Very few global companies are headquartered in Canada, yet our global economy requires professionals to interact on the world stage. As such, many professionals, seeking an edge, opt to work abroad. As can be expected, this choice comes with a plethora of logistical problems; it also can mean significant financial losses or gains depending on the depth of financial planning involved.
For advisors dealing with clients living and working abroad, or clients returning from working abroad, or non-Canadian clients, this planning can often take on a sense of urgency around RRSP and tax season.
This is because many non-resident Canadians and international resident employees qualify for the RRSP tax shelters offered by the Canadian government, despite their current citizen/residency situation.
The Canadian Revenue Agency states that all residents are subject to Canadian tax laws. Based on this, the CRA states that the residence of an individual “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.”
In other words, a person is deemed a resident of Canada if he or she has primary ties to the country, explains Wayne Bewick, CA and CFP with Trowbridge Professional Corporation. This definition does not imply citizenship; therefore, Canadians working overseas can keep their passports yet be considered non-residents for tax purposes, while foreign citizens can be considered residents of Canada for tax purposes. The question of residency, says Bewick, is one of fact and depends on the specific circumstances of each individual.
Advisors, then, need to be educated (or have a network of experts to aid them) in how the CRA determines residency when dealing with internationally earned income. According to Peter Merrick, CFP and founder of Merrickwealth.com, advisors should also be well versed in how other countries operate in relation to Canadian tax law.
Merrick uses the United States as an example. Though Canada and the U.S. “have a beautiful tax treaty,” Merrick warns that RRSPs are not recognized as tax shelters in the States. Rather, they are considered investment vehicles and are subject to taxes. Pension plans, however, are not penalized, explains Merrick. Knowing the specifics of how each country views Canadian investment vehicles helps non-resident citizens use the best possible tax strategy.
In practical terms, Canadians working abroad can still take advantage of RRSPs, as long as they appreciate that RRSP contribution limits apply only to income earned in Canada based on previous-year earnings. This is because a non-resident can be taxed only on Canadian income.
Canadians who give up all ties to Canada, including investment and residential ties, may not earn income in Canada. This would then disqualify them from being able to contribute to an RRSP, explains Bewick. However, if a Canadian severed ties in order to be deemed a non-resident for the purposes of tax, that person can still earn Canadian income if he or she chooses to lease out real property to an arms-length third party. By declaring income on the rental property, a Canadian working overseas can then offset this taxable income (because it was earned in Canada) with an RRSP contribution.
A person who is subject to taxes in both countries, due to residency, “will be required to pay the higher of the two tax rates,” says Bewick. “If Canada has the higher tax rate, then they will end up paying the rate for the country of employment and then the remainder of tax to Canada while receiving a foreign tax credit to ensure that double taxation does not occur.” As such, Bewick suggests using all legitimate Canadian tax planning strategies to lower the Canadian portion of the tax burden, including, if possible, an RRSP.
Citizens returning to Canada after working overseas can also use an RRSP.
“If a person was once a resident of Canada, they are not in a position to use immigration trusts,” says Bewick, even if that person lived and worked overseas for a significant period of time. His or her only recourse is to use an RRSP, if there is still room to contribute based on the last year of Canadian income prior to his or her departure. It requires work, but it can certainly help reduce the percentage of taxes paid upon return to Canada, says Bewick.
Finally, for advisors working with international clients based in Canada, an RRSP can also be used to reduce their tax burden.
“If a person is not a Canadian citizen, but is living and working in Canada, then they are considered a resident for tax purposes and are subject to tax on their worldwide income,” says Bewick.
The typical course of action would be to set up an immigration trust that effectively shelters any investment income for up to five years. “This encourages wealthy individuals to take advantage of employment and investment opportunities in Canada,” without being burdened with Canada’s tax regime.
However, if after the first year of working in Canada, an international employee still finds the need to maximize tax planning strategies — mainly because he or she is in Canada’s highest tax bracket — that employee can opt to invest in an RRSP.
While international employees will have to liquidate their RRSP upon return to their home country, the investment will reduce their tax burden in two ways, says Bewick. First, it reduced the annual tax burden they have to pay, since RRSPs are a tax-deferred investment vehicle. Second, the tax is reduced when international employees liquidate the RRSP upon return to their home country.
Bewick explains how this works. “If an [international professional] is in the 46% tax bracket, then an RRSP defers that tax burden. Upon returning to their home country, this professional must liquidate their RRSP. Rather than paying the 46% tax rate, they are subject to the non-resident 25% withholding fee. That’s a 20% tax savings.”
As with most complex tax issues, Bewick and his colleagues suggest clients seek out professional help. “We started our company five years ago because we saw so many people go abroad and not handle their planning properly. They would earn $100,000 tax free for three years and then be hit with the taxes when they came home to Canada. Now, we go abroad and try and educate the people while they are still overseas.”
Originally published in Advisor.ca in January 23, 2008