COVID-19 and Tax Residence Rules

Many people find themselves in circumstances where their ability to return to their home country is impaired by travel restrictions, border closings, illness and other effects of COVID-19.  Since the tax rules of both Canada and the United States are designed to levy tax on world income in the event that presence in country exceeds certain thresholds, many people could find that their inability to return home may result in an inadvertent classification as tax resident.  A tax resident of either Canada or of the United States is generally required to declare world income, and may also be subject to other information return filings as required by residents.  An inadvertent classification as a tax resident of either country could result in substantial tax cost and administrative compliance obligations.

In recognition of the potential hardship which may be faced by individuals and companies inadvertently classified as tax residents due to COVID-19 conditions or restrictions, each of the United States and Canada have provided the following guidance in an attempt to alleviate this possible problem.

United States - New Residence Rules Established due to COVID-19:

Exclusion of Up To 60 Days from U.S. Presence:

Internal Revenue Code section 7701(b) provides that a person who is other wise a non resident alien is considered a resident of the United States if the substantial presence test is met.  Generally, a person will meet the substantial presence test if the number of days in the U.S. in the year exceeds 183 in any one year, or if the sum of days of presence in the U.S. for the current year, plus 1/3 of the days in the prior year plus 1/6 of the days in the second prior year exceeds 183.  

New Revenue Procedure 2020-20 provides that a qualified individual may exclude up to 60 days of presence in the United States during the period February 1, 2020 to April 1, 2020 (COVID-19 Emergency Period) on condition that:

  • The person was in the United States during the COVID-19 Emergency Period;
  • That the substantial presence test was not otherwise met outside of the COVID-19 Emergency Period;
  • That the person was a non resident alien at the end of 2019, and
  • That steps have not been taken to become a permanent resident of the U.S. and the individual is not a legal permanent resident at any time in 2020.

If the above conditions are met, the person is presumed to have intended to depart from the U.S. but was prevented from doing so due to COVID-19, regardless of whether they had the disease.

A person who is otherwise required to file form 1040NR must also file Form 8843, [Statement for Exempt Individuals and Individuals with a Medical Condition] to claim this exemption.  If a form 1040NR is not required, form 8843 does not need to be filed.  However, it may be prudent for affected individuals to file a protective form 1040NR and Form 8843 to establish intent to apply these provisions for 2020.

Effect on Treaties:

Many Treaties which the United States has entered into with other countries base taxation in the U.S. on the number of days a person was present in the U.S.  For example, Article VII (Business Profits) and Article XV (Income from Employment) contain exemptions which are based on the number of days of presence in the U.S.  For the purpose of applying Treaty benefits, the exemption contained in Rev. Proc 2020-20 may be applied.

U.S. Trade or Business:

Non resident alien individuals, corporations and partnerships are subject to tax in the United States on their "U.S. Trade or Business" activities.  In many cases, the number of days of presence in the U.S. is a determining factor when deciding whether an entity has a U.S. Trade or Business.  Under the COVID-19 Emergency Period rules, up to 60 days of presence in the U.S. may be excluded in counting days of presence in the U.S.

Effect on the Foreign Earned Income Exclusion:

Normally, a U.S. citizen who establishes that they are physically present in a country other than the United States for at least 330 out of any 365 day period is entitled to an exemption of a limited amount of foreign earned income from U.S. taxation.  Revenue Procedure 2020-27 recognizes that travel restrictions and other conditions which arose as a consequence of COVID-19 may have resulted in a person being required to return to the U.S. prior to satisfying the required physical presence period.  Rev. Proc 2020-27 provides that a person who was present in a foreign country prior to the onset of the pandemic and who intended to stay abroad for at least a year, and who was required to return to the U.S. as a result of COVID-19 will be allowed to claim a foreign earned income exclusion and housing exclusion for any 12 month period in 2019 and 2020.

By way of example, if a person begins a foreign assignment on September 1, 2019 and reasonably expected to remain abroad for a year, and was required to return to the U.S. on March 31, 2020 would be able to claim a foreign earned income exclusion for September 1, 2019 to December 31, 2019 on their 2019 return, and for the period January 1, 2020 to March 31, 2020 on their 2020 return, notwithstanding that the full 330 days of foreign presence have not been completed.

