One of the most important rules of the Canadian tax system, which many people are unaware of, is that Canada taxes all worldwide income of its residents. This means that if you are a resident of Canada, you must pay taxes on any income you receive, regardless of where that income was earned. This could be income from foreign employment, dividends from foreign investments, rent from foreign property, or any other type of income outside of Canada.
This rule was not established to stick it to people in their wallets. In fact, it was established for a very practical reason. The Canadian government knew that if people weren't required to pay taxes on foreign income, many wealthy individuals would simply move their assets to tax havens such as the Cayman Islands, Switzerland, or other countries with low tax rates, and avoid paying taxes in Canada. Therefore, the system was designed so that it would not make sense for Canadian residents to move their assets abroad.
However, it would be unfair to pay taxes twice on the same income. Therefore, Canada also has a foreign tax credit system that allows you to reduce your Canadian tax liability by the amount of taxes you paid in a foreign country. This means that although you may be liable to pay taxes in both a foreign country and Canada, you do not pay the full amount twice on the same income.
Who is considered a resident of Canada for tax purposes
Before we talk about whether you need to pay taxes on foreign income, it is important to understand what makes you a resident of Canada for tax purposes, as this is the main factor that determines whether you need to pay taxes on your worldwide income.
Residency for tax purposes is not the same as residency for immigration purposes. You may be a permanent resident of Canada for immigration purposes, but that does not mean you are automatically a resident for tax purposes. Similarly, you may have some status in Canada but still be a resident for tax purposes.
The Canada Revenue Agency (CRA) uses several tests to determine whether you are a resident of Canada for tax purposes. The main test is the “permanent residence test.” If you have a permanent residence in Canada, you are generally considered a resident for tax purposes. Permanent residence means that you have a physical place where you live in Canada, such as a house, apartment, or rented room. This place must be available to you throughout the year, and you must intend to continue using it as your place of residence.
If you do not have a permanent residence in Canada, the CRA looks at other factors to determine your status. These factors include where your family is located, where you work, where your significant assets are located, where you engage in social and civic activities, and other factors. If most of these factors indicate that you live in Canada, you will be considered a resident for tax purposes.
If you have recently arrived in Canada, you may be considered a “new resident” for the year you arrived. As a new resident, you may be eligible for certain special conditions, such as choosing the date on which you are considered a resident for tax purposes. However, once you have established residency in Canada, you are considered a resident and may be taxed on your worldwide income.
If you are a resident of Canada for part of the year and a non-resident for part of the year (for example, if you left Canada in the middle of the year), you are considered a “partial-year resident.” As a part-year resident, you pay taxes on all worldwide income for the period you were a resident and on any Canadian income you earned during the period you were a non-resident.
Types of foreign income that must be reported
Now that we have established that Canadian residents must pay taxes on all worldwide income, let's look at what types of income are considered foreign income and how they are taxed.
Foreign income can take many forms. It could be salary or employment income that you receive from working outside Canada. It could be business income that you receive from operating a business in a foreign country. It could be investment income, such as dividends from foreign company shares, interest from a foreign bank account, or proceeds from the sale of a foreign investment. It could be rental income that you receive from renting property abroad. It could be pension income that you receive from a foreign pension program. It could be income from charities or gifts.
Each of these types of income is taxed in Canada in the same way as if it were Canadian income. This means that, for example, if you had a job in the US and received a salary in US dollars, that salary must be included in your Canadian tax return, converted to Canadian dollars based on the exchange rate on the day you received the payment, and included in your calculated total tax amount.
However, there are some types of income that may be exempt from taxation in Canada depending on the tax treaty between Canada and the foreign country. For example, if you receive a pension from a foreign country, that income may be exempt from taxation in Canada depending on which country it comes from. However, this is rare. In most cases, foreign income must be included in your Canadian tax return.
Exchange rate issue: How to convert foreign income
One important detail when reporting foreign income is how you convert foreign income into Canadian dollars. The Canada Revenue Agency has specific rules about this.
