Tax Residence in Canada: Part-Year Residence – A Canadian Tax Lawyer’s Analysis

Introduction – The Significance of Tax Residence

Your status as a tax resident determines the extent to which Canada may tax your income. Canada taxes its residents on their worldwide income. Canada taxes a non-resident’s Canadian-sourced income. In particular, Canada taxes a non-resident’s income from: (1) employment in Canada; (2) carrying on a business in Canada; or (3) disposing of a taxable Canadian property.

Notably, tax residence is unrelated to residence for immigration purposes. You can be a Canadian tax resident even if you aren’t a Canadian permanent resident or citizen. Similarly, you can be a Canadian citizen or permanent resident yet fail to be a Canadian tax resident.

This article discusses the possibility of being a part-year resident in Canada and the Canadian tax implications flowing from part-year residence.

For more information on determining your status as a tax resident, see our article “Tax Residence in Canada – Are Significant Residential Ties Less Significant for Immigrants to Canada than for Emigrants from Canada?”

For information on the tax residence of a corporation, see our article “Determining the Residence of a Corporation for Tax Purpose”

When Do You Become a “Resident in Canada” for Income-Tax Purposes?

An individual—i.e., a natural person—can become a tax resident in one of two ways. You can be a common-law resident (i.e., a factual resident), or you can be a deemed resident.

Common-Law Tax Resident (i.e., Factual Resident)

Although Canada’s Income Tax Act uses the terms “resident” and “ordinarily resident,” it doesn’t define either one. So, Canadian courts bear the responsibility of defining residence for tax purposes. Since Canada’s judiciary subscribes to the common-law system, the court definition of tax residence is often called “common-law residence.” (It’s also referred to as “factual residence” because the common-law analysis calls for a comprehensive exam of the individual’s circumstances.)

In its landmark 1946 decision, Thomson v Minister of National Revenue, the Supreme Court of Canada defined a taxpayer’s tax residence variously as: “the place where in the settled routine of his life he regularly, normally or customarily lives”; and “the degree to which a person in mind and fact settles into or maintains or centralizes his ordinary mode of living.”

In other words, your particular circumstances determine whether you’re a Canadian tax resident under common law. So, a court may examine any of the following factors (and then some):

• Past and present life habits;
• Regularity and length of visits in the jurisdiction asserting residence;
• Ties within that jurisdiction;
• Ties elsewhere; or
• The permanence or purposes of a stay abroad.

Not all jurisdictional ties are given equal weight. Courts and the Canada Revenue Agency both consider some residential ties more significant when discerning whether you’re a tax resident—e.g., your having a dwelling place, spouse, or dependent in the jurisdiction.

Deemed Resident: The Sojourner Rule

The sojourner rule—located in paragraph 250(1)(a) of the Income Tax Act—will deem you to have been a Canadian resident for the entire tax year if you “sojourned” in Canada for 183 days or more in that year.

You sojourn if you visit. So, unlike a common-law resident, a sojourner need not either have a “settled routine” in Canada or “customarily live” in Canada.

Your physical presence in Canada for just over half a year will thus brand you a Canadian tax resident for that entire year.

When Do You Cease to be a Canadian Tax Resident?

The rules for losing your status as a Canadian tax resident mirror those for becoming a Canadian tax resident. You can lose tax residence under the common-law test, or you can be a deemed non-resident.

Losing Residence under Common Law

Again, your particular circumstances determine whether you’re a Canadian tax resident under common law. And courts will examine the above-mentioned factors (among others) when deciding whether you’ve sufficiently cut ties with Canada so as sever tax residence.

Interestingly, some tax jurisprudence suggests that a home, spouse, or dependent in Canada proves far less significant when determining whether a foreigner has become a Canadian tax resident than when determining whether a Canadian-born individual has severed residence upon leaving Canada. For more details, see our article “Tax Residence in Canada – Are Significant Residential Ties Less Significant for Immigrants to Canada than for Emigrants from Canada?”

Deemed Non-Residence: Subsection 250(5)

Subsection 250(5) of the Income Tax Act deems a person to be a non-resident in Canada if a Canadian tax treaty renders that person a tax resident of Canada’s treaty partner.

But unlike the sojourner rule in paragraph 250(1)(a), which, if it applies, deems you to be a resident throughout the year, subsection 250(5) only deems you to be a non-resident starting from the particular time that you were a resident of another country per a tax treaty.

Canada’s tax treaties typically contain an article on residence. The treaty residence article will initially defer to each country’s domestic tax law. That is, the tax treaty will consider a person to be a tax resident in the country whose domestic tax laws assert jurisdiction to tax the person’s worldwide income on the basis of domicile, residence, place of management, or some similar criterion. If, however, each country’s domestic tax laws make this claim, the treaty sets out tie-breaker rules to identify only one country as the person’s tax residence.

The deemed non-residence rule in subsection 250(5) overrides the sojourner rule. As a result, subsection 250(5) gives rise to the possibility of part-year residence.

Part-Year Residence

When a person moves into or out of Canada, subsection 250(5) offers redress from the possibility of being a tax resident and thus paying tax on worldwide income in two countries throughout the year. If it weren’t for subsection 250(5), the sojourner rule would declare you a Canadian tax resident for the entire year—despite how thoroughly you severed ties to the country—so long as you departed after 183 days from the beginning of the year. Because subsection 250(5) both operates from the particular time that you qualify under a tax treaty as a resident of Canada’s treaty partner and overrides the sojourner rule, it allows a person to be a part-year tax resident in Canada.

In addition to part-year residence under subsection 250(5), you may also be a part-year tax resident under common law. This is mostly relevant where the sojourner rule doesn’t apply and Canada doesn’t have a tax treaty with the taxpayer’s country of immigration or emigration.

