What’s Your Tax Issue? Province of Residence

The Tax Issue:

I recently accepted a job position with my current employer which will transfer  me from Toronto to Montreal. Now I love Montreal however I hate Quebec income tax and I was looking for a way to physically work in Montreal (Quebec) however keep paying taxes as a resident of Ontario.  Any advice would help.

The Answer:

Welcome to the club! We Montreal-lovers and Quebec tax-haters have been struggling with this question for years. Some of have moved away never to return. Unfortunately, loving Montreal comes with a price (and I don’t mean Carey :-)).

Individuals are subject to Canadian income taxes in the province where they reside on December 31 of any given year. Residency for income tax purposes is not a choice one makes by ticking a box on a tax return. It is a question of fact, based on your residential ties.

The most important residential ties are where your home (owned or rented) is, and where your spouse or common-law partner or dependants reside. Other ties that may be relevant include social ties, bank accounts, driver’s licence and medicare.

So, unless you’re move is temporary or you plan to commute from Toronto each day, you’re pretty much going to have to set up residential ties in Montreal and pay Quebec taxes.

If you really feel very strongly about staying out of the Quebec tax system (as a resident of Ontario you’d be saving less than 2 per cent in income tax if you’re at the top marginal bracket), you could make your home in nearby Cornwall, Ontario, which is only about a 45 minute commute from Montreal (on a Sunday Morning :-)).

2010 Budget Tax Trap

If you are a emigrating from Canada and own shares of a private company , beware of a new tax trap that awaits you.

Generally, when a Canadian become a non-resident, he is deemed to have disposed of all capital property (with certain exceptions) at fair market value. Shares of private companies are therefore subject to capital gains tax.

There are a number of rules in place to ease the transition, and avoid double-taxation when, for example, these shares are finally sold or liquidated after emigration.

One such rule is contained in section 119 of the Income Tax Act. In essence, where shares of a private company have been taxed on emigration, a credit against that tax is allowed for any further withholding taxes paid on dividends coming from that company. The credit applies when the shares are finally disposed of.

Let’s look at a simple example. In year 1, a Canadian owning shares of his holding company moves to the U.S. The only asset in the company is $100,000 cash, and his shares have a nominal cost base. Upon emigration, therefore, the shares will be subject to capital gains tax at a rate of 25%. The taxpayer pays $25,000 to the CRA.

In year 2, the company pays a $100,000 dividend to its shareholder and is then dissolved. The dividend is subject to a 15% non-resident withholding tax in Canada. The taxpayer pays $15,000 to the CRA.

As you can see, the taxpayer has now paid the CRA twice on the same $100,000, first in capital gains tax on emigration and again upon paying himself the cash.

In order to alleviate this problem, section 119 was put in place when the emigration rules were first introduced. It essentially allows a credit for the $15,000 withholding tax so all that is ultimately paid is the $25,000 capital gains tax.

Since the March 2010 federal budget, things have changed. Section 119 is available only for shares that are “taxable Canadian property”, which no longer includes private company shares in most cases.

While the elimination of most private company shares as taxable Canadian property will be a relief for many non-resident shareholders, it creates a trap for emigrating Canadian shareholders.

Now that private company shares are not taxable Canadian property, there is no credit available under section 119 and the value of a private company’s assets, as in the above example, could be subject to two incidences of tax.

A taxpayer who has already left Canada, paid capital gains tax and may have already paid dividends subject to 15% withholding tax with the intention of availing themselves of section 119 in the future is protected by grandfathering rules which provide that if you emigrated prior to March 5, 2010, any taxable Canadian property you owned at that time will remain as such after the change.

Clearly, this places an unfair burden on Canadians leaving Canada; however, the Department of Finance does not agree. They are aware of the issue and they stand by the change as a matter of policy (for now). I am just not quite sure what the policy is that intentionally creates a double-tax trap for unwary Canadian taxpayers.

What’s Your Tax Issue? Related Party Sale of Home

The Tax Issue:

Hi David,

My girlfriend (soon to be fiance) and I are seriously considering purchasing her parents home since they will be moving in six months time.  Her father has offered to sell the house to us at a price that is $40,000 below the fair market value.  It is my understanding that as long as I purchase the house from him before we are married (therefore not related for tax purposes), then there will be no tax consequences for him or myself on the transaction.  However, I’m also of the understanding that if I purchased the house from him after we were married than there would also be no tax consequences for him or myself since he would have use of his principal residence exemption which would eliminate any tax on the deemed capital gain resulting from selling the house to me at less than FMV.  Is this correct?  Also, does the fact that my girlfriend will be contributing up to half of the down payment for the house impact the transaction in any way?
I really enjoy your website, keep up the great work! Cheers!

