US-Canada Tax Treaty Explained
The United States and Canada entered into a bilateral international income tax treaty several years ago. The purpose of the treaty is to provide clarity for certain tax rules impacting citizens and residents of either country on matters involving cross-border income. The tax treaty serves to benefit citizens and residents from Canada who reside in the United States, and vice-versa. When it comes to international tax in general, Taxpayers can (understandably) get very overwhelmed by the disparate tax treatment of certain income. Making matters worse is the fact that tax treaty language can be dense, confusing, and ambiguous. Further complicating the application of tax treaties is the fact that the saving clause can otherwise damper what would seem to be a clear understanding of the application of certain treaty articles. Instead of going through and detailing each aspect of the tax treaty, which would put all of us to sleep, here are seven important and common tips about the US-Canada Tax Treaty.
Saving Clause and Exceptions
The Saving Clause is one of the most important aspects of any US Tax Treaty. In general, the idea behind the Saving Clause is that despite any tax outcome within the treaty (for example private pensions), this clause allows each party to the agreement to still tax the person in the same way they would if the treaty was not in place. But, there are exceptions to the Saving Clause such as Social Security — and if there is an exception then that means that the Saving Clause will not apply to certain Articles of the treaty. Therefore, whatever is written into the treaty should hold true for the tax matter at issue. For example, Government payments are excluded from the Saving Clause, so that under the US-Canada Tax Treaty, Social Security payments are not to be treated differently than as set forth in the treaty — but tax rules are impacted by citizen/resident status.
Relief From Double Taxation
One primary benefit of the US-Canada Tax Treaty is the relief from double taxation. In other words, the double taxation relief allows a person to claim a credit for taxes paid in the other country to avoid double taxation. This helps to avoid and/or minimize having to pay tax in both jurisdictions on the same income.
Income From Real Property
When there is income generated from real property such as rental income, both countries are able to tax the income. That is because the portion of the treaty referring to income from real property provides that the contracting state in which the property is located may tax the income. In other tax treaties, the language would provide that the income shall only be taxable in one of the countries.
Private pensions and annuities are one of the more complicated aspects of the US tax treaty. That is because at first glance it would appear that the pension is only taxable in the contracting state of residence. The US-Canada Tax Treaty is a bit more complicated in that while pensions are excluded from the Saving Clause — the are very strict tax requirements (different than how most treaties tax pension). The general concept is that since the US taxes US persons on their worldwide income, pension income is almost always taxable by both countries (even if the tax rules are more limited) – although, for non-citizens, a tax treaty election to be treated as a foreign resident may be a consideration.
When it comes to government functions, the concept is that when a person is performing services for one country’s government, then that country will have the exclusive right to tax that person on the income – and will be exempt in the other country. There are some exceptions and exclusions identified in the treaty. In addition, while Government Services is exempt from the Saving Clause, it is generally limited to people who are not considered citizens or otherwise have immigration status in either of those two countries. In other words, the goal of the treaty is to protect citizens of one country for work performed on behalf of government functions of that country — whereas if the person is a citizen of the other country, then the other country is not precluded from taxing the income.
Social Security under the US- Canada Treaty is excluded from the Savings Clause. This means that the Treaty will be the final word on Social Security.
Exchange of Information
With the recent introduction of FATCA, the exchange of information is a crucial concern for Taxpayers who have accounts, assets, and investments outside of their residence country — especially if the person is a US Person with funds abroad. With the global interest in cracking down on matters involving tax non-compliance, it is important to keep in mind that by way of these tax treaties, the countries have agreed to work together in order to carry out the intent of the treaty. The goal is to equalize tax while reducing and eliminating tax fraud and other violations – noting, there are some limitations in just how far each country will go in terms of exchanging information.
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