To Reside or Not - A Taxing Question Part II

Part II of To Reside or Not - (Part I)

If this sounds like I am only talking about having a house in Palm Springs, Cape Coral, or Phoenix, be assured, it doesn't stop there. It also applies to shareholdings of U.S. companies. If you own U.S. securities or stock (which have to go through a U.S. transfer agent to be sold or transferred), you are also in trouble. The same rules and rates apply even if you have never been to the U.S. and the stock is in a safety deposit box in Regina, or your broker is holding it for you in St John's, Newfoundland.

If your only U.S. asset is less than $1,250,000 U.S. stock there is a special exemption in the new treaty. There would not be any U.S. estate tax in this case.  However, if you owned $100,000 worth of U.S. stock located in Canada and a $100,000 condominium in the U.S., you would have to file a 706NA estate tax return plus a state return if the property was in a state with an estate tax.

Right now, we are having trouble getting stocks released from two transfer agents in the U.S. because they want an estate tax clearance from the IRS.

If that isn't confusing enough so far, on the other hand, "money on deposit in a U.S. bank or Savings and Loan or Insurance Company does not count for U.S. estate tax if it is `not effectively connected with conducting a trade or business within the U.S." This means that if you died leaving a $1,460,000 deposit in the Bank of America, there would be no tax on the interest or any estate tax on the capital. But if you died owning $1,460,000 worth of shares of the Bank of America and the shares were in your wall safe at home in Horseshoe Bay, Saskatoon, Halifax, or Sudbury, you would owe tax on the dividends (to the U.S. and Canada) and estate tax to the Federal U.S. government (no state tax as it is not situated in a state).

What is the reason for this? Back in the oil problem days, the U.S. Congress had to recognize that if they taxed non-resident/non-citizen bank deposits, tens of billions of dollars would be pulled out of Chase Manhattan, CitiBank, Bank of America and so on. To keep that money there and stop their banking system from collapsing, they passed legislation which exempted foreign owned bank accounts from U.S. tax if they were deposit accounts only and not effectively connected with conducting a business within the U.S. The only requirement was that the holder have a U.S. `taxpayer identifying number' and report to the bank/savings and loan that he/she is still a non-resident/non-citizen at least once every three years. If the situation changes he/she is to notify the institution within thirty days.

Money on deposit in the U.S. is not subject to U.S. income tax or estate tax provided it is not effectively connected with a U.S. Trade or Business (remember, the interest IS subject to Canadian Tax so report it on your Canadian return). If the money is on deposit to fund your rental house in the states, the interest IS taxable on your U.S. federal income tax return because a rental house is generally considered to be effectively connected with a U.S. business.  This is an automatic election which you make when you file your 1040NR and claim expenses against the rent.  If the rental house was not effectively connected with a U.S. business, the U.S. federal income tax would be a 30% of the GROSS rents with no expenses allowed. 

As you can see from the article, there can be "taxing" moments between the two countries.

So what are the rules?

Well, to leave Canada for tax purposes, you must give up clubs, bank accounts, memberships, driving licences, provincial health care plans, family allowance payments (if you are a returning resident, you can continue to get Family Allowance out of the country), your car, and furniture. You can keep a house here as an investment and rent it out, but it must be rented on lease terms of a year or more. And you MUST have an agent sign an NR6 for you (see example). This NR6 has the Canadian Resident AGENT ** guarantee the Canadian Government that if YOU do not pay your tax to Canada, the AGENT WILL. Even after fulfilling the foregoing, the Canadian government can still tax you or "try" to tax you on your income out of the country. If you are being paid by a Canadian Company, they can quite often succeed.

Even though you can collect family allowance out of the country, don't! One client's wife found out that she could get family allowance out of the country if she said they were coming back to Canada. She got some $3,000 of family allowance and cost the family some $80,000 in income tax when they came back to Canada from Brazil. I will never forget the husband's expression when he found out why he had been reassessed and I will never forget his wife's explanation. She said he was a skinflint and never gave her any money. The total episode cost them their house.

** The "agent" referred to above can be a friend, relative, or a business such as ours. We charge a minimum of $40.00 per month to be an "AGENT" for an NR-6 filing. This $480 per year is "in addition" to any other fees but "well worth it" of course. It stops your mother, father, brother, next door neighbour or ex-best-friend from being plagued by paperwork they do not understand.