The Answer:

You are correct when you say that the consequences to your future father-in-law are the same no matter when you make the deal. No matter what his proceeds or “deemed” proceeds are, any gain on the sale of his house will be exempt from tax (see my previous post on the principal residence exemption).

So what was your friend alluding to? Section 69 of the Income Tax Act. Let’s say the property you were purchasing was not an exempt principal residence. Section 69 contains special provisions dealing with transactions between persons who are not dealing at arm’s length. The rules are somewhat punitive in nature because they make one-sided adjustments to the price.

If the price is less than fair market value, as in your case, then the deemed proceeds to the vendor are adjusted upwards to equal that value. However, the cost to the purchaser is not adjusted and remains whatever was paid. If the price is more than fair value, the proceeds are not adjusted downward, but the purchaser’s cost is reduced for tax purposes.

So, would these rules apply to you if the sale was made before you were married? Probably, yes. The rules apply to non-arm’s length transactions. People who are related are, by definition, not at arm’s length, so if you made the purchase after getting hitched, there would be an automatic non-arm’s length situation. However, there is also a rule that states that any two people may be deemed to be not dealing at arm’s length if the facts warrant it. In your case, the facts would seem to warrant it.

Finally, the fact that your future bride is putting in part of the money won’t make any difference, because there is only one principal residence allowed between spouses, so it really doesn’t matter who makes the claim in the end, when you finally pass the property on to your kids at a generous discount, right?

Congratulations!

What’s Your Tax Issue? – Overseas Employment

The Tax Issue:

I have been offered a job working in Afghanistan for a non-Canadian company. They do not report my income or any information to any government agency and they pay once a month in US dollars. After every 10 weeks I get a 3 week holiday where they pay my way home and back. My wife and I own a home in Ontario where she resides and doesn’t work. Is there a way to legally avoid paying income tax in Canada?

The Answer:

With so much mobility in the work place these days, I get this type of question quite often. While each set of facts is different, I can make the following general comments:

Every individual who is resident in Canada for tax purposes is subject to Canadian tax on his or her world income. That should be the starting point for everyone with this issue.

The next question should be obvious: If I leave Canada to work elsewhere for a fixed period of time, am I a Canadian resident? Residency is determined by “social and economic ties”. In order to become a non-resident of Canada, you must cut those ties. The most of important of these ties are your family and your home. If you leave to work on a temporary assignment and your family stays behind in your home, then it’s clear that you are still a Canadian resident.

Once we establish that you are still subject to tax in Canada, we then look to see if there are any rules that relieve you of your tax burden. There are two places to look: The Canadian domestic law, and the international tax treaties involving Canada.

Under Canadian law, there is really only one provision that might give you a break on your taxes. It’s called the Overseas Employment Tax Credit. This is a deduction of up to $80,000 on income earned outside of Canada by an employee, but it doesn’t apply to everyone. You must be employed by either a resident of Canada or its foreign affiliate. The credit only applies to employees working outside Canada for six months or more, in connection with a resource, construction, installation, agricultural or engineering project.

The next step is to look at the country in which you are carrying out your employment. They may have their own tax rules that conflict with ours. For example, many countries will tax non-residents on their employment income, or consider you as a resident for purposes if you live there for a period of time. Normally, we would look to any tax treaty  between that country and Canada in order to resolve any double-tax issues.

So, getting back to your question, it seems clear since your family and home remain here that you are still a Canadian resident, subject to Canadian tax on your income earned in Afghanistan. Even if your earnings are not reported to any tax authority, you must self-assess and report them (converted to Canadian dollars) on your Canadian income tax return. Since your employer is not Canadian (assuming it is not a foreign affiliate of a Canadian company) then you will not qualify for any relief from the overseas employment tax credit. Finally, Canada does not have a tax treaty with Afghanistan, so any tax you may have to pay there will not be exempt in Canada; however, it should be eligible for a foreign tax credit under Canadian rules.