The Importance of Determining Residence

Determining Residence - Image of a happy familySince both Canada and the U.S. impose an income tax on residents based upon their world income and since both countries have income tax laws dealing with the taxation of non-residents, it is important to understand the role that residence plays in determining the liability for income tax.

U.S. Residence Rules
Canadian Residence Rules
Residence of Both Canada and the U.S.

(a) U.S. Residence Rules

(i) Green Card Test

Under U.S. law, persons who satisfy the "green card test", including anyone who holds a permanent resident visa and others who reside permanently in the U.S. are considered taxable in the U.S. on their world income from the day they obtain their permanent resident status. Green card holders may therefore find themselves or their business interests subject to U.S. tax rules, even if the business activities or controlled business entities are outside the U.S., and foreign corporations may be subject to the Accumulated Earnings Tax, or Personal Holding Company Tax rules in the U.S. due to differences in the income tax planning, distribution.

(ii) Substantial Presence Test

Note:  The effect of unintended presence in the U.S. due to COVID-19 is discussed here.

A person who has not established a residence in but who spends a considerable amount of time in the U.S. may find that they are considered residents of the U.S. even if they do not spend 183 days or more in the U.S. in any given tax year. The time required to meet the substantial presence test is 183 days, counting all of the days in the current year, one third of the days in the first preceding year, and one sixth of the days in the second preceding year.

Year Days Present    Portion Counted    Days Included
2019 130   1/1 130
2018 126 1/3 42
2017              72 1/6 12
Total     184

The person whose situation is illustrated in Table 1 meets the substantial presence test, but may apply for exception from the substantial presence test rule by filing form 8840 (Closer Connection Exception Statement) to prove that they have closer ties to Canada than to the U.S. In order to qualify for exception, the Canadian resident must be able to establish that the usual indicators of residence (i.e. drivers license, club and religious affiliation, income, etc.) indicate stronger ties to Canada than to the U.S.

Many Canadians file form 8840 by itself with the IRS in Philadelphia as a protective measure each year, and Canadians who have U.S. source income and are required to file form 1040 NR file form 8840 along with the form 1040 NR.

(b) Canadian Residence Rules

Note:  The effect of unintended presence in Canada due to COVID-19 is discussed here.

(i) Residents of Canada

Surprisingly, there is no specific definition of residence in the Canadian Income Tax Act, but residence is determined as a question of fact. Primarily, any person who spends more than 183 days in any year in Canada is considered a resident. In other cases the court system in Canada has held that the residence of an individual is the place where he customarily lives. In determining residence, such factors as the following are taken into account:

  1. Permanence and purpose of being outside Canada. Generally, absences of less than two years are not considered sufficiently permanent to sever residential ties with Canada for tax purposes.
  2. Residential ties in Canada, including the maintenance of a home, location of dependents, investments, bank accounts, health coverage, drivers license, club memberships, professional memberships dependent on residence, personal property, vehicles, social ties, telephone listings, etc.
  3. Residential ties abroad, including visa status outside Canada, income, occupation and social ties. If a Canadian has not established a domicile in another country, he may be considered to have maintained Canadian residence. The type and duration of visas have a role in this factor.
  4. Regularity and length of visits to Canada, can establish continued residence in Canada.

Although visa status in the U.S. by itself will not determine Canadian residence, and even though immigration rules and income tax rules do not always maintain the same definitions of terms, care should be taken not to upset immigration status through an improperly planned elimination of residential ties to Canada. For example, persons working in the U.S. under the NAFTA TN visa are expected to be temporary residents of the U.S. An inability to prove an intention to return to Canada upon the expiry of the visa may affect the determination of visa status or renewal.

(ii) Deemed Residents of Canada

Persons who have sojourned in Canada for 183 days or more in any year are deemed to be residents of Canada, and must report world income on their Canadian income tax return for the year. In the year of departure from Canada, both spouses are deemed to be resident in Canada until the date of the latter of the two to depart. Care should therefore be taken to ensure that unplanned periods of tax residence in Canada are not encountered.

(iii) Deemed Non Residents of Canada

Under new interpretations of the tiebreaker rule contained in the Treaty, certain persons, after February 25, 1998, are deemed non-residents of Canada if they maintain closer connections to a country other than Canada. Persons in this category would pay tax to Canada only on Canadian source income regardless of the amount of time they spend in Canada.

(c) Residents of Both Canada and the U.S.

Many individuals may find themselves residents of both Canada and the U.S. as a result of the application of the above rules. Under dual residence circumstances, double taxation can be eliminated if filings are made on a timely and accurate basis. Contact us to find out how.