International Double Taxation Dangers - Canada and the UK

One of the worst headaches of relocating to another country to work or retire is the overlapping and duplication of taxation and the insanely complex rules governing this area. If you think tax rules in one country are bad enough, try figuring out those of two countries and how they inter-act. On top of that some determinations are based on fuzzy and slippery concepts such as residence and domicile that rely in part on your own intentions, as interpreted by tax authorities.

Take the example of someone going from Canada to the UK. It is entirely possible to end up being taxable in both countries with respect to various taxes like those on employment income, interest, dividends and capital gains. Most taxation is based on Residence. Note the spelling with a capital "R". It is a proper noun, indicating it has a specific defined meaning in the eyes of HMRC (the UK tax collector) and CRA (the Canadian tax authority), though amusingly or frustratingly, their definitions come from court cases that have had to interpret the natural lower case meaning of residence. Of course Residence is only the starting point since in the UK, the concepts of Ordinary Residence and Domicile also determine what taxes are payable by whom. It so happens that Canada's meaning of Residence is based on different criteria than the UK's (are you surprised?).

In Canada, it is ties to the country that count, such as having a permanent place to live, a spouse and dependants as the most important factors and any number of other secondary ties like bank accounts, club or union memberships. This is laid out in the CRA's bulletin IT-221R3 Determination of an Individual's Residence Status. You can be absent and not set foot in the country for 20 years and still be a Resident. That makes you subject to taxation on your worldwide income.

In the UK, the basic rule for Residency is whether you have spent 183 days or more in the country in a particular year. This is explained in HMRC's IR20 Residents and Non-Residents.

Enter the Canada-UK Double Taxation Convention, supposedly to eliminate the conflict according to its sub-title "For the Avoidance of Double Taxation". It has a different set of rules for deciding where you are Resident, resembling those of Canada through such tests as where one has a permanent home and where the centre of one's vital interests lie. The Convention is a critical document because it takes precedence over other laws in each country that may state something different or be in conflict with its provisions. (That this is so was confirmed by a call to the HMRC Inheritance Tax helpline at 0845 302 0900 and in the Zurich Tax Handbook 2006-07 on page 633).

The recent UK budget announced a change whereby non-domiciled but resident individuals who have been in the UK at least seven years out of the last ten will be taxable on their worldwide income unless they pay a £30,000 fee to be allowed to continue to be taxed only on income that is remitted to the UK (which has been the standard rule up to now). However, if you are also a tax Resident of another country like Canada, and its tie-breaker rules put you in Canada, then the new budget measures have no effect. Whew!

It is also true alas that the Double Taxation Convention does not make you a total non-taxpayer in the "non-resident" country. Note article 4 paragraph 1 which states, "For purposes of this Convention, the term "resident of a contracting state" means ...". In other words, you are non-resident of the other state only for purposes of the Convention and the taxes it covers. You are still a Resident and subject to any other taxes it does not cover. In the case of Canada and the UK, a significant such tax is Inheritance Tax (IHT). The Canada-UK Convention makes no mention of IHT, no doubt because such a tax does not exist in Canada. Thus, any UK rules about IHT might apply to a Canadian who is non-resident in other respects under the Convention.

The key for IHT is whether you are Domiciled in the UK, which is where you have your "permanent home " according to HMRC. (Thankfully you can only have one Domicile at a time). Living for many years in another country doesn't automatically change your domicile according to HMRC's IR20 on page 22 ... unless you happen to have been Resident for 17 of the last 20 years, in which case you automatically acquire "Deemed Domicile" in the UK (see HMRC's FAQ on Domicile and IHT). That will make your worldwide assets subject to IHT, which covers not just death duties but gifts as well. Imagine someone dieing as a Canadian tax Resident but also as a UK Deemed Domicile. The deemed disposition and final return income inclusion of all retirement account holdings, likely at the highest marginal tax rate in Canada could be double-whammied by IHT at 40% for amounts over the zero rate/exemption amount of £312,000. Despite a principal residence being tax-exempt in Canada, that is not so with respect to IHT in the UK, so a Canadian house would be taxable in the UK. One could end up with a huge tax bill, leaving little for inheritances.

For those former UK residents who emigrated to Canada and then return later to the UK, perhaps upon retirement, they might be considered never to have changed domicile in the first place and become subject to IHT immediately upon return.

Canada and the UK are not the only countries with double taxation treaties. Where other countries also levy inheritance taxes, there may by provisions in the bilateral treaty that address IHT. The HMRC Customer Guide on IHT (isn't the terminology charming? - "Customer" guide) lists countries like the USA where the treaty includes IHT. The Telegraph article Inheritance Tax Abroad; taxmen sans frontières warns of the unanticipated consequences of inheritance laws in favoured retirement locales like France and Spain.

There are hundreds of bilateral treaties between countries (almost all are based on the OECD model treaty), most very similar but with slight variations which can be critical. They sustain a thriving industry for tax accountants who can advise on the consequences and make suggestions for minimizing the damage if at all possible. The Institute of Chartered Accountants of England and Wales has a good list with links to treaties of major countries. All of Canada's are listed on a Department of Finance page - see the In Force section. The UK's are listed here and the HMRC DT Digest is a handy table of key types of income and the rates applied in all the countries with treaties with the UK.