Tax Residency & Ceasing Canadian Tax Residency

Under the Income Tax Act (Canada) (the “ITA”), a resident of Canada is taxable on worldwide income, whereas a non-resident is taxable only on certain income that is connected to Canada. Non-residents are also subject to withholding tax on certain types of Canadian-source income (e.g., dividends from a Canadian corporation). Upon ceasing to be a resident of Canada for tax purposes, a taxpayer will be deemed to have disposed of the taxpayer’s assets, subject to certain exceptions, for proceeds equal to the fair market value of each such asset on the date the taxpayer ceases to be a resident of Canada, potentially giving rise to a tax liability in the year of departure.

Clearly, residency is crucial to determining the taxpayer’s obligations under the ITA. It is important to note that the determination of the residency status of a taxpayer for Canadian tax purposes is distinct from the determination of residency status or citizenship for the purposes of Canadian immigration law. The ITA and Canadian common law set out the applicable tests for Canadian tax residency.

This blog post reviews the principles of residency for Canadian tax purposes for individuals, corporations, and trusts. It discusses the residency tests under the ITA, the factors outlined by the Canadian courts and the Canada Revenue Agency (the “CRA”), and the applicability of the Organisation for Economic Co-operation and Development (the “OECD”) Model Tax Convention on Income and on Capital 2017 (the “Treaty”) and associated commentary. Our next blog post will summarize key consequences of ceasing Canadian tax residency.

All statutory references are to the ITA.

I. Individuals

The ITA does not define the term “resident.” Rather, the determination of an individual’s residency for tax purposes may be determined under certain deeming rules in the ITA, common law principles, and international tax treaties to which Canada is a party.

A. Statutory rules

The ITA contains certain rules which may deem an individual to be resident in Canada throughout a taxation year. For example, paragraph 250(1)(a) deems that an individual is resident in Canada throughout a taxation year if that individual “sojourned” in Canada for 183 days or more in that year. Canadian courts have interpreted the term “sojourned” to mean stayed temporarily.

Note that these deeming rules do not limit or restrict the ordinary meaning of “resident,” as set out in the jurisprudence and discussed below; rather, they provide additional circumstances in which a person may be deemed to be resident in Canada in a taxation year.

Subsection 250(3) provides that a reference to a person resident in Canada includes a person who is “ordinarily resident” in Canada. As is the case with the term “resident,” the ITA does not define the term “ordinarily resident,” leaving Canadian courts to enumerate the key analytical framework to determine tax residency.

Pursuant to subsection 250(5), the “tiebreaker” rules in a tax treaty (discussed below) may apply to deem that a person is not a resident of Canada at any given time, such that they will be considered a non-resident of Canada for tax purposes, notwithstanding any other provision of ITA.

B. Common law principles and administrative positions

Under common law principles, Canadian tax residency is a question of fact and depends on the specific circumstances of a particular case. The leading case on Canadian residency—and particularly the meaning of “ordinarily resident”—is Thomson v MNR, [1946] C.T.C. 51 (S.C.C.) (“Thomson”). In Thomson, the Supreme Court of Canada found that “residence” is “chiefly a matter of the degree to which a person in mind and fact settles into or maintains or centralizes his ordinary mode of living with its accessories in social relations, interests and conveniences at or in the place in question.” The Court held that a person “is ‘ordinarily resident’ in the place where in the settled routine of his life he regularly, normally or customarily lives.”

The key takeaway: the concept of residency for tax purposes is determined on a case-by-case basis considering all the relevant facts and circumstances. As such, Canadian courts have enumerated several factors to be considered in determining residency, such as, among others, the past and present habits of life, regularity and length of visits in the jurisdiction asserting residence, ties within that jurisdiction, ties elsewhere, and permanence of any stay abroad. A single factor will likely be insufficient to establish residence, but several factors, taken together, may do so. In any event, a thorough review of the taxpayer’s situation is required.

