Tax Considerations on Emigrating from Canada

Every year, Canadians make the choice to leave Canada and take up residency elsewhere. Before emigrating, however, it is imperative to consider the Canadian tax implications of ceasing to be a resident of Canada.

This article provides an overview of some of the more common Canadian tax issues, including severing residential ties with Canada, Canadian exit tax, and certain tax planning opportunities prior to emigrating.

Determining Canadian Residency

Determining Canadian tax residency is a critical step in emigration planning and should not be overlooked. While Canadian tax residents are taxed on their worldwide income, non-residents of Canada are only taxed on their income from Canadian sources, such as income and gains from Canadian real estate, Canadian source employment and business income, and non-resident withholding tax on certain passive investments (such as dividends and non-arm’s length interest).

Canada is a “sticky” jurisdiction as it relates to residency. This means that once an individual is a resident of Canada, unless they take certain steps to cut their residential ties, the Canada Revenue Agency (the “CRA”) may continue to consider them a Canadian tax resident and subject them to tax on their worldwide income.

In determining Canadian residency for individuals, it is necessary to apply a two-part test. First, it is necessary to consider whether the individual is factually resident or statutorily deemed resident in Canada. Second, it is necessary to consider whether a tax treaty applies to deem the individual to be a resident of a foreign jurisdiction and not resident in Canada.

Part One: Factual Residence and Statutory Deemed Residence

In determining whether someone remains factually resident in Canada, Canadian common law looks to certain “primary” and “secondary” residential ties that the individual continues to have with Canada.

The “primary”, or the most significant, residential ties an individual can have with Canada, are:

• A dwelling place available for their use;

• Spouse or common law partner; and

• Dependents.

Less significant, or “secondary”, residential ties can include (a) personal property in Canada (such as furniture, clothing, automobiles, and recreational vehicles), (b) social ties with Canada (such as memberships in Canadian recreational or religious organizations), (c) economic ties with Canada (such as employment with a Canadian employer and active involvement in a Canadian business, and Canadian bank accounts, retirement savings plans, credit cards, and securities accounts); (d) a Canadian driver’s license, (e) a Canadian passport, (f) memberships to social clubs and religious institutions and (g) telephone listings, amongst other factors.

Secondary residential ties are considered collectively and, generally, no one secondary tie alone will be determinative of Canadian residency.

The primary and secondary ties mentioned above are listed and used by the CRA in Form NR73 to determine an individual’s Canadian tax residency status.

Accordingly, when leaving Canada, it is necessary to consider whether the individual has sufficiently severed their residential ties with Canada. Such steps can include selling or leasing their home on a long-term basis on arm’s length terms, closing banking and investment accounts or ceasing to be a member of their local synagogue, church or country club.

Even if someone does not have sufficient residential ties to be considered factually resident in Canada, they may still be statutorily deemed resident of Canada. The most common example of a deemed resident is someone who sojourned in Canada for 183 days or more in any given calendar year.

Part Two: Treaty Tiebreaker rules

If an individual is factually or deemed resident in Canada under Canadian domestic law, they may be deemed to be a non-resident of Canada if they are resident in another country and not resident in Canada under the terms of a tax treaty.

Residency tie-breaker rules in a tax treaty will apply where an individual is a resident of Canada and resident in another country under each country’s domestic laws. While the residency tie-breaker rules may differ from treaty to treaty, most treaties include the following tie-breaker test:

1. Permanent home test. Generally, the permanent home test states that an individual will only be a resident of the country in which the individual has a permanent home available to them. This dwelling place could be rented or owned. Importantly, it is the availability of the home that is relevant rather than its size or the nature of its ownership or tenancy.
   

2. Centre of vital interests. Where an individual has a permanent home available to them in both jurisdictions, the individual’s tax residency will be determined based on the country to which they have closer personal and economic ties. Personal and economic ties include the individual’s family and social relations, occupation, political, cultural or other activities, place of business, and the place from which they administer their property.

If an individual’s residence cannot be determined based on the foregoing factors, certain treaties consider further tie-breaker rules, including the individual’s habitual abode and nationality. In instances where residency still cannot be determined, residency is generally determined by mutual agreement between the countries (otherwise known as competent authority procedure).

When planning to emigrate from Canada, it is generally preferable for the individual to avoid ambiguity and structure their affairs in a way that clearly maintains residency in only one jurisdiction.

Canadian Departure Tax

Subject to certain limited exceptions, upon emigrating from Canada an individual is deemed to have disposed of all their assets, resulting in capital gains tax. However, this does not necessarily mean that an individual leaving Canada should liquidate all of their assets prior to departure.