OUT OF CANADA AND RESIDENT - IN CANADA AND NON-RESIDENT

It is possible to be physically "in Canada" and be treated as a Non-Resident and it is possible to be out of the country for seven years, or never have even lived in Canada, but wanted to, and be taxed as a Canadian resident as the following three cases show. In case you missed it, the reason for the different rulings is the "INTENT" of the parties involved.  Wolf Bergelt intended to leave Canada.  David MacLean was only working out of the country.  He still maintained a residence and could not ever become a resident of Saudi Arabia anyway. Dennis Lee "wanted" to live in Canada.

In 1986, Wolf Bergelt won non-resident status before Judge Collier of the Federal Court, even though he was only out of the country for four months and his family stayed behind to sell his house. He had given up his memberships, kept only one bank account and rented an apartment in California until his house in Canada was sold. Four months after his move, his company advised him that he was being transferred back to Canada. Judge Collier said his move was a permanent (although short) move and he was a non-resident for tax purposes for those four months.

In 1985, David MacLean lost his claim for non-residence status even though he was gone for seven years. He kept a house and investments in Canada and returned a couple of times a year to visit parents. He had even been to the Tax Office and received a letter on January 29, 1980 stating that his Canadian Employer could waive tax deductions because he was a non-resident. However, he did not advise his banks, etc. that he was a non-resident so that they would withhold tax, he did not rent his house out on a long term lease and he did not do any of the things that makes a person a "NON-RESIDENT". Judge Brule of the Tax court of Canada said that he thought Mr. MacLean had stumbled on the non-resident status by chance rather than by design. In other words, to become a non-resident of Canada, you must become a bone fide resident of another country.  As a rule, only a Muslim born in Saudi Arabia to Saudi Arabian parents can become a Saudi Arabian citizen.  The best that David MacLean can hope for is that he has a Saudi Arabian temporary work permit.

In other words, when a person leaves a place, they usually leave and establish a new identity where they are because the "new place" is where they live now. Trying to "look" like a non-resident is not the same as "BEING" a non-resident - think about it.

In 1989, Denis Lee won part but lost most of his claim for non-resident status. He was a British Subject who worked on offshore oil rigs. He maintained a room at his parents house in England and held a mortgage on his ex-wife's house in England. For the years 1981, 82 and 83 he did not pay income tax anywhere. in 1981 he married a Canadian and she bought a house in Canada in June of 1981. On September 13, 1981, he guaranteed her mortgage at the bank and swore an affidavit that he was "not" a non-resident of Canada. [As I have said in the capital gains section of this book, bank documents will get you every time.] During this time he had a Royal Bank account in Canada and the Caribbean but no Canadian driver's licences or club memberships, etc.

Judge Teskey said:

"The question of residency is one of fact and depends on the specific facts of each case. The following is a list of some of the indicia relevant in determining whether an individual is resident in Canada for Canadian income tax purposes. It should be noted that no one of any group of two or three items will in themselves establish that the individual is resident in Canada. However, a number of the following factors considered together could establish that the individual is a resident of Canada for Canadian income tax purposes":

• - past and present habits of life;

• - regularity and length of visits in the jurisdiction asserting residence;

• - ties within the jurisdiction;

• - ties elsewhere;

• - permanence or otherwise of purposes of stay;

• - ownership of a dwelling in Canada or rental of a dwelling on a long-term basis (for example, a lease of one or more years);

• - residence of spouse, children and other dependent family members in a dwelling maintained by the individual in Canada;

• - memberships with Canadian churches, or synagogues, recreational and social clubs, unions and professional organizations (left out mosques);

• - registration and maintenance of automobiles, boats and airplanes in Canada;

• - holding credit cards issued by Canadian financial institutions and other commercial entities including stores, car rental agencies, etc.;

• - local newspaper subscriptions sent to a Canadian address;

• - rental of Canadian safety deposit box or post office box;

• - subscriptions for life or general insurance including health insurance through a Canadian insurance company;

• - mailing address in Canada;

• - telephone listing in Canada;

• - stationery including business cards showing a Canadian address;

• - magazine and other periodical subscriptions sent to a Canadian address;

• - Canadian bank accounts other than a non-resident account;

• - active securities accounts with Canadian brokers;

• - Canadian drivers licence;

• - membership in a Canadian pension plan;

• - holding directorships of Canadian corporations;

• - membership in Canadian partnerships;

• - frequent visits to Canada for social or business purposes;

• - burial plot in Canada;

• - legal documentation indicating Canadian residence;

• - filing a Canadian income tax return as a Canadian resident;

• - ownership of a Canadian vacation property;

• - active involvement with business activities in Canada;

• - employment in Canada;

• - maintenance or storage in Canada of personal belongings including clothing, furniture, family pets, etc.;

• - obtaining landed immigrant status or appropriate work permits in Canada;

• - severing substantially all ties with former country of residence.