The general rule is that you must convert foreign income into Canadian dollars based on the exchange rate on the day you received the income. This means that if you received a payment at your American job on Friday and the rate was one to one, you convert the payment based on that rate on Friday. If you received another payment on the following Monday and the rate had changed, you would convert that payment based on the new rate on Monday.
However, if this is too complicated, especially if you receive many payments throughout the year, the CRA allows you to use the average exchange rate for the year instead of the exact rate on the day you received the payment. This simplifies calculations and makes errors less likely.
To convert the exchange rate, you can use the official rates published by the Bank of Canada, or even rates from other official sources, such as interbank rates. However, you cannot simply use any random rate you find on the Internet. It must be official and transparent.
This exchange rate issue becomes very important if the exchange rate fluctuates significantly during the year. For example, if you earn income in US dollars and the US dollar strengthens significantly against the Canadian dollar during the year, your Canadian income will be higher than if the exchange rate had remained stable. This means you will pay more taxes. Similarly, if the US dollar weakens, you will pay less tax.
Tax credit system: Avoiding double taxation
As I mentioned earlier, one of the potential problems with worldwide income taxation is that you may end up paying tax twice on the same income. For example, if you earn wages in the US, the US may tax those wages. When you bring that money to Canada and report it as income on your Canadian tax return, Canada may also tax that income. In that case, you are paying taxes on the same income twice.
To address this issue, Canada has a foreign tax credit system. This system allows you to reduce your Canadian tax liability by the amount of foreign taxes you have already paid on that income.
Here's how it works. Let's say you earned USD 50,000 in the United States and paid USD 7,500 in U.S. federal tax on that income. When you convert this income into Canadian dollars and calculate your Canadian tax amount, let's say it turns out that you have to pay CAD 12,000 in Canadian taxes on this income. Without a tax credit, you would have to pay CAD 12,000 in Canada in addition to the USD 7,500 you already paid in the United States. Together, this would be a very large tax amount.
However, with a tax credit, you can deduct the amount of foreign tax you paid from your Canadian tax amount. The system allows you to deduct the lesser of the two amounts: the amount of foreign tax you paid or the amount of Canadian tax you owe on this income. In this example, the foreign tax (USD 7,500) converted to Canadian dollars will be less than the Canadian tax (CAD 12,000), so you can deduct the lesser amount.
However, there is an important limitation here. The tax credit cannot result in your total Canadian tax liability being less than zero. This means that if the foreign tax you paid is more than the Canadian tax you owe, you cannot get a refund for the difference. Instead, you may be able to carry the difference forward to other years (this is called a carryforward) or carry it back to previous years (this is called a carryback).
In order to claim the foreign tax credit, you need to document the foreign taxes you paid. This means keeping receipts, slips, or official documents from the foreign tax authority that show the amount of tax you paid. Without these documents, the CRA will have no proof that you paid foreign taxes and will not give you the credit.
Forms and documents for reporting foreign income
To report foreign income and claim a foreign tax credit, you need to complete several forms and documents.
First, all foreign income must be included in your main tax return (T1 General). Depending on the type of income, you will need to complete different sections of the return. For example, if you had income from employment, you would complete the section on employment income. If you had income from investments, you would complete the section on investment income. If you had income from a business, you would complete Form T2125, which shows your net business income.
Second, if you paid foreign taxes, you would need to complete Form T2209 for the federal foreign tax credit. This form shows the amount of foreign taxes you paid and calculates the amount of credit you can claim.
Third, if you live in a province that has its own tax system (all provinces do), you also need to fill out a provincial form for foreign tax credit. Different provinces may call this form by different names, but it serves the same purpose.
Fourth, if you have foreign assets worth more than CAD 100,000, you need to complete Form T1135 (Foreign Income Verification Statement). This form shows the value and description of your foreign assets. It is important to note that you must complete this form even if these assets do not generate income. For example, if you have a house in Ukraine that you do not rent out, you must still report it on Form T1135 if its value exceeds CAD 100,000.
