Changes to Canadian overseas income tax exemptions

Written by Andrew Henderson

Dateline: Budva, Montenegro

Canada is one of the most popular countries for immigration. In light of a possible Trump presidency, more and more people are threatening to leave the US for Canada. Still, there are also over 1.5 million Canadians living and working abroad.

As with most expats who work abroad, Canadians need to understand the laws concerning taxation on their foreign-earned income.

Canada is a little more moderate than the United States when it comes to taxing its offshore citizens and residents. In fact, Canadian tax courts are known to be more flexible. During the contestation process, they consider each case on its individual merits.

Canada uses a “hybrid tax system“, a combination of territorial taxation and taxing on worldwide income. Consequently, it is important to understand the nuances of the system. While most Canadians expect to be taxed on their worldwide income, there are exceptions.

For instance, consider the story of David, a foreign-born Canadian resident who had to return to his home country to take care of his aging parents. While his immediate family lived in Canada, David lived abroad to see after the daily needs of his parents. While living in his country of citizenship, David took on a part-time job. And — even though he earned his income abroad — he paid Canadian income taxes each year.

One day, however, his wife read an article from the local Canadian expat community. The article explained that, in some cases, income earned abroad could qualify for Canadian tax exemptions. To make a long story short, their situation was one of those cases and David was able to exempt his foreign-earned income.

Why?

The Tax Court of Canada ruled that David’s culture expected him — as the eldest son — to take care of his parents when they could no longer support themselves. The only stipulation was that, if the money were repatriated back into Canada, it would be taxed. Otherwise, his income was exempt.

What actually qualifies for exemption?

This type of flexibility gives Canadians an advantage that US residents and citizens do not. But how can Canadians officially qualify as tax non-resident? Residency is usually at the heart of qualifying to exempt offshore income. Typically, the Canadian Tax Court defines residency by:

  • Where you work
  • Where you live the majority of the time
  • Where you receive your mail
  • Where you have family
  • Where your social life exists

You are a non-resident for tax purposes if you:

  • Normally, customarily, or routinely live in another country and are not considered a resident of Canada; or
  • Do not have significant residential ties in Canada; and
  • You live outside Canada throughout the tax year; or
  • You stay in Canada for less than 183 days in the tax year

Applying Canadian tax exemptions to real life

To get a better idea of how these rules apply, let’s look at a couple more examples.

First, a situation in which a Canadian citizen lives near the US-Canadian border and commutes to work in the US. In this case, the Canadian citizen is considered a Canadian resident and would be required to pay Canadian income tax on the US-earned income.

The good news is that the US and Canada — like many nations — have a tax treaty. The treaty helps people in this situation avoid the ugly possibility of double taxation. The bilateral tax treaty provides for income tax exemption in a person’s home country if the taxes paid to the offshore country are higher than they would pay at home.

There are some cases, however, where no offshore income tax needs to be paid.

Take the case of the Canadian airline pilot. Let’s call him Paul. As a longtime employee of a Canadian based airline, Paul signed a two-year contract to fly with a foreign airline based in the Caribbean. Each Sunday, Paul flew down to his Caribbean base to take his flights. Each Friday, he flew back to his family and home in Canada.

Paul did not pay any taxes to Canada on his foreign-earned income. The Caribbean nation where he worked did not have a tax treaty with Canada. When the situation was brought to court, though Paul was a Canadian citizen, the court ruled in Paul’s favor.

Why?

The court felt that Paul’s “real life” took place offshore and that the 48 hours he spent in Canada visiting his family each weekend were not sufficient to establish residency. As long as he didn’t exceed the in-country rule of 183 days, Paul’s foreign-earned income was exempt from Canadian income taxation.

The Overseas Employment Tax Credit

For many years, tax resident Canadians could still enjoy a special tax credit on their overseas income. Since 1979, the Overseas Employment Tax Credit (OETC) has served as a tax reduction on the first $100,000 of income earned outside of Canada.

