Understanding Dual Residency and Tax Treaty Tie-Breaker Rules

It is possible for a taxpayer to be a resident of two countries, which can lead to the issue of double taxation. To address this, Canada has established tax treaties with numerous countries, allowing for the determination of residence for tax purposes in order to avoid double taxation.

Starting from 1998, the regulations outlined in a tax treaty may take precedence over the rules specified in the Income Tax Act.

The tax treaties between Canada and other countries determine how income should be taxed if it is earned in one country while the taxpayer resides in another. These treaties set limits on taxation rates or allocate exclusive taxing rights to either country.

Factors That Determine the Tax Home of an Individual:

The "Tie-Breaker Rules" in Tax Treaties

Under certain circumstances, an individual can be considered a resident of both Canada under the Income Tax Act and another country based on the provisions of a tax treaty.

In such cases, the Residence Article in the tax treaty includes "tie-breaker rules" that help determine in which country the individual should be considered a resident for the purposes of the treaty.

If the tie-breaker rules are applied and it is determined that the individual is a resident of the other country according to the tax treaty between Canada and that country, then for the Income Tax Act, the individual will be deemed a non-resident of Canada.

This means that the individual's tax status and obligations in Canada will be adjusted accordingly based on the outcome of the tie-breaker rules in the tax treaty.

"Permanent Home Test"

The purpose of the tie-breaker rules found in many modern income tax treaties is to address residency issues. These rules, typically outlined in Article IV, paragraph 2, give priority to the "permanent home" test when determining an individual's residency for treaty purposes.

According to this test, an individual is considered a resident of the country where they have a permanent home available to them, regardless of whether they own, rent, or occupy it permanently.

In cases where an individual maintains two permanent homes while living outside of Canada, such as a rented residence abroad and a property they own in Canada that remains available for their use, the "permanent home" test alone may not be sufficient to determine residency.

In such situations, the tie-breaker rules in most tax treaties turn to the "center of vital interests" test.

"Center of Vital Interests" Test

The "center of vital interests" test considers various factors to determine an individual's residency, including:

• Personal and economic ties.
• Family and social relationships.
• Occupation.
• Habitual abode.

The objective of this test is to identify the country with which the individual has the strongest personal and economic connections.

By applying these tie-breaker rules in tax treaties, it is possible to determine an individual's residency status for treaty purposes. This helps prevent double taxation and ensures that appropriate taxation is applied based on their actual residency.

"Center of Vital Interests" Test

The "center of vital interests" test requires a thorough evaluation of an individual's personal and economic connections with each country under consideration to determine which country has stronger ties.

The personal and economic ties examined are similar to those used to determine factual residence for Canadian income tax purposes.

If the "center of vital interests" test provides an inconclusive result, the treaty then considers the concept of "habitual abode."

"Habitual Abode"

Based on the above-mentioned tests, if residency cannot be determined, the treaty considers the individual to reside in the country where the individual maintains their habitual abode.

"Nationality"

If the individual has a habitual abode in either country or neither country, they will be considered a resident of the country of which they are a national.

The citizenship of the individual provides the tie-breaker.

"Competent Authorities"

If the individual is a dual citizen or is not a citizen of either country, the CRA may be asked to determine the individual's status.

This may be done using the form "Determination of Residency Status" – NR74 E.

Example

Scenario:

Steven, a U.S. citizen, entered into a five-year employment agreement with Hudson's Bay Company and relocated to Canada on May 15th. He possesses a valid work permit for the next five years and intends to pursue Canadian immigration.

Being single, he currently resides in a rented apartment in Toronto, while retaining ownership of an apartment in New York that remains accessible for his personal use.

Based on these circumstances, how should he proceed with filing his taxes? Additionally, is he eligible to claim moving expenses?

Answer

To determine whether Steven is a Canadian resident, the following factors need to be considered:

Physical Presence

Steven has been present in Canada since May 15th and has been residing in a rented apartment in Toronto. Although he still has property available for use in New York, he has been primarily staying in Toronto since his arrival.

Habitual Abode

Since May 15th, Steven has been consistently present in Canada for work, except for a short vacation during Christmas. His business interests have been primarily located in Toronto.

Social Connections

Steven attends Church regularly and has developed friendships in Canada. He also maintains regular contact with his cousins. On the other hand, he has limited contact with his previous friends in New York.

Nationality

While Steven's U.S. citizenship is a relevant factor, based on the information provided, it is not necessary to rely solely on nationality to determine his residency.

Based on the above-mentioned information, it is not necessary to go further to confirm that Steven is considered a resident of Canada for tax purposes.

Implications of Canadian Residency

• Steven became a Canadian resident as of May 15th and would be considered a part-year resident.
• He must declare his worldwide income starting May 15th.
• His non-refundable credits will be prorated based on the number of days he was in Canada.
• Steven cannot claim moving expenses because he was a non-resident before the move.
• Steven must also file a U.S. tax return because he is a U.S. citizen.