Failure to complete Form T1135, if you are required to do so, can result in serious penalties. Penalties can range from CAD 100 to CAD 2,500 per year if the form is not completed or filed late. If the CRA finds that you have intentionally failed to report foreign assets, the penalties can be much higher.
Non-residents and Canadian income: The other side of the coin
While our focus has been on Canadian residents who pay taxes on foreign income, it is important to understand the other side of the coin. If you are a non-resident of Canada, you generally do not pay taxes on your worldwide income. Instead, you only pay taxes on income you earn from Canadian sources.
Canadian income includes income from working in Canada, income from doing business in Canada, and income from selling Canadian real estate. However, even for non-residents, certain types of income from Canadian sources may be exempt from taxation depending on the tax treaty between Canada and the country where the non-resident lives.
For non-residents who receive income from Canadian sources, taxes are generally deducted at source. This means that a Canadian employer or Canadian source of income will deduct taxes before paying the non-resident. However, the non-resident can still file a Canadian tax return to calculate their exact tax amount and potentially receive a refund if too much tax was deducted.
Special situations: US citizens and other special cases
One important special situation is that of US citizens. The US is one of the very few countries in the world that taxes its citizens on their worldwide income, regardless of where they live. This means that if you are a US citizen or have a US Green Card, you need to file a US tax return even if you live in Canada and all your income comes from Canadian sources.
For US citizens living in Canada, this dual reporting obligation can be challenging. They must pay taxes in both the US and Canada on the same income. However, the US also has a foreign tax credit system similar to Canada's, which allows Americans to reduce their US tax bill by the amount of taxes they paid in Canada.
In addition, the US and Canada have a tax treaty that allows certain Americans to claim a tax exemption on certain types of income in the US if they pay taxes on that income in Canada. However, these rules are very complex, and Americans in Canada are often advised to hire a professional tax advisor who specializes in U.S. taxes.
Another special situation is students. If you are a foreign student in Canada, you may be a non-resident for tax purposes, even if you live in Canada on a permanent basis. However, if you earn income in Canada, you will still need to pay Canadian taxes on that income. In addition, if you receive income from your country of origin, that income is generally not subject to Canadian taxation, so you may not need to report it on your Canadian return if you are a non-resident.
Practical examples: Understanding the impact of worldwide taxation
Let's look at a few practical examples to better understand how worldwide taxation works in practice.
The first example is Mariana, a newcomer to Edmonton. Mariana arrived in Canada in July and started working for a company in Edmonton with a salary of CAD 60,000 per year. However, earlier this year, before arriving in Canada, Mariana worked in the United States and earned USD 15,000 between January and June. Mariana is a resident of Canada for tax purposes from July to December. When she files her tax return, she must include all her US income from January to June because that income was earned before she became a resident. In fact, Mariana must report all worldwide income for the period she was a resident (July to December), plus any Canadian income she earned during the period she was a non-resident (January to June). In this case, she may not need to report her foreign income from the US for the period from January to June on her Canadian return, as she was a non-resident at that time. However, she will need to report all Canadian income she received during the period from January to June, if any.
The second example is Sergei, who lives in Toronto and has investments in both Canada and the US. Sergei will receive dividends of USD 3,000 from US stocks and dividends of CAD 2,000 from Canadian stocks. Sergey is a resident of Canada, so both types of dividends must be included in his Canadian taxation. The US dividends must be converted into Canadian dollars based on the exchange rate. If the exchange rate is 1.25, then USD 3,000 converts to CAD 3,750. Sergey must report CAD 3,750 from US dividends and CAD 2,000 from Canadian dividends, for a total of CAD 5,750. However, the US may also impose taxes on dividends. If the US has deducted 15% dividend tax, then Sergey has paid the US USD 450 in dividend taxes. Sergey can claim a foreign tax credit in Canada to reduce his Canadian tax amount by the amount he paid in the US.
