The Law Office of Joseph C. Grasmick is prepared to assist HR managers with U.S. immigration permits for Canadians. Nevertheless there are other related employment issues to handle. The first non-immigration question our Canadian clients ask is "What will the move to the U.S. do to our employees' income tax liability?" An HR manager will need to field this question for these reasons:
For this reason, we share our Web site with James Yager of KPMG Peat Marwick Thorne in Toronto, to further service our immigration clients. James is a Principal with the International Executive Tax Services group of KPMG Toronto.
by JAMES M. YAGER, CA, CPA
WINNER OF THE CANADIAN EMPLOYEE ROLOCATION COUNCIL ANNUAL EDITORIAL
AWARD
KPMG Peat Marwick Thorne
Director,
International Executive Tax Services Group
Suite 3300, Commerce Court West
PO
Box 31
Toronto, Ontario M5L 1B2 CANADA
Voice: 416.777.8214
FAX:
416.777.8818
jyager@kpmg.ca
Short term assignments can be an expensive alternative for positioning employee talent in the United States. Although the typical short term assignment would not involve expenses related to the selling of the family home, there are many tangible and intangible costs involved with two relocations within a short period of time. Fortunately, advanced tax planning can significantly reduce one of the major costs of any relocation.
Most companies consider assignments lasting less than two years to be short term. The general intent of a short term assignment is to accomplish a specific task or provide a training/development opportunity for key employees. Typically, the employee will return to his/her home location with as little disruption as possible to career and family life.
The tax laws in both Canada and the United States have provisions that reduce the tax burden on expense reimbursements associated with short term relocations. However, if the specific requirements are not met, the benefits will be lost. Furthermore, with aggressive use of the Canada and U.S. Tax Treaty (the Treaty), it may be possible to significantly reduce the applicable tax rates.
Employees who are neither citizens nor residents of the U.S. are subject to U.S. taxation if they work even one day in the U.S. unless they work for a non U.S. entity, the earnings allocated to U.S. work does not exceed US$3,000 and they spend no more than 90 days in the U.S. during the calendar year.
Canadian residents working in the U.S. can take advantage of two provisions in the Treaty to avoid the U.S. tax net:
Another possibility to avoid U.S. taxation is for the employee to be transferred to the U.S. under a training program. Compensation paid by a non-U.S. employer to an employee who is neither a citizen nor resident of the U.S. who enters the U.S. under a trainee visa (J visa) is not subject to U.S. taxation. Such compensation cannot be borne by a U.S. entity and must be for training purposes.
Unfortunately, avoiding the U.S. tax net may provide little benefit if the employee remains subject to the higher Canadian resident tax rates. If the employee can terminate Canadian residence or take advantage of the Overseas Employment Tax Credit, as discussed below, significant savings can be realized.
When a Canadian resident is transferred to the U.S. for a short term assignment, the starting point for saving taxes is determining whether it is possible to break Canadian residence. A Canadian resident is subject to Canadian tax on global income regardless of the source of the income or where it is paid. A non-resident of Canada would be subject to Canadian tax only on income from Canadian sources. Since the U.S. tax rates are typically much lower than Canadian rates, it is generally advantageous to be taxable in the U.S. rather than in Canada. Exhibit 1 illustrates the tax liabilities as a resident of Canada as compared to the taxes payable as a resident of the U.S. at different income levels.
EXHIBIT 1 - Income Tax Liabilities At Different Income Levels
TAXABLE COMPENSATION / U.S. TAX LIABILITY 1 /CANADIAN TAX LIABILITY 2
(US$)
70,000 15,496 28,643
100,000 25,696 44,599
200,000 64,156 97,785
400,000 151,974 204,158
(1) Assumes Married Filing Joint And 6% State Tax Rate
(2) Assumes Ontario Resident
An individual can be either a factual or a deemed resident of Canada. Although not specifically defined in the tax law, a factual resident of Canada is an individual who lives primarily in Canada. Whether a person lives primarily in Canada is based on whether the individual has residential ties to Canada and whether the individual has residential ties elsewhere. Some of the factors which indicate residential ties to Canada would include such things as a family, a year-round dwelling, personal property, memberships, etc. located in Canada. Revenue Canada presumes that an individual maintains Canadian residence if the individual leaves Canada for less than two years. A deemed resident is an individual who sojourns (visits) Canada for periods totaling 183 days or more during a tax year.
