Canada-US Income Tax Treaty:
The United States and Canada have an income tax treaty in place. This treaty applies to taxes imposed by (1) the Government of Canada under the Income Tax Act, and (2) the Federal income taxes imposed by the Internal Revenue Code of 1986. However, as applied to U.S. accumulated earnings tax and personal holding company tax, the treaty applies only to the extent necessary to carry out certain provisions related to permanent establishments and transportation. Additionally, US excise taxes imposed with respect to private foundations shall only be covered to the extent required by the “Exempt Organizations” Article. Further, U.S. social security taxes are only covered to the extent necessary to implement certain paragraphs within the article discussing the Elimination of Double Taxation and the article discussing Miscellaneous Rules. Finally, United States estate taxes are only covered to the extent necessary to allow the implementation of provisions within the article titled Mutual Agreement Procedure and the article titled Taxes Imposed by Reason of Death.
Key Income Tax Treaty Features:
Income that residents of Canada receive for personal services as independent contractors or self-employed individuals is subject to taxation in the same manner as business profits. Business profits are exempt from U.S. income tax unless the individual has a permanent establishment in the United States. If they have a permanent establishment in the United States, they are taxed on the profit attributable to the permanent establishment. Under Article V (Permanent Establishment), you may be considered to provide services through a permanent establishment in the United States even if you do not have a fixed place of business.
Income that residents of Canada receive for personal services performed as employees (dependent personal services) in the United States is exempt from U.S. tax if it is not more than $10,000 for the year. If the income is more than $10,000 for the year, it is exempt only if (1) the residents are present in the United States for no more than 183 days in any 12-month period beginning or ending in the tax year, and (2) the income is not paid by, or on behalf of, a U.S. resident, and is not borne by a permanent establishment in the United States.
Public entertainers (actors, musicians, athletes, etc.) from Canada who derive more than $15,000 in gross receipts, including reimbursed expenses, from their entertainment activities in the United States during the calendar year are subject to U.S. tax. However, this article does not apply to athletes participating in team sports in leagues with regularly scheduled games in both Canada and the United States.
If you are a Canadian student, apprentice, or business trainee studying in the United States and you receive payments from sources outside of the United States for the purpose of covering your living expenses or education, these payments are exempt for United States Income Tax. This exemption last for the student’s first year in the United States.
Income or gains derived from the alienation or real property situated in the United States is taxable in the United States. For purposes of this article, real property situated in the United States includes standard real property, such as land and buildings, but also includes agriculture, forestry, and other natural resources situated in the United States.
The tax relief provided to Canadians under the tax treaty assumes they have not been a resident of the United States within the past 10 years, or for 120 months out of the past 20 consecutive years (this is also true for relief provided to Americans who were previously resided in Canada).
Dividends received by a Canadian resident will be taxable in Canada. If these dividends are paid by an American company, then they may also be taxed in the United States. However, there is a ceiling for this tax. Generally, the United States will not be able to tax these dividends at a rate higher than 15%. Under specific caveats, this ceiling drops. For instance, the ceiling drops to 5% if the investor owns at least 10% of the company. Other specific caveats do exist, but discussing each individual caveat in depth is beyond the scope of this blog. Finally, it should also be noted that when the payment of dividends is effectively connected to work performed at a permanent location in the United States, then any restrictions imposed by this portion of the treaty are not applicable, and both countries may tax the dividends in accordance with their own respective laws. For a more detailed understanding of these portions of the treaty as well as other additional dividend caveats not discussed here, see Article 10 of the Tax Treaty between Canada and the United States.
Interest received by a Canadian resident will be taxable in Canada. As with dividends, an exception to this rule exist if that interest is effectively connected to work performed at a permanent location in the United States. In that event, restrictions imposed by the treaty are not applicable. Further, interest arising from a payor in the United States and that does not qualify as portfolio interest may be taxed in accordance with the dividend provision of the tax treaty (See above). For a more detailed discussion of the provisions related to interest, see Article 11 of the Tax Treaty between Canada and the United States.
