The COVID-19 pandemic caused many employees to pivot from their normal work routines and cross-border commuters were no exception. With travel restrictions and border closures between Canada and the United States fluctuating throughout 2020, individuals who normally cross the border were required to work remotely in their home country. As the Canadian and US tax deadline approaches, these taxpayers must navigate how this shift will impact the preparation of their personal tax returns.
On April 1, 2021 the Canada Revenue Agency provided further guidance and tax relief for those individuals whose tax situation was affected by travel restrictions imposed by the COVID-19 crisis.
To better understand the situation at hand, it may help to consider the example of a Canadian resident individual who commutes to the United States to work for a US resident employer. Under normal circumstances, the individual would have US tax and social security withheld from their pay for work performed in the United States. However, given the COVID-19 pandemic, the individual is now required to work from home in Canada.
Under the current laws of the Canada-US tax treaty, employment income is sourced to the country where the duties are physically performed. As such, any work conducted from home in Canada is considered Canadian sourced. If the US resident employer was not proactive in switching the employee to its Canadian payroll, there will now be a mismatch between where income is sourced and where taxes are withheld.
The CRA’s recent administrative concession gives Canadian resident commuters (who were required to work from home due to the pandemic) a choice when sourcing their 2020 employment income:
Canadian resident taxpayers may apply the normal income sourcing rules of the Canada-US income tax treaty. This would result in Canadian-sourced income for employment duties performed in Canada.
With the income and withholding mismatch mentioned above, Canadian resident taxpayers will see a significant refund on their US tax return and a large balance owing on their Canadian tax return. Given the longer processing times for returns in light of COVID-19, an individual may not receive the US refund in time to pay the Canadian liability, resulting in cash flow issues for the individual.
To combat this, the CRA will waive the interest and late-payment penalties until the individual receives their US refund and pays their Canadian liability. As well, filing under this method may result in required tax installment payments for the 2021 taxation year. The CRA will also waive any installment penalties and interest, if charged, on these balances.
Under the new administrative concession, the CRA will consider remuneration paid in 2020 by the US employer to be US-sourced employment income, regardless of where the work was actually performed. Under this option, the income sourcing and withholdings will align, and individuals can follow the same process as prior years by reporting the income and withholdings on their US tax return and claiming a foreign tax credit on their Canadian return for the associated US tax liability.
In filing a Canadian tax return in respect of US-source employment income, individuals can claim the following items as foreign tax credits:
Individuals may also claim a deduction on Form RC268, Employee Contributions to a United States Retirement Plan – Cross-Border Commuters, for contributions to a US retirement plan in 2020. Please note that these contributions will count towards a reduction in an individual’s RRSP contribution room.
Now that we’ve clarified the income tax challenges of Canadian residents commuting to the United States, let’s consider the example of a US resident individual who temporarily came to Canada to work from home or remained in Canada due to travel restrictions resulting from the COVID-19 pandemic.
Under normal circumstances, the income associated with working from home in Canada would be Canadian sourced. However, after applying provisions of the Canada-US tax treaty, the income is not taxable in Canada if the remuneration earned in Canada is not greater than CAD$10,000 or if the individual is physically present in Canada for less than 183 days in any rolling 12-month period beginning or ending in the fiscal year. Additionally, the remuneration will not be borne by either an employer resident in Canada or a permanent establishment which the employer has in Canada.
Because of the travel restrictions, some individuals have been “stuck” in Canada beyond the 183-day limit, exposing them to Canadian taxation. To help accommodate this, the CRA’s additional guidance provides more lenience in relation to the Canada-US tax treaty, stating that any employment income earned in Canada up to December 31, 2020 as a result of travel restrictions will not count towards the 183-day test. However, any days present in Canada after December 31, 2020 will count towards the 183-day test.
Moreover, individuals who were stranded in Canada for the majority of the year may be considered a “deemed resident” for staying in Canada for more than 183 days. The CRA’s administrative concession states that any days that an individual is in Canada due to travel restrictions will not count as a day of physical presence until either travel restrictions are lifted or December 31, 2021 (whichever is earlier). Please note that an individual may still be considered a factual resident of Canada depending on the facts and circumstances of their individual situation.
The CRA’s additional guidance is intended to help taxpayers avoid cash flow difficulties while simplifying 2020 income tax compliance. As such, the administrative concession will not apply to any individuals who received the proper payroll withholdings from their employer.
Certain relief that determined whether a company had a permanent establishment in Canada won’t be extended, but the CRA expects the application of international tax treaty provisions will generally not result in the finding of a permanent establishment in Canada.
The COVID-19 pandemic is creating a range of unique and complex challenges for Canadian businesses, and human resource professionals will be key to responding effectively to these emerging issues. Through proactive engagement, mobility professionals can help businesses navigate the turbulence by identifying tax risk, managing complexity and cost, and enabling more employees to continue working wherever they are located.
If you require support navigating these CRA provisions or others, please reach out to your Grant Thornton advisor.
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