Canadian COVID-19 Guidelines – International Tax

On April 1, 2021, Canada Revenue Agency (“CRA”) updated its guidance with Part VII – Supplemental Guidance[1] which provides further relief from Canadian residency and Canadian permanent establishment for certain non-residents of Canada and businesses by extending the relief period to December 31, 2020. The updated guidelines also provide an alternate method for cross-border employment income to be taxed. The alternate method may be a significant tax win for affected individuals. 

Cross-border Employment

A Canadian resident employee who normally works in the U.S. for a U.S. employer would be subject to U.S. tax on the related income. Due to COVID-19 and government travel restrictions, many employees were forced to work for their U.S. employers from Canada for most of 2020. 

Where Canadian resident individuals work in Canada for a U.S. employer, the related income would be taxable in Canada and not the U.S.[2]  The U.S. employer would normally withhold U.S. taxes from their pay. The affected individuals would receive a large U.S. tax refund but would have a large Canadian tax liability.

CRA is concerned with both the complexity individuals face in preparing their Canadian and U.S. tax returns and their cash flow. Would such individuals receive their U.S. tax refund in time pay an abnormally large Canadian tax liability by the April 30^th deadline? CRA allows individuals in these circumstances two choices for the 2020 year:

1. CRA will provide interest relief for individuals who cannot pay by the Canadian tax deadline if they are waiting for a U.S. tax refund, or
2. CRA will grant a foreign tax credit for the U.S. tax reported on the U.S. tax return where the individual files their U.S. and Canadian tax returns as if all the income was earned from employment services rendered in the U.S.

The individual should pay no more overall tax under either Option 1 or 2. Most individuals will get a better tax result using the second option due to better foreign exchange rates and increased foreign tax credits for U.S. payroll taxes.

Example A

• Canadian resident normally works in the U.S. for a U.S/ employer.
• They make US$120,000 a year with US$20,000 U.S. federal income tax withheld and US$9,000 of U.S. Social Security and Medicare Tax. 
• In 2020, they worked in the U.S. from January 1 to March 31 and Canada from April 1 to December 31. 
• Their U.S. federal tax is normally equal to the U.S. tax withheld. 
• The average 2020 exchange rate is C$1.34 to US$1.00, while the current April 2021 exchange rate is C$1.25 to US$1.00.

Option 1

Their U.S. federal income tax is US$3,000 They can claim a US$3,000 foreign tax credit in Canada and have a US$17,000 refund (C$21,250)[1].

Option 2

They have no U.S. tax refund. They increase their foreign tax credit on their Canadian tax return from US$3,000 to US$20,000 in option 2, resulting in an increased foreign tax credit of C$22,800[2], C$1,550[3] more than in option 1.

Option 2 also gives the individual has more US source income which will allow more of the US Social Security and Medicare Tax paid to be claimed as a foreign tax credit in Canada compared to Option 1.  In this situation, the individual can claim approximately US$5,000 (C$6,700) more foreign tax credit under Option 2.

Conclusion

The individual should choose option 2 for 2020 to realize and increase their overall savings by C$8,250.

Option 2 has a great result for the individual but results in a reduction US$22,000 of tax revenue to the Canadian government. Canada would lose over US$100 million of tax revenue in 2020 if there were 5,000 Canadian resident cross-border commuters that take advantage of option 2.[4]

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If you are a cross-border commuter impacted by the 2020 COVID-19 travel restrictions, please contact us to determine your best tax strategy for 2020.

[1] US$17,000 X 1.25 = C$21,250

[2] US$17,000 X 1.34 = C$22,800 (rounded)

[3] C$22,800 – C$21,250 = C$1,550

[4] 5,000 x $22,000 = over $100 million

[1] https://www.canada.ca/en/revenue-agency/campaigns/covid-19-update/guidance-international-income-tax-issues.html

[2] US citizens and US residents are treated differently for US tax purposes.