Certain assets are exempt from departure tax and an individual may also elect to defer their departure tax to a much later date (provided that adequate security is provided to the Canadian government).

Exceptions: Assets not Subject to Canadian Departure Tax

While not exhaustive, the following is a list of common exceptions to the general departure tax rule:

• Canadian real estate: directly held Canadian real estate is not subject to departure tax. This exception allows an individual to retain his house and directly owned rental properties without incurring a tax liability when leaving. However, the CRA will tax the real estate on the full gain when it is eventually disposed of (the CRA ensures Canadian tax on the disposition of Canadian real property through the “section 116” withholding procedure). This exception does not extend to real estate owned by a corporation, the shares of which are still subject to Canadian departure tax. Moreover, in relying on this exception for their personal home, individuals should be wary that keeping their personal home may result in the CRA considering them to remain factually resident in Canada (see “Determining Canadian Residency”, above). It is therefore necessary to take a holistic view when planning for emigration.

• Registered accounts: investments in an RRSP, RRIF, RESP, TFSA and FHSA are all exempt from Canadian departure tax.

• Interest in a trust: interests in certain trusts, including most discretionary interests in inter-vivos family trusts are exempt from departure tax.

• Property of a Canadian business: property (including capital property, intangible property and inventory) of a business carried on in Canada through a permanent establishment is not subject to Canadian departure tax. These assets, however, will generally be subject to Canadian capital gains tax once they are sold.

Importantly, the above noted exception for Canadian real estate does not apply to real estate situated outside of Canada, which is still subject to Canadian departure tax. While tax paid to the other country on an eventual sale of the real estate may be credited against the Canadian federal departure tax, a difference in tax rates between Canada and the other country and the timing of the eventual sale may lead to adverse tax and cash flow consequences.

Deferring the Departure Tax Obligation

Individuals can also elect to defer their departure tax obligation. If the departure tax obligation exceeds a certain monetary threshold (the federal threshold is $16,500 and the provincial threshold varies from province to province), security will need to be posted with the Canadian government prior to April 30 of the year after which the departure occurred. This process can involve submitting a deferral application, certain CRA prescribed forms, negotiating and entering into a security agreement with the Canadian government and the production of certain other documentation including opinions, financial statements and valuation reports.

The CRA is willing to accept certain forms of security, including letters of credit, a mortgage on Canadian real estate or public company shares. The CRA may also accept private company shares as security for the emigration tax arising as a result of the deemed disposition of those shares.

Planning Opportunities

In addition to deferring the departure tax, depending on the assets owned by the departing individual, there may be tax planning opportunities to reduce the individual’s Canadian tax liability both prior to and after emigration. This section only covers some of the planning opportunities and considerations when departing Canada. When planning, it is also critical that the tax laws and rates of the destination country are considered.

Individuals that own a privately held company may be able to take advantage of certain tax attributes of the private company, including the corporation’s capital dividend account, the eligible and non-eligible refundable dividend tax on hand account and the general rate income pool balance to maximize tax savings on distributions both before and after leaving Canada. For example, capital dividends (up to the corporation’s capital dividend account balance) paid by the corporation to the individual while they are still resident in Canada will not be subject to tax, but those same dividends will be subject to non-resident withholding tax if they are paid post-departure. Another planning opportunity arises if the shares of the corporation are “qualified small business corporation” shares, since the individual may also be able to utilize their lifetime capital gains exemption to reduce their departure tax obligation.

Individuals who invest in Canadian real estate through a corporation may also be able to take advantage of certain tax planning opportunities that would allow the individual to credit the withholding tax on dividends paid from the corporation post-departure against the individual’s departure tax obligation on exit, when the shares of the corporation are ultimately disposed of (on death, a winding-up of the company or sale of the shares). This will require careful planning as the shares of the corporation will need to be “taxable Canadian property” and remain as such until they are ultimately disposed of. Depending on the type of investments and other assets contained in the corporation, planning could be done to take advantage of this credit.

Depending on the tax bracket of the individual and the available contribution room in their registered accounts, they may also be able to take advantage of the difference in tax rates (including the deduction received on the contribution, the withholding tax rate on a subsequent withdrawal from the account and the destination country’s tax laws and rates) to reduce their tax liability prior to their departure.

Conclusion

To conclude, there are many factors and tax saving opportunities that individuals should consider before leaving Canada, which vary from one individual to the next.  A tax professional can advise on the different structures and opportunities that may be available to individuals before making the move.