Your income tax liability in Canada depends on your country of residence for income tax purposes.
If you are resident in Canada, you are subject to tax on your worldwide income, although as discussed below, you may receive a credit for foreign tax paid on that income.
If you are not resident in Canada, you are subject to tax in Canada only on certain Canadian-sourced income.
Resident in Canada
You must report your income from all worldwide sources on your Canadian tax return. Income earned in another country must be converted into Canadian dollars on your Canadian return.
In most cases, if you earn income in or from another country and pay income tax to that other country, you will receive a foreign tax credit in Canada to ensure that you are not double-taxed.
You are a resident of Canada. You worked for a couple of months in the United States and earned employment income there. You paid C$10,000 in US income tax. You also report the income on your Canadian tax return and are initially subject to C$12,000 tax in Canada.
On your Canadian tax return, you would report the income that generates the liability for $12,000 of tax, along with a $10,000 foreign tax credit for the US tax, meaning that you would only pay $2,000 net tax in Canada.
(There may be adjustments in the foreign tax credit calculations; the above example is straightforward and does not require the adjustments.)
In some cases, you will be taxed in Canada on the foreign-sourced income, but not taxed in the other country because of Canada’s tax treaty with the other country. For example, under many treaties, if you have a capital gain on the sale of a foreign investment, you can be subject to tax in the other country only if the investment is real estate located in that country, or shares in a corporation (or interests in a trust or partnership) whose value is derived mainly from real estate in that country. Otherwise, the capital gain can be taxed in Canada but not the other country. If you carry on a business, you will normally not be taxed in the other country unless it is carried on through a “permanent establishment” in that country. Of course, not all treaties are the same, and each one needs to be considered carefully to determine the Canadian and foreign tax exposure.
Not resident in Canada
If you are not resident in Canada, you are subject to tax only on Canadian-sourced income.
First, you are subject to the regular “Part I tax” at graduated tax rates (the same as apply to residents of Canada) on the following types of income:
- Income from employment carried on in Canada;
- Income from a business carried on in Canada; and
- Taxable capital gains from disposition of “taxable Canadian property”, which includes Canadian real estate, property used in a business carried on in Canada, and shares in certain corporations (or interests in trusts or partnerships), where the value of the share (or interest) is derived primarily from Canadian real estate or Canadian resource properties.
For the above types of income, you will file a Canadian tax return and, as noted, you will pay the same graduated tax rates that apply to residents. In some cases, a tax treaty will exempt you from Canadian tax. For example, Canada’s tax treaties generally provide that you can be taxed in Canada on business income earned in Canada only if it is earned through a “permanent establishment” that you have in Canada.
Second, you may be subject to “non-resident withholding tax” on certain types of passive investment income, such as dividends, rent, royalties and income from Canadian trusts (interest paid at arm’s length is no longer subject to this tax since 2008, unless it is “participating” interest, based on profits or cash flow). In such case, a 25% withholding tax applies, which the payer of the amount must withhold and remit to the Canadian government on your behalf. You do not file a Canadian tax return and the regular Part I tax does not apply. The withholding tax is simply your final Canadian tax liability on that income.
However, the 25% rate is often reduced by treaty. For example, the withholding rate for dividends from a Canadian corporation is typically lowered to 5%, 10% or 15%, depending on the treaty and the level of shareholdings of the non-resident in the corporation.
In some cases, you can elect to have passive income reported on a tax return under the regular “Part I tax” instead of being subject to the withholding tax. For example, if you earn rental income from a Canadian rental property, you are normally subject to the 25% withholding tax on the gross amount of the rent (and Canada’s tax treaties generally do not reduce this rate). However, if you elect to file a Canadian tax return and be taxed under the regular Part I rules, you will be subject to the graduated tax rates on your net rental income (gross rent minus applicable expenses). In most cases, deducting expenses means it makes sense to make the election as the Part I tax on your net rental income will normally be much less than the 25% withholding tax on your gross rental income.
Meaning of residence
If you are resident in Canada under Canadian law, but also resident in another country under its law, and Canada has a tax treaty with that country (Canada has over 90 such treaties), then the treaty will have “tie-breaker” rules to determine which country you are resident in (generally based on which one you have closer ties to). If such a rule applies, the Canadian Income Tax Act has a specific rule that says that if the treaty makes you resident in the other country, you are deemed to be a non-resident of Canada for Canadian income tax purposes. So, as well as determining whether you are resident in Canada, you have to determine whether such a treaty “tie-breaker” rule applies.
The primary or most important residential ties to a country are:
- Location of your home;
- Where you (and your spouse, if married) are physically present; and
- Where your dependents, like your children, are physically present.
Secondary residential ties include:
- Location of your personal property (such as furniture, cars, other vehicles, boats);
- Memberships in recreational or religious organizations;
- Economic ties such as where you are employed or carry on your business, hold bank accounts, retirement savings plans, credit cards, and trading accounts;
- Landed immigrant or permanent resident status under immigration laws;
- Medical or health insurance;
- Your driver’s license; and
- Your citizenship.
Note that your citizenship is not itself determinative. That is, you can be a Canadian citizen and non-resident for income tax purposes, or a citizen of another country but resident in Canada for tax purposes.
Also, although physical presence is important, you could be physically present in another country but remain resident in Canada for tax purposes. For example, if you have lived in Canada all of your life and your employer sends you to work in an office in another country for a year, and you expect to return after the year, you will likely remain resident in Canada for that entire year.
Although there is no bright-test in the factual residency determination, there are some deeming rules that apply in limited circumstances. For example, if you “sojourn” in Canada for 183 days or more in a year, you are deemed to be resident in Canada for the entire year. “Sojourn” means to visit temporarily, such as visiting to study or work, or visiting on a vacation.