Canada - Tax Residence Rules Modified by COVID-19

Many aspects of taxation in Canada are determined by residence, and residence may be determined by the amount of time spent in Canada.  Accordingly, due to the restrictions on travel imposed by Canada and other countries as a result of COVID-19, Canada has issued the following guidance which is applicable for the period March 16 through August 31, 2020.  This period may be extended in the future if deemed necessary.

Residency for Tax Purposes:

Individuals:

Although there is no definitive single factor which defines tax residence in Canada, Canada uses a common-law principle to determine residence.  When an individual is present in Canada for over 183 days in any year, or sojourns in Canada, they will be deemed to be tax residents of Canada and therefore taxable in Canada on world income.  If an individual was in Canada when the COVID-19 restrictions commenced, they may be unable to return to their home country, and as a result may spend over 183 days in Canada in the year.

Canada Revenue Agency (CRA) will not count the days present in Canada as a result of travel restrictions during the relevant period as days of presence in Canada in the determination of residence.  However, other factors which may determine residence would be considered on a case by case basis.

Corporations:

A corporation is normally considered to be resident where its "central management and control" is located, and in many circumstances the location in which meetings of the board of directors takes place is a determining factor.  Under the COVID-19  imposed travel restrictions it may be impossible to hold directors meetings abroad, and the meetings may need to be held in Canada because one or more directors are present in Canada.

Although a corporation may still be considered a resident of Canada even if directors meetings are held abroad, where central management and control is deemed to be in Canada, CRA will not determine that a corporation is resident in Canada solely because directors meetings are held in Canada during the COVID-19 period.

Carrying on Business Through a Permanent Establishment In Canada:

Non residents of Canada are required to pay tax in Canada on income earned through a permanent establishment in Canada.  Canada's treaties with various countries define the extent of connection to Canada necessary for the determination of a permanent establishment.  It is possible that a non resident entity engages individuals to work outside of Canada, but due to COVID-19 travel restrictions the employees may be required to perform their services in Canada.

CRA has taken the position that it will not determine that an entity is carrying on business in Canada solely because employees conduct their activities in Canada during the COVID-19 period.

Cross Border Employment:

U.S. Resident Employees:

A United States entity with U.S. resident employees often sends employees to work in Canada.  Article XV of the Canada U.S. Income Tax Convention exempts the employee from taxation in Canada if they work for a U.S. entity and do not spend over 183 days in Canada in any twelve month period (or earn under $10,000 while in Canada).  Under the COVID-19 travel restrictions, otherwise exempt individuals may spend over 183 days in Canada, thus subjecting their income to taxation in Canada.

CRA will not determine that an employee who otherwise meets the conditions of Treaty Article XV is taxable in Canada due to an extended stay during the COVID-10 period.

Canadian Resident Employees Working in the U.S.:

A U.S. employer may engage residents of Canada to travel to the U.S. and to perform employment duties in the U.S.  Under such conditions the employer would be required to withhold U.S. federal and applicable taxes and to report them on a form W-2.  During the travel restrictions imposed during the COVID-19 pandemic, certain Canadian resident employees may be required to perform their duties from Canada.  Normally under these conditions the employer would be required to withhold Canadian tax since the work is performed in Canada.

During the COVID-19 period, CRA will not require a U.S. employer who normally engages employees to work in the U.S. but has employees working from Canada to withhold Canadian tax.

Waiver Requests:

Non resident withholding tax must be withheld and remitted in cases where a non resident performs services in Canada.  In cases where the payment is exempt from tax under Regulation 102 (Non resident providing office or employment services in Canada) or Regulation 105 (Non resident providing services in Canada) a waiver may be applied for to exempt the foreign entity from the requirement to remit non resident withholding tax.

Since CRA has delayed or closed its processing of Regulation 102 and 105 waiver applications during the COVID-19 period, urgent Waiver Requests may be submitted electronically on a temporary basis.

Where an applicant has shown that they have taken reasonable steps to apply for a waiver, and one has not been issued within 30 days, CRA will not assess the applicant for failure to withhold and remit non resident withholding tax.

Certificate for Non Resident Disposition of Canadian Real Property:

A non resident who intends to sell Canadian real property must apply for a Section 116 Certificate to calculate and remit any required non resident withholding tax.  The application for a certificate must be made within 10 days of the sale of a property. 

Since CRA has delayed, closed, or increased its processing times for Section 116 Certificates due to COVID-19, in cases where an application has been submitted but not processed a request may be made for a comfort letter to advise the purchaser, vendor and representatives to hold withheld funds pending processing of the certificate.