Structuring compensation around taxation issues to make the most of your relocation offering.
By moving from one taxation system to another, international assignments create complex tax situations that require careful planning and complex calculations to minimize taxes.
Because of this complexity, more than 70 per cent of Canadian companies use the services of external firms for providing financial planning services to expatriates, the Canadian Employee Relocation Council found in a recent survey.
Here are some suggested approaches that help deal with taxation-related issues.
Transfers to Canada
Given that Canada is considered a high-taxed jurisdiction, the cost of bringing someone from a low-taxed jurisdiction, such as the United States, is significant.
Most individuals working in the United States demand a substantial premium to move to Canada. The most common way to deal with this request is through a mechanism called tax equalization: It attempts to put an individual in the same after-tax position they would have been in had they not moved to Canada.
Here is how it works: At year-end, the expatriates’ total tax payments are reviewed. These payments are compared to what their tax liability would have been in their home country. Assuming that the tax they would have paid in their home country is less than what they paid in Canada, expatriates receive a payment equal to the difference ‘grossed up’ for Canadian tax purposes.
Consider the following example:
•an individual earns $100,000 annually;
•Canadian tax is $50,000;
•home country tax is $40,000; and
•the Canadian income tax rate is 50 per cent.
This individual has incurred an additional $10,000 in income tax because of the transfer to Canada. The company would pay this individual an equalization payment of $20,000, since $20,000 less the 50 per cent tax leaves the individual with $10,000 net.
A couple of other issues arise with a tax equalization approach:
Cost: Tax equalization is costly. And, because the corresponding calculations are often complex, many organizations outsource this task to the large chartered accounting firms, which adds to the expense.
Fairness: Tax equalization may result in two individuals in comparable positions receiving substantially different compensation because one is from Canada and the other comes from a foreign jurisdiction.
Companies must take the time to assess the number of individuals to be transferred to Canada. If there is a regular flow of individuals into Canada, a company ought to develop a policy to deal with the tax implication for the transferees in a systematic manner.
Transfers from Canada
When transferring an individual from Canada to a foreign location, companies need to assess the taxation impact both from a Canadian perspective and also from a host country perspective.
From a Canadian perspective, two key areas need to be addressed. First, it must be determined whether an individual will become a non-resident of Canada.
This has a major impact on taxes: If an employee isn’t considered a non-resident of Canada, the person remains taxable in Canada on worldwide income. This essentially wipes out any tax savings the employee could receive by transferring to a lower-tax jurisdiction.
The Canada Customs and Revenue Agency (CCRA) administrative policy is that people leaving Canada for two years or less aren’t considered non-residents of Canada. However, an individual leaving Canada for more than two years is not automatically considered a non-resident.
To become a non-resident of Canada, CCRA states that someone must sever most, if not all, ties with Canada. They need to sell their principal residence, close bank accounts, give up their Canadian driver’s license and access to provincial health care, for example.
While maintaining one or two ties does not make an individual a resident of Canada, maintaining a number of ties to Canada makes it difficult to achieve non-residency status. International transferees should meet with someone familiar with CCRA’s rules to determine if they can be considered non-residents.
The other key area that needs to be addressed is CCRA’s deemed disposition rules. When an individual becomes a non-resident of Canada, for Canadian taxation purposes, she is essentially deemed to have sold her assets the day she left Canada.
Therefore, she may realize significant capital gains on paper, even though the assets have not been sold. CCRA recognizes that this causes a cash flow issue as the tax becomes payable prior to any actual sale, and therefore allows an individual to defer the payment of this tax until the actual sale of the assets. In the meantime, the individual must post security with CCRA, such as a line of credit. Companies can assist with this process by having the corporate banker set up the necessary lines of credit prior to the individual commencing assignment.
Companies should consider having an equalization policy for individuals transferred out of the country. While it is counterintuitive to equalize an individual transferred to a lower-tax jurisdiction, companies must consider that they probably want the individual to return to Canada at some point in the future.
At that point, convincing someone who has become accustomed to a low-tax environment that he should return to Canada is not always easy. Some expatriates react by looking for expatriate assignments in the same location with another company; tax equalization reduces this risk significantly.
Other issues that need to be addressed include:
Host countries tax compliance: Providing access to professional tax assistance in the host country helps ensure that expatriates’ taxes are properly calculated and paid. Typically this support is made available for the first two years of international assignment (longer if the individual is part of an equalization process).
Estate tax: While Canada does not have an estate tax per se, many countries do. The rate of estate tax can be as high as 55 per cent of the value of someone’s estate; this is the case in the U.S., for example. Transferring someone to a lower-tax environment may be a financial disaster for the transferee’s estate if this issue is not addressed.
Matthew Smith is vice-president at T.E. Financial Consultants and specializes in financial planning for executives. He may be contacted at (416) 366-8880 ext. 259 or [email protected]. Lionel Laroche is president of ITAP Canada; ITAP Canada provides cross-cultural training services to expatriates and their families. He may be contacted at (416) 248-4064 or [email protected].
