THE INTERNATIONAL TAX ADVISOR

by:  Douglas J. Kingston, CPA/MBA  • Mailing Address: 16443 N 59th Place; Scottsdale, AZ 85254

• Telephone: +1 (602) 595-5885 (GMT-7) • E-Mail: doug@iTaxCPA.com • URL: http://www.iTaxCPA.com/

CANADA-U.S. TAX TREATY TIE BREAKER CLAUSE

 

Background

 

 

Text of Treaty

 

 

U.S. Treasury Technical Explanation

 

 

How Does the Tax Treaty Affect You?

 

 

Sample Picture

 

It is important for Canadians emigrating or visiting the U.S. to review their tax plans in order to take advantage of the Canada-U.S. tax treaty.

 

Background

 

Article IV Paragraph 2 sets forth a test whereby an individual is considered a tax resident of U.S. or Canada but not both countries. Individuals potentially taxable in both countries should arrange their lives and affairs with an eye on the Canada-U.S. tax treaty in order to minimize their worldwide taxation.

 

Text of Treaty - Article IV Residence

1. For the purposes of this Convention, the term "resident" of a Contracting State means any person that, under the laws of that State, is liable to tax therein by reason of that person's domicile, residence, citizenship, place of management, place of incorporation or any other criterion of a similar nature, but in the case of an estate or trust, only to the extent that income derived by the estate or trust is liable to tax in that State, either in its hands or in the hands of its beneficiaries. For the purposes of this paragraph, an individual who is not a resident of Canada under this paragraph and who is a United States citizen or an alien admitted to the United States for permanent residence (a "green card" holder) is a resident of the United States only if the individual has a substantial presence, permanent home or habitual abode in the United States, and that individual's personal and economic relations are closer to the United States than to any third State. The term "resident" of a Contracting State is understood to include:

(a) The Government of that State or a political subdivision or local authority thereof or any agency or instrumentality of any such government, subdivision or authority, and

(b) (i) A trust, organization or other arrangement that is operated exclusively to administer or provide pension, retirement or employee benefits; and

(ii) A not-for-profit organization

that was constituted in that State and that is, by reason of its nature as such, generally exempt from income taxation in that State.


2. Where by reason of the provisions of paragraph 1 an individual is a resident of both Contracting States, then his status shall be determined as follows:

(a) He shall be deemed to be a resident of the Contracting State in which he has a permanent home available to him; if he has a permanent home available to him in both States or in neither State, he shall be deemed to be a resident of the Contracting State with which his personal and economic relations are closer (centre of vital interests);

(b) If the Contracting State in which he has the centre of vital interests cannot be determined, he shall be deemed to be a resident of the Contracting State in which he has an habitual abode;

(c) If he has an habitual abode in both States or in neither State, he shall be deemed to be a resident of the Contracting State of which he is a citizen; and

(d) If he is a citizen of both States or of neither of them, the competent authorities of the Contracting States shall settle the question by mutual agreement.


3. Where by reason of the provisions of paragraph 1 a company is a resident of both Contracting States, then if it was created under the laws in force in a Contracting State, it shall be deemed to be a resident of that State. Notwithstanding the preceding sentence, a company that was created in a Contracting State, that is a resident of both Contracting States and that is continued at any time in the other Contracting State in accordance with the corporate law in that other State shall be deemed while it is so continued to be a resident of that other State.


4. Where by reason of the provisions of paragraph 1 an estate, trust or other person (other than an individual or a company) is a resident of both Contracting States, the competent authorities of the States shall by mutual agreement endeavor to settle the question and to determine the mode of application of the Convention to such person.


5. Notwithstanding the provisions of the preceding paragraphs, an individual shall be deemed to be a resident of a Contracting State if:

(a) The individual is an employee of that State or of a political subdivision, local authority or instrumentality thereof rendering services in the discharge of functions of a governmental nature in the other Contracting State or in a third State; and

(b) The individual is subjected in the first-mentioned State to similar obligations in respect of taxes on income as are residents of the first-mentioned State.

The spouse and dependent children residing with such an individual and meeting the requirements of subparagraph (b) above shall also be deemed to be residents of the first-mentioned State.