"The Appellant claims that he did not want to be a resident of Canada during the years in question. Intention or free choice is an essential element in domicile, but is  entirely absent in residence."

Even though Dennis Lee was denied residency by immigration until 1985 (his passport was stamped and limited the number of days he could stay in the country) and he did not purchase a car until 1984, or get a drivers licence until 1985, Judge Teskey ruled that he was a non-resident until September 13, 1981 (the day he guaranteed the mortgage and signed the bank guarantee) and a resident thereafter.

My point is made. Residency for "TAX PURPOSES" has nothing to do with legal presence in the country claiming the tax. It is a question of fact. My thanks to Judge Teskey for an excellent list. The italics are mine and refer to the items which I usually see people trying to "hold on to" after they leave and are trying to become non-residents. No single item will make you a resident, but there is a point where the preponderance of "numbers" leap out and say, "He / She is a resident of Canada, no matter what he / she says." 

The case above is not unusual in any way. It is a fairly typical situation in my office.

In 1990, John Hale was taxed as a resident on $25,000 of directors fees he had received from his Canadian Employer and on $125,000 he received for exercising a share stock option given to him when he had been a resident of Canada (the option, not the stock). Judge Rouleau of the Federal Court ruled that section 15(1) of the Great Britain / Canada Tax Convention did not protect the $125,000 as it was not "salaries, wages, and other remuneration". It was, however a benefit received by virtue of employment within the meaning of section 7(1)(b) of the act.

Even a car you do not own can make you a resident as the next sailor found out.

In 1988, FrederickReed was claimed by the Canadian Government as one of their own. He lived on board ship and shared an apartment with a friend in Bermuda but only occasionally. He also stayed with his parents in Canada when visiting his employer in Halifax. Judge Bonner of the Tax court ruled that he could not claim his place of employ or the ship as his residence and just because he did not have a fixed abode, did not make him a non-resident. He was also the beneficial owner of a car in Canada which even though of minor consequence, served to add to his Canadian Residency. He had in fact borrowed money from a credit union to buy the car, even though it was registered in his father's name. He had maintained his Canadian Driver's licence as well.

An interesting case in June, 1989 involved Deborah and James Provias who left Canada in October of 1984. They had sold a multiple unit building to James' father on September 21, 1984 but the statement of adjustments did not take place until December 1, 1984. They tried to write off rental losses and a terminal loss against other income as `departing Canadians'. Judge Christie of the Tax Court ruled that they had left before the sale and were not entitled to the terminal loss or another capital loss as these could only be applied against income earned in Canada from October 13, 1984 (the day they left) to November 30, 1984 (the day before the sale) and there was no income, only a rental loss.

But June, 1989 was a good month for Henry Hewitt. He had been a non-resident living in Libya for four years and received some back pay after returning to Canada. DNR tried to tax him on the money but Judge Mogan of the Tax Court came to the rescue. He ruled that although Canadians were usually taxable on money when received, that assumed that the money itself was taxable in Canada, which was not true in this case.

In 1989, James Ferguson lost his claim for non-residency status but from the information, it didn't stand a chance anyway. He had been in Saudi Arabia on a series of one year contracts for four years. His wife remained employed in Canada, and he kept his house, car, driver's licence, union membership, and master plumber's licence. Judge Sarchuk ruled that he had always intended to return to Canada and was a resident.

A similar situation involved John and Johnnie M. Eubanks in the United States. He was working on an offshore oil rig in Nigeria with a Nigerian work permit and attempted to claim non-resident status for the purposes of exempting the foreign earned income exclusion. His wife was in the United States at all times and because he worked 28 days on and 28 days off, he returned to the U.S. for his rest periods using 4 days for travel and 24 days for rest with his family. He did not spend any 330 day period (out of a year) in Nigeria and only had a residency permit for the purposes of working in Nigeria. Judge Scott ruled he was a resident of the U.S. and taxed him some $20,000 with another $6,000 penalties and interest.

The Tax departments in Canada and the U.S. issue Interpretation Bulletins and Information Circulars and Guidance Pamphlets. These documents sometimes get people in trouble because the individual reads the good part and doesn't pay any attention to the exceptions. The following case ran contrary to a Guidance Pamphlet issued by the IRS.

On and Off-shore Oil rigs were involved with William and Margaret Mount and Jesse and Mary Wells. William and Jesse worked in the United Arab Emirates. However, they kept their homes and families in Louisiana and kept their driver's licences in Louisiana and voted in Louisiana. No evidence was shown that they had tried to settle in The United Arab Emirates. Judge Jacobs turned down claimed exclusions of approximately $75,000 each.