Since most short term assignments last less than two years it may not be possible to break Canadian residence based on Revenue Canada guidelines. Should the assignment be expected to last longer than two years and other residential ties can be terminated, Canadian residence can be avoided during the assignment.
Even if the employee cannot break Canadian residence under Canadian domestic law, the tax treaty between the United States and Canada may provide relief to a Canadian employee who transfers to the U.S. without completely severing residential ties to Canada. If an individual finds that he/she is considered a resident of both Canada and the U.S., the Treaty will determine which country the individual will be considered resident for purpose of taxation. The Treaty generally determines residence according to the location of a permanent home. If the individual has a permanent home in both locations, residence will be determined in the country where the individual has closer personal and economic relations. If it cannot be determined where he/she has closer personal and economic relations, residence will be determined according to the location in which he/she has a habitual abode. If a habitual abode exists in both locations, residence will be determined according to citizenship. Therefore, if a Canadian is considered a U.S. resident for tax purposes, he/she will be considered a nonresident of Canada pursuant to the Treaty if he/she maintains a U.S. permanent home, but no Canadian permanent home, even if other residential ties to Canada exist.
Although an employee who cannot break Canadian residence will be subject to global Canadian taxation, Canada will allow the employee to reduce his/her Canadian tax liability by a foreign tax credit which is generally equal to the amount of U.S. income tax paid. The credit is generally limited to the Canadian income tax on the income from U.S. sources. Since the Canadian tax rate is higher than the U.S. rate, it is likely that the foreign tax credit will not completely eliminate the Canadian tax liability.
Many companies provide their transferred employees with reimbursements for travel, meals and lodging while on short term assignments. Such reimbursements are typically considered taxable compensation under both U.S. and Canadian tax rules. However, both jurisdictions provide relief if specific guidelines are met.
If the transferred employee maintains Canadian residence, reimbursed expenses are generally considered taxable compensation to the employee. However, the tax law provides an exception to the general rule for reasonable board, lodging and transportation allowances paid in connection with temporary employment at a special work site. To qualify for the exemption, the employee must have his/her principal residence at another location, which is not within reasonable daily commuting distance. The principal residence must not be rented and must be available for the employees use throughout the temporary assignment. Furthermore, the employee must be required to be away from the principal residence for at least 36 hours.
A room (or rooms) in a hotel, boarding house or bunkhouse would not ordinarily qualify as a principal residence for this purpose. However, a principal residence does not necessarily have to be in Canada.
Revenue Canada considers an assignment to be temporary, if it can reasonably be expected that the work will not provide continuous employment beyond a period of two years. The determination of the expected duration of employment must be made on the basis of the facts known at the commencement of the assignment.
The employer can exclude the reimbursements from the employees T4 slip (Canadian statement of remuneration paid) if the requirements are met and the employee provides the employer with a complete form TD4 Declaration of Exemption-Employment at Special Work Site. Since an employee must not rent out his/her principal residence during the temporary assignment in order to be able to exclude the reimbursed expenses from income, the employee must forgo any potential rental income. In many cases, it will be more advantageous to obtain the tax benefits from the special work site provisions than to rent the principal residence.
U.S. tax law requires an employee working in the U.S. to include in taxable compensation reimbursements for meals, lodging and transportation. Even if the employee is not considered a U.S. resident, the reimbursement will be subject to U.S. taxation, if the reimbursement relates to services performed within the U.S. However, where the period of employment away from home in a single location is expected to last less than 12 months, the assignment is considered temporary and the employee will be allowed to deduct such expenses (subject to various limitations). If the employee complies with certain substantiation requirements, the employer will not be required to report the reimbursement as taxable compensation and the employee can exclude the reimbursements from income.
If the temporary assignment in a single location is realistically expected to last for one year or less, but at a later date this expectation changes, the employment will be treated as temporary until the date that the expectation changes. If the assignment was originally expected to last more than 12 months, but was unexpectantly shortened, the provisions indicate that the assignment would not be considered temporary, and therefore the expense reimbursements would be taxable.