 

U.S. Treasury Technical Explanation of Art. IV

Article IV provides a detailed definition of the term "resident of a Contracting State." The

definition begins with a person's liability to tax as a resident under the respective taxation laws of

the Contracting States. A person who, under those laws, is a resident of one Contracting State and

not the other need look no further. However, the

 

U.S. Treasury Technical Explanation (cont’d)

 

Convention definition is also designed to assign

residence to one State or the other for purposes of the Convention in circumstances where each of

the Contracting States believes a person to be its resident. The Convention definition is, of course, exclusively for purposes of the Convention.

Paragraph 1 provides that the term "resident of a Contracting State" means any person

who, under the laws of that State, is liable to tax therein by reason of his domicile, residence,

place of management, place of incorporation, or any other criterion of a similar nature. The phrase

"any other criterion of a similar nature" includes, for U.S. purposes, an election under the Code to

be treated as a U.S. resident. An estate or trust is, however, considered to be a resident of a

Contracting State only to the extent that income derived by such estate or trust is liable to tax in

that State either in its hands or in the hands of its beneficiaries. To the extent that an estate or trust

is considered a resident of a Contracting State under this provision, it can be a "beneficial owner"

of items of income specified in other articles of the Convention - e.g., paragraph 2 of Article X

(Dividends).

Paragraphs 2, 3, and 4 provide rules to determine a single residence for purposes of the

Convention for persons resident in both Contracting States under the rules set forth in paragraph

1. Paragraph 2 deals with individuals. A "dual resident" individual is initially deemed to be a

resident of the Contracting State in which he has a permanent home available to him in both

States or in neither, he is deemed to be a resident of the Contracting State with which his personal

and economic relations are closer. If the personal and economic relations of an individual are not

closer to one Contracting State than to the other, the individual is deemed to be a resident of the

Contracting State in which he has an habitual abode. If he has such an abode in both States or in

neither State, he is deemed to be a resident of the Contracting State of which he is a citizen. If the

individual is a citizen of both States or of neither, the competent authorities are to settle the status

of the individual by mutual agreement.

Paragraph 3 provides that if, under the provisions of paragraph 1, a company is a resident

of both Canada and the United States, then it shall be deemed to be a resident of the State under

whose laws (including laws of political subdivisions) it was created. Paragraph 3 does not refer to

the State in which a company is organized, thus making clear that the tie-breaker rule for a

company is controlled by the State of the company's original creation. Various jurisdictions may

allow local incorporation of an entity that is already organized and incorporated under the laws of

another country. Paragraph 3 provides certainty in both the United States and Canada with respect

to the treatment of such an entity for purposes of the Convention.

Paragraph 4 provides that where, by reason of the provisions of paragraph 1, an estate,

trust, or other person, other than an individual or a company, is a resident of both Contracting

States, the competent authorities of the States shall by mutual agreement endeavor to settle the

question and determine the mode of application of the Convention to such person. This delegation

of authority to the competent authorities complements the provisions of Article XXVI (Mutual

Agreement Procedure), which implicitly grant such authority.

Paragraph 5 provides a special rule for certain government employees, their spouses, and

dependent children. An individual is deemed to be a resident of a Contracting State if he is an

employee of that State or of a political subdivision, local authority, or instrumentality of that

State, is rendering services in the discharge of functions of a governmental nature in any State,

and is subjected in the first-mentioned State to "similar obligations" in respect of taxes on income

as are residents of the first-mentioned State. Paragraph 5 provides further that a spouse and

dependent children residing with a government employee and also subject to "similar obligations"

in respect of income taxes as residents if the first-mentioned State are also deemed to be residents

of that State. Paragraph 5 overrides the normal tie-breaker rule of paragraph 2. A U.S. citizen or

resident who is an employee of the U.S. government in a foreign country or who is a spouse or

dependent of such employee is considered to be subject in the United States to "similar

obligations" in respect of taxes on income as those imposed on residents of the United States,

notwithstanding that such person may be entitled to the benefits allowed by sections 911 or 912 of

the Code.

 

How Does the Tax Treaty Affect You? Review Your Tax Planning

 

Canadians considering emigration to (or from) the U.S. should consider the pitfalls or tax savings available under the “tie breaker clause” of the Canada-U.S. tax treaty.

 

Douglas J. Kingston is an Arizona certified public accountant (CPA) specializing in international tax planning and compliance for U.S., Canadian, European, Latin American and Asian business and individual clients and may be reached by:

Telephone: (602) 595-5885E-Mail: doug@iTaxCPA.com • URL: http://www.iTaxCPA.com/