There isn't any question about what oil rig people talk about on oil rigs. It has to be "how to beat the tax man". Unfortunately, they all seem to think it is easy. Another such story follows.

In 1989, Clarence Ritchie found out that bona fide residence means just what it says. You cannot be a non-resident of the U.S. for tax purposes if you are not a bona fide resident of another country. He was working on the Mobil Oil Pipeline in Saudi Arabia and although when he left he was married with a couple of kids, by the time he returned permanently, he was a happily divorced man. Judge Scott ruled that though he did not have an abode in the United States, he had not established one in Saudi Arabia and therefore was not entitled to the foreign earned income exclusion which requires you to be away for 330 days out of 365. He had worked a 42 days on, 21 days off schedule and usually returned to the U.S. for his days off although he did spend time in Tunisia, England, Italy and Greece.

On a final note, as explained on page 143 of the "PINK" 17th edition of my ULTIMATE TAX BOOK, it is possible to have three countries after you for tax. If you are thinking of taking a job because a recruiter told you the money is tax free, think twice and check three times with competent individuals about what the rules "really are". No government likes giving up the right to tax its citizens.

DEBT SECURITIES - BANK ACCOUNTS

Non-residents of Canada with investments in Canada are subject to a 25% non-resident withholding tax on any money paid to them while they are out of the Canada. Therefore, if they have $10,000 in the Bank of Montreal and they live in Argentina, The Bank of Montreal must withhold 25 cents out of every dollar of interest paid to the account. Most tax treaty countries such as Great Britain, Germany, the United States, and Australia have a reciprocal agreement with Canada that limits the withholding to 15%. So we have the anomaly that a Canadian with money in a bank in the U.S. has no withholding but an American with money in a Canadian Bank has 15 cents out of every dollar withheld as a foreign withholding tax. The American would report his interest on schedule A of his 1040 tax return and claim the tax withheld as a foreign tax credit on a form 1116.

RENTAL PROPERTIES - CANADA - OWNED BY U.S. RESIDENT

More important perhaps is the problem with rental properties in Canada. When owned by a non-resident, they are subject to a 25% withholding (or 15% if living in Bangladesh) tax. If the renter does not pay this tax,  the government can come along two years later and demand the tax.

Imagine the consternation of a tenant of a house in the British Properties in West Vancouver, or Rosedale in Toronto. Assume the tenant has been paying $2,000 a month for a $500,000 house owned by a Hong Kong resident. After three years of paying $24,000 a year to the `non-resident', they finally buy a house and move. Two months later, there is a knock on the door and a National Revenue representative is standing there demanding 25% of $72,000 for NON-RESIDENT withholding tax (this is a true story by the way, only the owner was in London).

There is a way around this problem. The tenant can ask to see, or rather DEMAND to see a copy of the landlord's filed and accepted NR6 form. (See forms in back of book). This form allows the tenant or agent of the landlord to deduct a lesser amount (or nil if a loss) than 25% of the gross rent. It allows for expenses to be taken off and the tax can then be withheld at 25% of the net, rather than the gross. The property management division of david ingram & Associates Realty Inc. files about 300 of these NR6 forms a year. (This is only necessary if you are paying directly to a landlord whom you KNOW to be a non-resident of Canada.  If you are paying to an agent or Canadian Resident, you are okay.)

Please note, the NR6 MUST BE FILED BEFORE the first rent cheque is received or 25% of the gross rent must be remitted. For years, we were in the habit of filing `this years' NR6 late with last years tax return. In 1989, National Revenue stopped accepting this sloppy practice and demanded them on time.

IF YOU SIGN THIS FORM AS AN AGENT, AND THE OWNER DOES NOT FILE HIS OR HER RETURN BY JUNE 30TH OF THE FOLLOWING YEAR, YOU, THE AGENT, ARE RESPONSIBLE FOR THE 30% OF THE GROSS RENT WITH NO REFUND PROVISIONS FOR ANYONE.

RENTAL PROPERTIES - UNITED STATES - OWNED BY A CANADIAN

If paying 25% of the GROSS rent to Canada sounds bad, cheer up. The United States taxes the Canadian 30% in the same situation. To avoid this, the Canadian needs to notify the U.S. Government that he wishes to be taxed as a business rental house on the "net income" received. But if you do not notify the IRS in advance, the IRS CAN tax you at the 30% of gross rate.