It sounds similar to the Foreign Earned Income Exclusion in the US, but there are a couple of key differences. On the positive side, the OETC is a tax credit available to Canadian tax residents, meaning they do not have to have a second residency in order to qualify. On the downside, Canadians are only allowed to exempt 80% of their income, which means a maximum exemption of $80,000.

Furthermore, they must meet specific requirements in order to qualify. One of the main requirements is that the individual must be working abroad for six consecutive months or longer for a Canadian or Canadian affiliated company. Additionally, the business must be involved in one of the following:

  • The exploration for or exploitation of petroleum, natural gas, minerals, or other similar resources;
  • Any construction, installation, agricultural, or engineering activity; or
  • Any activity performed under contract with the United Nations (UN)

But here’s the worst news of all, the credit is in the process of being phased out. In fact, Canada is eliminating the tax credit completely this year. In 2015, the exemption was reduced from 80% to 20% and, in 2016, the exemption has been reduced all the way to zero.

Never take any tax exemption for granted

Of course, if the program has been phased out, I’m not telling you about the OETC so you can include it in your plans to save on tax. No, I’ve brought this program to your attention to illustrate one important fundamental of offshore strategies: never take any exemption for granted.

Over the past few decades, globalization, cheap airfares and internet telephony have all seen a real growth in expat contract employment in foreign lands. Needless to say, the home country tax authorities keep an interested eye on the potential tax revenues that can be extracted from those knowing and unknowing expat workers.

Indeed, when Australia recently changed its offshore income taxation rules, many Australians who had made substantial income from abroad were unaware of the changes and had to pay out past taxes along with some steep penalties.

So, if you are a Canadian resident and plan to be working abroad, make sure to be up-to-date on the foreign income exemption program. In fact, no matter where you’re from, make sure that all your information is up-to-date. You don’t want to go overseas to reduce your tax burden just to get yourself into trouble for going about it all wrong.

Andrew Henderson
Last updated: Dec 26, 2019 at 10:55PM

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4 Comments

  1. Bill

    What are the recent changes to Australia’s offshore income taxation rules?

    Reply
  2. Bill M

    Just wanted to thank you for your piece re: ‘Marc’ on staying in your own country and paying tax… You were bang on as in more cases than not, there are too many not paying tax at all levels and the expectation is if you have a little more, you should pay for everyone else ! Nope, don’t think so ! I actually spoke to someone in a major city there where the guy couldn’t afford to live there but expected “ME” to pay the difference so he could stay in that city. Last time I checked one does not have the RIGHT to live in any given place if you can’t afford to live there by your own devices. Anyway, the Canadian govt’s agenda is [UN 2030 agenda not withstanding] working to ‘flatten’ but make a larger middle class while lowering the higher levels of that class and raising the lower class [in “theory”] by falsely named taxes ie: carbon tax which does nothing for the environment; its another revenue line number and is NOT revenue neutral [what tax is ?!!?]. The Provinces are also trying to “falsely” raise the standard of living by raising the minimum wage to what they deem ‘livable’. Not really as they go into a higher tax bracket AND consumer prices will go up as well. Why would a business person absorb that ‘hit’ and lower their own income ?!? Prices go up, or instead of having 3 employees, you reduce it to 2 or 3 part timers instead.
    Now having two new flags outside the country myself, its time to exit stage left from ALL N American countries. With UN 2030, its actually better to be in a net positive country that will benefit from their “policies”/plan ! For those thinking of getting out of the ‘west’, my advise is to RUN, run hard, run fast because in 12 years, you won’t recognize your society as you know it today.

    Reply
  3. Pietro Forenza

    I am a non resident.I live in Italy and I am 76 years old.
    I receive a little pension from QPP and it is taxable.
    It is not there an income limit
    to be exempt from payng tax?

    Reply
  4. Adan Hedrick

    Could anyone advise me regarding the deadline for Shearman & Sterling LLP Training Contract Application? Wishing you Happiness and Good Cheer this Christmas

    Reply

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