreign assets and interests, including:
- T106 for business transactions with related non-residents,
- T1141 for transfers to non-resident trusts,
- T1135 for specified foreign property ownership,
- T1134 for foreign affiliates,
- T1142 for distributions from non-resident trusts.
Failure to file the required forms may result in penalties, with maximum penalties reaching $12,000 in cases of gross negligence. It’s important to comply with these rules to avoid substantial fines.
Conclusion
The determination of tax residency, especially in the context of part-year residence, has significant tax implications. Part-year residents are required to report their worldwide income during their residency period and must also account for deemed dispositions. For anyone navigating the complexities of Canadian tax residence, especially in cases of emigration or immigration, consulting with a Canadian tax lawyer is crucial to ensure compliance and mitigate tax risks.
This article is written for educational purposes.
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