The CRA has largely adopted the meaning of residence developed by Canadian courts. The CRA’s current stated positions are outlined in Income Tax Folio S5-F1-C1, Determining an Individual’s Residence Status (the “Folio”). Although the CRA’s stated positions do not have the force of law and may be applied inconsistently, they provide useful guidance and insights pertaining to CRA audit activity and administration.

The primary factor the CRA considers in determining whether an individual leaving Canada remains resident is whether the individual maintains “residential ties” in Canada while abroad. In this respect, the CRA categorizes residential ties into three tiers—significant, secondary, and other—and generally considers an individual to be a “factual resident” unless they sever all significant residential ties with Canada upon departure.

“Significant” residential ties, as contemplated by the CRA, are an individual’s dwelling place(s), spouse or common-law partner, and dependant(s). Where an individual physically leaves Canada but keeps a dwelling place in Canada available for the individual’s occupation (e.g., where the individual does not lease the dwelling place to a third-party on arm’s-length terms), the CRA will consider the dwelling place to be a significant residential tie. Further, where the individual leaves Canada while the individual’s spouse, common-law partner, or dependants remain in Canada, the CRA will likely consider such factors to be a significant residential tie.

The CRA considers “secondary ties” on a collective basis in order to evaluate the significance of any one secondary tie. This determination appears to be distilled from factors applied in the post-Thomson jurisprudence. Secondary ties include the individual’s personal property, social ties, economic ties, immigration status, hospitalization and provincial/territorial medical insurance coverage, driver’s license, vehicle registration, seasonal dwelling places, passport, and union or professional organization membership.

Finally, the Folio states that “other residential ties” may be taken into consideration but will generally be of limited importance when taken together with other residential ties.

Where an individual maintains residential ties with Canada but is physically absent, the CRA will evaluate the significance of those ties by considering evidence of the taxpayer’s intention to permanently sever residential ties with Canada, the regularity and length of visits to Canada, and residential ties outside Canada.

With respect to an individual’s intent to permanently sever residential ties, the CRA will consider the length of absence, evidence that the taxpayer’s return to Canada was foreseen at departure, and steps taken to comply with the ITA.

The CRA’s stated position is to disregard “occasional” return visits to Canada, whether for personal or business reasons. But where those visits are “more than occasional” and secondary residential ties exist, the CRA will consider such visits in evaluating the significance of the secondary residential ties.

The CRA will also consider whether the taxpayer has established residential ties elsewhere. Where the individual has failed to do so, the CRA’s position is to afford greater significance to the remaining residential ties to Canada.

Finally, the CRA states that an individual becomes non-resident as of the date “all residential ties” with Canada are severed, which is generally the latest of the date that (1) the individual leaves Canada; (2) the individual’s spouse, common-law partner, or dependant(s) leave Canada; or (3) the individual becomes a resident of the country to which the individual is immigrating. The courts, however, do not provide such rigid guidance and tend to view the taxpayer’s situation holistically.

C. Tax treaties

A person may be a resident of more than one country for tax purposes. For example, a taxpayer can be a tax resident of Canada under the tests outlined above and a tax resident of another jurisdiction under the domestic laws of that jurisdiction. Where both countries assert jurisdiction to tax, relief may be available under a tax treaty. Where there is no such treaty, the taxpayer may be fully subject to tax under the domestic laws of both jurisdictions, leading to potentially punitive results.

The Treaty, and many treaties based on it, contains tie-breaker provisions that apply when a taxpayer is a resident of both contracting states. The relevant treaty may differ from the Treaty, including the residency tiebreaker rules. Careful consideration must be given to the terms and interpretation of the treaty relevant to any given situation. Note that multiple agreements may apply (e.g., the “Multilateral Instrument” or “MLI”).