The provisions apply to employees traveling away from home in pursuit of a trade or business. No portion of such travel expenses can be deducted or excluded if it relates to personal, living, or family expenses. A persons home is considered to be located at the place where the individual has his/her regular or principal place of business. Therefore, if the employee has no regular or principal place of business, the provisions will not apply.
In order to be able to exclude the reimbursement from compensation, the employee must substantiate the expenses by providing the employer with details regarding;
Failure to meet the substantiation rules would obligate the employer to report the reimbursements as compensation and subject the amounts to payroll withholding. Any amounts reimbursed to the employee in excess of amounts substantiated are also taxable to the employee and subject to payroll reporting and withholding tax requirements.
In lieu of substantiating the expenditure, the employer can provide the employee with a per diem amount. If the per diem falls within specified guidelines, the employee does not have to substantiate the amount of the expenditure and the per diem will not be included in the employees income nor reported on form W-2 (U.S. wage and tax statement).
The U.S. Internal Revenue Service issues per diem guidelines each year. For 1995 the per diem rate is US$95 for lodging, meals and incidental expenses incurred for travel within the continental United States. If lodging is reimbursed separately, the per diem is US$28 for meal and incidental expenses. For certain high cost localities, the per diem rates are increased to US$152 and US$36 respectively. High cost localities include such places as Los Angeles, San Francisco, Chicago and New York City. Separate per diem guidelines are issued for locations outside the U.S. Some of the locations are included in Exhibit 2.
EXHIBIT 2 - U.S. Per Diem Guidelines For Locations Outside The U.S. LOCALITY MAX. LODGING AMT MEAL AND INCIDENTAL MAXIMUM PER DIEM Calgary 67 50 117 Montreal 114 82 196 Toronto 97 48 145 Vancouver (Oct-Apr) 64 58 122 Vancouver (May-Sept) 105 60 165 Paris, France 144 118 262 Hong Kong 200 114 314 Tokyo, Japan 252 116 368 Moscow, Russia 188 98 286 London, U.K. 156 90 246 Monaco (Apr-Oct) 272 140 412 (All U$S)
Per diem guidelines appear to be fairly generous and avoid the need for detailed substantiation. Yet, the requirement that the assignment cannot be expected to exceed one year substantially limits its application.
Most short term assignments do not involve relocation expenses other than transportation expenses to the new location. However, in some situations the employer may provide relocation expense reimbursements to accommodate the employee at the new location. Although most relocation expense reimbursements are not taxable for both Canadian and U.S. tax purposes, there are certain reimbursements which may be taxed in the U.S. but not Canada.
Payments made to Canadian employees to reimburse them for their moving expenses are generally tax-free if the employee has been transferred from one location to another location of the employer or where the employee has accepted employment at a place other than where the employees former home was located.
Most reasonable expense reimbursements related to the relocation would not be taxable including house-hunting trips, traveling costs, transportation and storage of goods, costs of buying and selling a residence, temporary living expenses, reimbursement for the loss on the sale of the old residence, etc.
Generally, allowances not supported by expenses are taxable to the employee.
Similar to the Canadian rules, reimbursement of relocation expenses are generally not taxable to the employee if specific distance tests and employment tests are met.
Unlike the Canadian rules, expense reimbursements for temporary living, home loss reimbursement, closing costs for buying or selling a residence, and house hunting are taxable to the employee. Even if these expenses are reimbursed prior to the assignment, they would be subject to U.S. tax if it relates to a move to the U.S. where services will be performed in the U.S. Reimbursement of such expenses for a move back to Canada would not be subject to U.S. taxation if the reimbursement is paid after the employee terminates U.S. residence.
Although reimbursement of the costs of selling a residence may be taxable to the employee if the costs are incurred directly by the employee, the tax can be avoided if the employee sells the home to his/her employer or to a relocations company. Any expense related to the subsequent sale of the residence incurred directly by the employer would not be taxable to the employee.
Similar to the Canadian rules, allowances not supported by expenses are taxable to the employee. Generally, reimbursement of expenses related to moving an employees family or personal effects would be taxable to the employee if he/she qualifies for the away from home for less than 12 months provisions discussed above.
When Canadian residence cannot be terminated, the Overseas Employment Tax Credit (OETC) may provide relief, if the requirements can be met. The credit applies to Canadian residents who are employed outside Canada for a period of at least six months by a resident in Canada or certain entities related to a resident in Canada.