Because of this complexity, more than 70 per cent of Canadian companies use the services of external firms for providing financial planning services to expatriates, the Canadian Employee Relocation Council found in a recent survey.
Here are some suggested approaches that help deal with taxation-related issues.
Transfers to Canada
Given that Canada is considered a high-taxed jurisdiction, the cost of bringing someone from a low-taxed jurisdiction, such as the United States, is significant.
Most individuals working in the United States demand a substantial premium to move to Canada. The most common way to deal with this request is through a mechanism called tax equalization: It attempts to put an individual in the same after-tax position they would have been in had they not moved to Canada.
Here is how it works: At year-end, the expatriates’ total tax payments are reviewed. These payments are compared to what their tax liability would have been in their home country. Assuming that the tax they would have paid in their home country is less than what they paid in Canada, expatriates receive a payment equal to the difference ‘grossed up’ for Canadian tax purposes.
Consider the following example:
•an individual earns $100,000 annually;
•Canadian tax is $50,000;
•home country tax is $40,000; and
•the Canadian income tax rate is 50 per cent.
This individual has incurred an additional $10,000 in income tax because of the transfer to Canada. The company would pay this individual an equalization payment of $20,000, since $20,000 less the 50 per cent tax leaves the individual with $10,000 net.
A couple of other issues arise with a tax equalization approach:
Cost: Tax equalization is costly. And, because the corresponding calculations are often complex, many organizations outsource this task to the large chartered accounting firms, which adds to the expense.
Fairness: Tax equalization may result in two individuals in comparable positions receiving substantially different compensation because one is from Canada and the other comes from a foreign jurisdiction.
Companies must take the time to assess the number of individuals to be transferred to Canada. If there is a regular flow of individuals into Canada, a company ought to develop a policy to deal with the tax implication for the transferees in a systematic manner.
Transfers from Canada
When transferring an individual from Canada to a foreign location, companies need to assess the taxation impact both from a Canadian perspective and also from a host country perspective.
From a Canadian perspective, two key areas need to be addressed. First, it must be determined whether an individual will become a non-resident of Canada.
This has a major impact on taxes: If an employee isn’t considered a non-resident of Canada, the person remains taxable in Canada on worldwide income. This essentially wipes out any tax savings the employee could receive by transferring to a lower-tax jurisdiction.
The Canada Customs and Revenue Agency (CCRA) administrative policy is that people leaving Canada for two years or less aren’t considered non-residents of Canada. However, an individual leaving Canada for more than two years is not automatically considered a non-resident.
To become a non-resident of Canada, CCRA states that someone must sever most, if not all, ties with Canada. They need to sell their principal residence, close bank accounts, give up their Canadian driver’s license and access to provincial health care, for example.
While maintaining one or two ties does not make an individual a resident of Canada, maintaining a number of ties to Canada makes it difficult to achieve non-residency status. International transferees should meet with someone familiar with CCRA’s rules to determine if they can be considered non-residents.
The other key area that needs to be addressed is CCRA’s deemed disposition rules. When an individual becomes a non-resident of Canada, for Canadian taxation purposes, she is essentially deemed to have sold her assets the day she left Canada.
Therefore, she may realize significant capital gains on paper, even though the assets have not been sold. CCRA recognizes that this causes a cash flow issue as the tax becomes payable prior to any actual sale, and therefore allows an individual to defer the payment of this tax until the actual sale of the assets. In the meantime, the individual must post security with CCRA, such as a line of credit. Companies can assist with this process by having the corporate banker set up the necessary lines of credit prior to the individual commencing assignment.
Companies should consider having an equalization policy for individuals transferred out of the country. While it is counterintuitive to equalize an individual transferred to a lower-tax jurisdiction, companies must consider that they probably want the individual to return to Canada at some point in the future.
At that point, convincing someone who has become accustomed to a low-tax environment that he should return to Canada is not always easy. Some expatriates react by looking for expatriate assignments in the same location with another company; tax equalization reduces this risk significantly.
Other issues that need to be addressed include:
Host countries tax compliance: Providing access to professional tax assistance in the host country helps ensure that expatriates’ taxes are properly calculated and paid. Typically this support is made available for the first two years of international assignment (longer if the individual is part of an equalization process).
Estate tax: While Canada does not have an estate tax per se, many countries do. The rate of estate tax can be as high as 55 per cent of the value of someone’s estate; this is the case in the U.S., for example. Transferring someone to a lower-tax environment may be a financial disaster for the transferee’s estate if this issue is not addressed.
Matthew Smith is vice-president at T.E. Financial Consultants and specializes in financial planning for executives. He may be contacted at (416) 366-8880 ext. 259 or [email protected]. Lionel Laroche is president of ITAP Canada; ITAP Canada provides cross-cultural training services to expatriates and their families. He may be contacted at (416) 248-4064 or [email protected].