Article 4(1) of the Treaty provides that a “resident of a Contracting State” is any person who, under the laws of the state, is liable to pay tax by reason of domicile, residence, place of management, or any other criteria of similar nature. The Supreme Court of Canada has interpreted the “liable to tax” requirement as being met where the person is subject to “full” or “comprehensive” tax liability (e.g., tax liability on all worldwide income as opposed to a portion of such income). Crown Forest Industries Ltd. v. Canada, [1995] 2 C.T.C. 64 (S.C.C.); Canada v. Alta Energy Luxembourg S.A.R.L., 2021 SCC 49.

The tiebreaker rules apply sequentially and are as follows:

1. Permanent Home: The tiebreaker rules first give preference to the state in which the individual has a permanent home available to the individual.

According to the OECD commentary on the Treaty (the “Commentary”), any form of home is relevant if it is permanent and available at all times continuously. The CRA’s administrative position is that a permanent home is any kind of dwelling place that an individual retains for permanent (as opposed to occasional) use, whether rented, purchased, or otherwise occupied on a permanent basis.

2. Centre of Vital Interests (“COVI”): If there is a permanent home in both countries, the Treaty then gives preference to the state in which the individual has closer personal and economic ties.

The Commentary states that this is a factual determination, considering familial and social relations; occupations; and political, cultural, business, and administrative activities. The Commentary also gives special attention to personal acts and states that retaining a home in one country while moving to another may demonstrate that the COVI remains in the first. The CRA states that the COVI test invokes an analysis similar to determining factual residence in the domestic context.

3. Habitual Abode: If the COVI cannot be determined or there is no permanent home in either country, then preference goes to the state in which the individual has a habitual abode.

Under the Commentary, the habitual abode is generally the place where the individual, regularly and in the settled course of the individual’s life, spends most of the individual’s time. Habitual abode has been interpreted by the Canadian courts as a “habitual residence,” or where a taxpayer’s lifestyle and activities are located. This goes beyond the number of days spent in a certain country and involves notions of frequency, duration, and regularity of stays of a quality that is more than transient. That is, the concept refers to a stay of some substance in the jurisdiction as a matter of habit, so that the conclusion can be drawn that that is where the taxpayer normally lives.

4. Nationality: If none of the first three tests are determinative, then nationality becomes the determining factor. In Article 3(1), the Treaty defines “national” in respect of a contracting state to include an individual possessing nationality or citizenship of that state and a person, partnership, or association deriving its status as such under the laws of that state.

5. Mutual Agreement: Finally, if none of the above are determinative, then competent authority may determine the question. The Treaty establishes a mutual agreement procedure in Article 25.

Pursuant to subsection 250(5), if the tiebreaker rules apply to deem that a person is not a resident of Canada at any given time, they will be considered a non-resident of Canada for tax purposes, notwithstanding any other provision of ITA.

II. Corporations

Like individuals, corporate residence can also be determined under statutory rules, common law principles, or tax treaties.

A. Statutory rules

Under paragraph 250(4)(a), all corporations incorporated in Canada after April 26, 1965, are deemed to be resident in Canada. Those incorporated before April 27, 1965, may also be deemed resident under paragraphs 250(4)(b)–(c).

Note that, under subsection 250(5.1), a continued corporation is generally treated as having been incorporated in the jurisdiction to which it is continued from the time of the continuation until a subsequent continuation into a different jurisdiction.

In other words, a corporation that was incorporated in Canada and continued into another jurisdiction will generally be treated, from the time of the continuation, as if it was incorporated in that other jurisdiction. As described below, however, a corporation that has continued out of Canada may still be a resident of Canada under common law principles.

Conversely, a corporation that has continued into Canada will be deemed to be resident in Canada from the time of the continuation. A corporation’s deemed residence in Canada under subsection 250(4)—whether from the time of actual incorporation or by virtue of continuation—may be overridden under a treaty, pursuant to subsection 250(5), as described below.

B. Common law principles

Under Canadian common law principles, a corporation is resident in the jurisdiction in which its central mind and management is carried out. This is the place where the company’s directors meet, other meetings of the corporation are held, the business of the company is transacted, and the powers conferred on the directors are exercised. The test is factual; that is, the issue turns on where the actual place of management is, not the place from which management was intended to occur. For example, where the constating documents provide that a company is to be managed from one jurisdiction but management in fact occurs in another, the latter will be determinative.