Part-year residence or a change in residence gives rise to various Canadian tax consequences and reporting requirements. The following sections discuss three of these consequences: (1) part-year worldwide income reporting; (2) deemed dispositions; and (3) foreign-reporting rules.

Part-Year Worldwide Income Inclusion for Part-Year Residents: Section 114

Subsection 2(1) of the Income Tax Act taxes “every person resident in Canada at any time in the year.” As a result of subsection 2(1), a part-year Canadian resident is liable to Canadian tax on worldwide income throughout the entire year.

This is obviously harsh. And it discourages cross-border worker mobility.

Section 114 provides relief by allowing a part-year resident to exclude from taxable income all foreign income earned while a Canadian non-resident.

Still, section 114 only applies to a part-year resident in Canada. And if you spend 183 days or more in Canada, the sojourner rule deems you to be a Canadian resident throughout the entire year. So, if the sojourner rule applies, you’re unfortunately required to report your worldwide income throughout the entire year on your Canadian tax return.

By implication, section 114 is only relevant where either:

• the sojourner rule doesn’t apply and the taxpayer is a part-year Canadian tax resident under the common law; or
• the taxpayer is a part-year Canadian tax resident as a result of a tax treaty and subsection 250(5).

Otherwise, a part-year tax resident’s Canadian tax returns may need to report worldwide income from throughout the year. (Foreign tax credits may provide relief from double taxation.)

Deemed Disposition on Change in Residence: Section 128.1

When a taxpayer changes residence, section 128.1 deems a taxpayer to have disposed of and immediately reacquired most property for fair market value. These rules may cause a taxpayer to incur Canadian tax liability for capital gains upon emigrating from Canada—in other words, a departure tax. Likewise, these rules provide a Canadian immigrant with a bump in the tax cost of non-Canadian capital property.

Foreign-Reporting Rules: Sections 233.1 to 233.6

Canadian immigrants often maintain property or business interests in their home countries. As a result, if they become tax residents in Canada, they will need to report these interests when filing Canadian tax returns.

Canada’s Income Tax Act contains five basic rules requiring a Canadian resident to report either a business transaction involving a foreign party or an interest in foreign property:

• Section 233.1 requires a Canadian resident to file a T106 if the resident entered a business transaction with a related non-resident.
• Section 233.2 requires a Canadian resident to file a T1141 if the resident transferred or loaned property to a non-resident trust or similar entity.
• Section 233.3 requires a Canadian resident to file a T1135 if the resident owns or has an interest in “specified foreign property.”
• Section 233.4 requires a Canadian resident to file a T1134 if the resident has a “foreign affiliate.”
• Section 233.6 requires a Canadian resident to file a T1142 if the resident is a beneficiary of—and receives a distribution from—a non-resident trust.

Notably, these reporting rules do not hinge upon tax liability. That is, these rules obligate a Canadian taxpayer to report a foreign interest regardless of whether that interest generates income that is taxable in Canada.

The Income Tax Act provides a first-year resident in Canada with some relief: section 233.6 exempts certain first-year resident individuals from the reporting requirements of sections 233.2, 233.3, 233.4, and 233.6.

A steep penalty may apply if you fail to file a required foreign-reporting form with your tax return.

For more details on these foreign-reporting rules, see our article “Canada’s Foreign Transaction Reporting Rules.”

Tax Tips – Obtaining Certainty with Residence Status or Relief for Unreported Foreign Transactions or Property

If you misconstrue your tax-residence status, you may erroneously under-report or over-report your Canadian taxable income. Under-reporting your taxable income may lead to monetary penalties, while over-reporting may result in excessive Canadian tax liability.

A residence-determination request is one measure for obtaining certainty when preparing your Canadian tax return. You can submit a residence-determination request to the Canada Revenue Agency using Form NR73 (Determination of Residency Status – Leaving Canada) or Form NR74 (Determination of Residency Status – Entering Canada). In response, the CRA will provide you its opinion on your status as a Canadian tax resident.

Still, the CRA’s opinion is only as reliable as the details you provide. And the CRA’s administrative view doesn’t always correspond with Canada’s tax law. As a result, your residency-determination application must not only frame the relevant facts but also bring attention to the case law favoring your position. Otherwise, the CRA agent appraising your residence-determination application might render an unfavorable decision based on CRA publications yet contrary to tax law.

Our experienced Canadian tax lawyers can provide you with advice on your status as a tax resident in Canada or prepare your residence-determination application to ensure that it contains the needed factual and legal analysis.

Furthermore, a change in your residence status may result in tax liability for a deemed capital gain or a potential penalty for failing to file a foreign-reporting information return (e.g., T1134, T1135, T106, T1141, or T1142).

These reporting requirements don’t hinge upon tax liability. So, many taxpayers consider them to be unimportant. But the Income Tax Act imposes steep penalties on taxpayers who fail to file an information return per the foreign-reporting rules. For example, a simple failure to file can result in a penalty of up to $2,500 plus interest. But if the failure to file constitutes gross negligence, the maximum penalty can reach $12,000. Moreover, an additional 5% penalty may apply if a T106, T1141, or T1135 is over 24 months late. A T1135 form is due if you own specified foreign property with a cost of $100,000 or more. So, if you’re over 24 months late in filing a T1135, your minimum penalty is $5,000.00 per outstanding year.

An application under the Voluntary Disclosures Program (VDP) may allow you to avoid these penalties. Contact one of our expert Canadian tax lawyers to discuss whether a voluntary disclosure is a viable option.

Author: Kevin Persaud