The credit is equal to the lesser of:
The $80,000 is prorated for qualifying periods less than the full tax year.
To be eligible, the employee must perform duties for the purpose of obtaining a contract for his/her employer or in connection with performing duties pursuant to such a contract. The contract must relate to:
For qualifying employees, the OETC can significantly reduce the Canadian tax burden.
Social security taxes payable in Canada are significantly lower than the social security taxes payable in the U.S. on the same level of compensation. The Agreement on Social Security Between the U.S. and Canada (known as the Totalization agreement) may allow Canadian employees temporarily transferred to the U.S. to continue to be covered by the Canadian system and avoid the higher U.S. contributions.
Canadian employees are subject to the Canada Pension Plan (CPP). An employee participates in CPP through compulsory contributions based on earnings from employment. The employer must match the contribution made by the employee. For 1995 the maximum amount of earnings subject to CPP is C$31,500 and the employee contribution rate is 2.7%. Consequently, the maximum employee and employer contribution for 1995 is C$850.50 for each.
Employees working in the United States are subject to U.S. Social Security tax of 6.2% of the first US$61,200 of taxable compensation or a maximum of US$3,794.40. In addition, the employee is subject to Medicare tax of 1.45% of total compensation. The employer must pay a matching U.S. Social Security tax and the Medicare tax. It is readily apparent that the U.S. Social Security and Medicare taxes far exceed the CPP liability on equivalent income.
Under the Totalization agreement, an employee sent by his/her Canadian employer to work in the U.S. can continue to be covered by CPP for assignments up to 60 months. During that period, the employee would be exempt from U.S. Social Security and Medicare tax on the same income. This can result in significant savings to both the employee and employer.
Generally, an employer cannot contribute to CPP on behalf of a nonresident employee. However, a Canadian employer can apply to cover nonresident employees located outside of Canada if the employment would be pensionable employment if it were in Canada and the employee was hired by the employer when the employee was present in and resident in Canada. The election will allow the employee to utilize the benefits of the totalization agreement and avoid the higher U.S. contributions.
To establish an exemption from U.S. social security and Medicare taxes, the Canadian employer should request a Certificate of Coverage from the Department of National Revenue, Taxation in Ottawa. The approved certificate should be maintained by the U.S. payroll agent. The Canadian employer should file a T4 each year indicating the CPP contributions. A footnote on the T4 should read filed for purposes of the Canada-U.S. Totalization Agreement.
Canadians working temporarily in the U.S. will undoubtedly be amazed at the amount of paperwork involved to comply with all the tax laws. Unless the employee can cease Canadian residence, the employee with likely be required to file both Canadian income tax returns and U.S. income tax returns. It is also likely that state tax returns will be required. Some local jurisdictions, such as New York City or Philadelphia may require their own tax returns. Failure to timely file these returns can result in severe penalties.
Most jurisdictions will require either estimated tax payments to be made throughout the year or payroll tax withholding. Failure to pay these taxes can also result in penalties. Due to the minefields of penalties it is advisable to seek professional assistance prior to initiating a foreign assignment.
Properly planning for the short term assignment can save the employee taxes and avoid the minefields of penalties. If the employer has a tax equalization policy (an agreement to keep the employee in the same tax position), the tax savings would benefit the company rather than the employee. Such savings could help offset the other significant costs of U.S. short term assignment.
James Yager is a Principal with the International Executive Tax Services group of KPMG Peat Marwick Thorne in Toronto. His clients consist primarily of corporations who have employees on international assignments.
Prior to relocating to Toronto in June 1993, he worked in New York, Hong Kong and Miami where he served U.S. based clients expanding internationally and foreign based clients from Canada, Europe, Asia and Latin America expanding into the U.S.
Having been an expatriate for over eight years, he is "intimately" aware of the cross border tax issues faced by both employees and employers.
Mr. Yager has been actively involved with the Canadian Employee Relocation Council and the National Foreign Trade Council. He recently testified before the U.S. House Ways and Means Committee for increased tax benefits for Americans working Abroad. He is also the treasurer of the American Club in Toronto.
Mr. Yager is a U.S. Certified Public Accountant and Canadian Chartered Accountant. He has received a B.A. in economics from Cornell College, an M.B.A. from The University of Iowa and an M.S. in Taxation from Florida International University.
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