SALE OF REAL ESTATE - IN CANADA

The situation is different with the sale of REAL ESTATE. A non-resident with property in Canada who sells the property is subject to a withholding tax of 33 1/3% on the GROSS sale price unless they fill out a form 2062A (sample at back of book) and submit it to Revenue Canada for approval. You cannot use the form in the book, it is the wrong size. It must be obtained from Revenue Canada and filled out in quintuplet (5 copies). It does not have to be filed before the sale unless you need the money immediately to close a back to back deal - the lawyer can keep money in his trust account until the form is approved.

CAUTION - This is serious, a Realtor and lawyer who were not aware of this fact are at possible risk of law suit from a purchaser. The purchaser was called upon to pay 25% of the purchase price of the property to Revenue Canada for failure to withhold. The rate was 25% up to 1987, 30% for 1988 and 1989, and is now 33 1/3%). There is a proposal to make it 50% unless the form 2062 is filed. The situation is serious enough that one should not accept a person's declaration that they are a resident as sufficient reason to "not withhold tax". In one case, the purchaser and the real estate agent drove the vendor to the airport to fly back to Hong Kong. The vendor is not a resident of Canada. Is it any wonder that National Revenue wants to collect the tax from the purchaser and the purchaser wants to sue the real estate agent and lawyer. "THE ONLY SAFETY IN THIS SITUATION IS FOR THE PURCHASER TO REQUEST A T2062 EXEMPTION FROM REVENUE CANADA."

What form T2062 does is allows you to calculate the actual gain WHICH WILL BE EARNED AND TAXABLE. The purchaser may then only DEDUCT/pay a withholding tax on the taxable gain, not the gross sale price. Revenue Canada is wonderful when it comes to quick approval of this form. I would love to give out names of people who have gone overboard to accommodate clients but they have said, "NO, NO, NO! " (Please note. Even though Real Estate Commissions and other costs of sale are deductible when calculating the actual taxable income for tax purposes on a return, they may NOT be deducted for the purposes of the T2062).

If you are having trouble with a sale or purchase with a non-resident, feel free to call upon the services of our office. David Ingram at (604) 649-4755 or FAX (604) 649-4759 is available to assist your lawyer or real estate agent. In addition, if you need the services of a lawyer for this special service, David Stoller, LLB shares office premises with us and is available at the same numbers.

SALE OF UNITED STATES REAL ESTATE

The U.S. government does the same thing when a Canadian is selling property in the states. They have a 10% withholding tax on the gross as well and there is usually a state government withholding of another 3 1/2%. However, all is not lost. The U.S. government has a form as well. It is form 8288-B and is reproduced at the back of this book as well, next to the 2062. You can use this form or a photocopy to request a reduction or total cancellation of the 10% withholding. For instance, if you inherited a condo in Wheeling, West Virginia and sold it right away, the estate tax would be paid already and you would have inherited it at its present value. There would be no capital gains expected and therefore, you could get the withholding cancelled.

In addition, if the property is being transferred for $300,000 or less and is being used as a personal residence by the purchaser, and the purchaser will sign a letter saying that they intend to live it for six months or more a year for the next two years as a principal residence, they or the escrow agent do not have liability for withholding tax. However, it is still my opinion that if on either side of this problem, one should read pages 17 and 18 of the 1990 edition of Publication 17 for more information and following that format, write to the Internal Revenue Service with an 8288 and ask for the exemption formally. Remember also that individual states like California also have a withholding of (California 3 1/3%) non-resident tax and it is necessary to write to them as well.

(After all, why should the average person get stuck with withholding tax in what is an extremely sophisticated tax matter.)

REMEMBER THOUGH, Real estate capital gain profits from sales in the US by Non-residents are subject to ALTERNATIVE MINIMUM TAX. The rate started at 17% in 1987 and is 26% today in 1999.

That means that if you had bought a property for $10,000 and sold it now for $110,000 and had $11,000 tax withheld, you will; actually owe the IRS another $15,000 when you file your tax return.  When we prepare these returns, about one/half get refunds, half pay more. See my June, July and August newsletter for more information.  (Page ???? in this book).  

The manual says the preparation of the 8288A and B takes a total of 4 hours for the first one you do (i.e. record keeping is 1 hr, 33 min; learning the law of the form is l hr, 43 min; preparing the form is 37 min; and copying, mailing, etc. is another 20 min). It is mailed to:

The Director
Philadelphia Service Center
P. O. Box 21086 
Philadelphia, PA 19114

Last Updated Wednesday, July 22 2009 @ 11:25 AM PDT|5,296 Hits