Royalties received by a Canadian resident will be taxable in Canada. If these royalties are paid by an American company, they may also be taxable in the United States at a rate of 10%. Royalties paid relating to films/movies and in connection with television are taxable by both countries. Other royalties paid, such as royalties paid in conjunction with the right to use computer software, are only taxable in the country where the resident who is receiving the payments lives. See Article 12 of the Tax treaty between the U.S. and Canada for a more in-depth discussion of the treaties treatment of royalties.
Generally, gains from the alienation of property, other than real property as defined within the tax treaty, are taxable only in the country where the alienator is a resident. However, certain exceptions do exist. Generally, gains derived by a resident of Canada in the alienation of shares forming part of a substantial interest in the capital stock of a company principally situated in the United States or gains from an interest in a partnership or trust/estate of value is principally derived from real property in the United States which the can be taxed in the United States.
Pension and Annuity payments arising in the United States and paid to Canadian residents can be taxed by the Canadian government. These payments are also taxable in the United States, but cannot exceed a tax rate of 15%. Further, had the payments been taxable only in the U.S. and a portion of the payment that would have been exempt from tax, then Canada should honor that exemption and not charge tax on the portion that would have been tax exempt in the United States.
Social Security benefits paid by the United States to a Canadian resident should be taxed by Canada, except that 15% of the amount of the benefit should be exempt from Canadian tax. Social Security paid by Canada to a U.S. resident will be taxed in the same way the U.S. taxes social security payments from the U.S., except that the U.S. will not tax Canadian payments that Canada would have exempted from tax.
Alimony is taxable in the country where it is received, except that alimony is exempt from tax to the extent that it would have been exempt in the country where the payor is situated.
Gains associated with other income, such as the payment of certain trust/estates that are not otherwise covered, can be taxed at a rate up to 15% by the country where the resident is situated
U.S. Estate and Gift Tax Treaty:
There is not a current gift tax treaty between the United States and Canada.
Within the U.S. Income Tax Treaty with Canada, there is an article titled Taxes Imposed by Reason of Death. This article is essentially dedicated to estate tax. While this article is within the income tax treaty, to keep this discussion consistent with the remaining portions of the blog, this article will be discussed within this section rather than with the income tax treaty.
Where the property of an individual passes to an exempt organization, then the transfer of the estate will be taxed by the country where the decedent was a resident.
In determining the amount the United States can tax the estate transfer of a decedent from Canada, the estate of an individual who was a resident of Canada shall be allowed a unified credit equal to the greater of (1) the amount that bears the same ratio to the credit that would have been allowed by the United States or (2) the unified credit allowed to a nonresident not a citizen of the United States.
In determining the amount the United States can tax the estate of a married individual, if that individual or his/her spouse was a citizen of the United States or Canada at the time the decedent died, then a credit should be allowed that equals the lesser of the (1) credit mentioned in the preceding paragraph, and (2) the amount of estate tax that would otherwise be imposed by the U.S. on the transfer of qualifying property.
In calculating estate tax due in Canada, if an individual was a resident of the United States immediately before the individual’s death, both the individual and their spouse should be considered residents of Canada for Canadian estate tax purposes. Further, if an individual was a resident of Canada and will owe estate tax in the United States, to the extent such taxes are imposed, a related deduction can be taken on Canadian estate tax due. Other specific caveats and exemptions are available, but are beyond the generic scope of this article. For further detail on the exemptions listed and other exemptions/deductions not listed see Article XXIXB in the Income Tax Treaty between Canada and the United States.
Canada and the United States try to avoid many scenario’s where they each assess overlapping taxes on the same American or Canadian income. However, it is up to the tax remitter to understand the tax treaty between the two countries and file the appropriate paperwork. While the tax treaty between the two countries can be very helpful in avoiding taxes due, it is only helpful to the extent that it is utilized. While there are some generic sections in the tax treaty between the United States and Canada, there are also many tailored sections. As such, in order to benefit from the tax treaty between the United States and Canada, it will often make sense to use a professional familiar with tax treaty between Canada and the United States.