The third example is Anna, who lives in Vancouver and rents an apartment in Lviv, Ukraine. Anna receives rental income of UAH 500,000 per year from this apartment. Anna is a resident of Canada, so she must report this income on her Canadian tax return. She must convert the hryvnia to Canadian dollars based on the exchange rate. If the exchange rate is 0.04 (i.e., 1 hryvnia = 0.04 Canadian dollars), then UAH 500,000 converts to CAD 20,000. Anna must report CAD 20,000 as rental income in Canada. She can also deduct any expenses related to the rental, such as property maintenance, insurance, and any repairs. In addition, Ukraine may also impose taxes on this rental income. If Anna has paid Ukrainian taxes on this income, she may be eligible for a foreign tax credit in Canada.
Reporting foreign assets and Form T1135
As I mentioned earlier, if you have foreign assets worth more than CAD 100,000, you need to complete Form T1135. This is an important issue that many people do not understand or forget. Form T1135 is not about income. It is about assets. You must complete this form even if your foreign assets do not generate any income.
Foreign assets that must be reported include foreign bank accounts, foreign investments, foreign real estate, shares in foreign companies, debt instruments of foreign companies, and many other types of assets. However, assets held in registered accounts, such as RRSPs or TFSAs, are generally not required to be reported on Form T1135, even if they contain foreign investments. In addition, personal use property, such as a home or car that you use for personal use, may be exempt from reporting.
The value for the purposes of Form T1135 is your cost (i.e., how much you paid for the asset) or the fair market value at the end of the year, whichever is higher. This means that if you bought a house in Ukraine for USD 50,000 five years ago, but its value has increased to USD 100,000, you need to report USD 100,000 on Form T1135, not USD 50,000.
Failure to complete Form T1135, if required, is a serious matter. Penalties can range from CAD 100 to CAD 2,500 for each year the form is not filed or is filed late. In addition, if the CRA determines that you intentionally failed to report foreign assets in order to avoid taxation, you could face much more serious consequences, including criminal charges.
Tax treaties: Avoiding double taxation
Canada has tax treaties with more than 100 countries around the world. These treaties are designed to prevent double taxation and resolve certain technical issues that arise when taxing international income.
Among the issues that tax treaties address is the question of which country has the right to tax certain types of income. For example, the treaty between Canada and the United States states that employment income earned by a person who works in the United States and lives in Canada must be taxed in the United States. This means that the US has the right to tax this income first, and Canada must provide a foreign tax credit for taxes paid in the US.
In addition, some treaties allow for certain exemptions. For example, some treaties exempt non-residents from taxation on certain types of income, such as pensions. However, this depends on the specific treaty.
If you receive income from a country with which Canada has a tax treaty, you should review the terms of that treaty. This may help you reduce your tax liability or determine whether you are eligible for certain exemptions.
Conclusion: Understanding Global Income Reporting Obligations
Canadian residents have clear obligations to report and pay taxes on all global income. This includes income earned outside of Canada from any source. However, the system is also designed to be fair. If you pay taxes on this income in a foreign country, you may be eligible for a foreign tax credit in Canada to reduce your Canadian tax bill.
In addition, if you have foreign assets, you are required to report them on Form T1135 if their value exceeds CAD 100,000. Failure to do so can result in serious penalties.
Understanding these requirements is very important for Canadian residents, especially newcomers who may have assets or income abroad. If your situation is complex, especially if you have significant foreign assets or income from multiple countries, it is recommended that you hire a professional tax advisor who can help you report this income correctly and determine what credits you may be eligible for.
In conclusion, remember that Canada's tax system is fair and transparent. The worldwide income tax system is not designed to penalize you for earning money abroad. Instead, it is designed to ensure that all Canadian residents contribute fairly to the funding of public services in Canada, regardless of where they earn their money.