Management decisions will not be impugned solely because they are ill-advised or ill-considered. The degree of circumspection with which management decisions are approached by the board is not relevant in determining residency.

Given the foregoing principles, it appears that the threshold that must be met for central management and control to exist in the jurisdiction in which directors hold meetings is quite low. Even if the directors act in accordance with the advice of outsiders from another jurisdiction, the directors act without additional research or analysis, or meetings are short and infrequent, corporate residence will remain where the directors act so long as they have the power to refuse to follow the outsider’s advice.

C. Tax treaties

While it is relatively rare that a corporation will be resident in multiple jurisdictions, the Treaty also addresses the residence of corporations. Rather than a series of tiebreaking rules, the Treaty simply directs the competent authorities to determine the question under the mutual agreement procedure, having regard to the place of effective management, the place of incorporation or constitution, and “other relevant factors.” In the absence of mutual agreement, the corporation will not be entitled to relief under the Treaty. The Commentary to this paragraph provides a list of factors expected to be considered by the competent authorities.

As noted above, treaties often deviate from the Treaty. For example, under the Canada-U.S. treaty, a corporation created under the laws of one contracting state and not the other will be deemed to be a resident of the first state, and in any other case, the competent authorities are to determine the question.

III. Trusts

A trust is a legal relationship between the settlor, the trustee, and the beneficiaries, the former holding certain property for the benefit of the latter. At law, a trust is not considered a separate legal entity like a corporation; rather, a trust is a legally recognized relationship which is treated as a separate person for Canadian tax purposes. Generally, resident trusts are subject to Canadian income tax on undistributed taxable income that is not made payable to a beneficiary in the year in which the income arose, and non-resident trusts are subject to tax only on taxable income earned in Canada. As is the case with individuals and corporations, the residence of a trust may be decided under common law principles or statutory rules. Note that the Treaty does not contain residency rules for trusts, but some tax treaties do.

Under common law principles, the residence of a trust is also determined under the central mind and management test. In the trust context, this entails considering where the powers and duties of the trustee are being exercised or carried out. Typically, central mind and management will lie with the trustee even where a beneficiary puts strong recommendations to the trustee, provided that the trustee is free to decide how to exercise the powers and carry out the duties under the trust relationship. But where an “outsider” exercises the powers or carries out the duties such that the appointed trustee is “displaced,” the central mind and management will lie with the outsider. This is, of course, a question of fact determined under the legal fiction that the trust is a separate legal entity with a residence for tax purposes.

Under section 94, a factually non-resident trust may be deemed resident in Canada for several purposes under the ITA if it has a “resident contributor” or a “resident beneficiary.” Generally, a trust has a “resident contributor” if a Canadian-resident person has made a “contribution” to the trust. A trust generally has a “resident beneficiary” at any time there is a Canadian-resident beneficiary and a person who has made a “contribution” to the trust within five years of that person becoming or ceasing to be a Canadian resident. A “contribution” to a trust is defined to mean, among other things, a transfer or loan of property to the trust.

As the deemed resident trust rules in section 94 are not for the faint of heart and a detailed review  is outside the scope of this blog post, specialized advice should be sought.

Conclusion

The scope of this topic is expansive and encompasses a multitude of considerations. This post’s objective is more modest: to provide an overview of tax residency, the threshold income tax issue that commonly arises in the context of emigration from Canada.

Do not mistake this post as a substitute for expert tax advice. Tax-motivated exit planning will typically be dictated by the relevant parties’ particular desires, tax attributes, assets, and destination—particularly whether that jurisdiction has a tax treaty with Canada and the impacts of any such treaty. In any event, tax consequences will be a critical consideration, requiring thoughtful and nuanced technical Canadian income tax advice and foreign income tax advice.