Written by Eric Hendry, Associate, Gowling WLG (Canada) LLP
What happens when the domestic tax rules of two different countries look at the same person and both conclude that the individual is a tax resident? Navigating situations of “dual tax residency” is becoming increasingly common for estate planners and their clients. Whether for business, family, or lifestyle reasons, more and more Canadians seem to be putting down roots in more than one country. Others may seek to leave Canada altogether, only to discover that severing Canadian tax residency is more difficult than expected (as explored in a previous post on this blog). The result is that tax dual-residency situations are quite common.
Fortunately, most of Canada’s bilateral tax treaties contain a set of “tie-breaker” rules designed to resolve dual-residency by assigning a single country of residence for treaty purposes. The result is typically relief from what would otherwise be double taxation from both states simultaneously. Understanding how these rules work is essential to managing the risks and complexity that dual-residency introduces. In this post, I cover what estate planners should know when navigating these rules. International tax is notoriously complex, and the goal here is not to make everyone a technical expert. Rather, it’s to provide a solid high-level understanding of treaty tie-breakers so you know what to look for when you encounter dual-residency.
What’s at stake?
A client’s treaty residence can determine not only which country holds the primary right to tax income during life, but also which tax regime applies at death.
Consider, for example, an individual who is a dual tax resident of Canada and the United States. Canada generally imposes tax on unrealized capital gains at death through a deemed disposition of capital property, whereas the United States does not tax unrealized gains but instead levies an estate tax on individuals whose estates exceed certain thresholds. The interaction of these two regimes is governed in part by the Canada–US Tax Treaty. A Canadian treaty resident would generally be entitled to certain relief from US estate tax but would remain fully subject to Canada’s deemed disposition rules and the resulting capital gains tax. Conversely, a US treaty resident would generally be eligible for some measure of relief from Canadian capital gains tax on death.
Understanding how tax treaties resolve questions of dual-residency is therefore essential to determining which tax regime applies on death and to structuring an effective cross-border estate plan.
The Treaty Framework
Most of Canada’s tax treaties are modelled on the OECD’s Model Tax Convention on Income and on Capital (the “Model Treaty”). When an individual qualifies as a resident of both countries under their respective domestic laws, the Model Treaty’s tie-breaker rules in Article 4(2) step in. These rules are a sequence of tests: you work through them in order, and once a test produces a clear answer, you stop. It is worth noting that while most Canadian treaties follow the Model Treaty closely, the specific wording can vary from treaty to treaty. The relevant treaty must always be read very carefully.
The Tie-Breaker Tests
Step 1 — Permanent Home: The first test asks whether the individual has a permanent home available to them in one or both countries. If a permanent home exists in only one country, the individual is resident in that country. Any form of dwelling can qualify, whether owned, rented, or otherwise occupied. What is critical is that it is available to the individual at all times on a continuous basis, not merely for occasional or short-term stays.
Step 2 — Centre of Vital Interests: If there is a permanent home in both countries, the analysis moves to which state the individual’s personal and economic relations are closer to. This is a holistic, fact-driven inquiry that considers family and social relationships, occupation, political and cultural activities, place of business, and where the individual administers their property. If for example an individual has a home in both Canada and the US, but their business activities and family are only in Canada, they’ll likely be considered a Canadian under the Treaty because of their “centre of vital interests”.
Step 3 — Habitual Abode: If the centre of vital interests cannot be determined, the treaty looks to where the individual has a habitual abode. This goes beyond simply counting days: Canadian courts have emphasized that what matters is the frequency, duration, and regularity of stays of sufficient substance that one can conclude the individual normally lives there as a matter of habit.
Step 4 — Nationality. Passports matter, but only if everything else is unclear. If the habitual abode test is also inconclusive, the treaty assigns residence based on nationality or citizenship.
Step 5 — Mutual Agreement. As a final backstop, if none of the above tests resolve the question, the competent authorities of the two countries must settle the matter by mutual agreement.
For clients with cross-border lives, treaty tie-breakers should be an important consideration when thinking about estate planning. Getting this analysis right can be difficult and time-consuming: it involves a careful analysis of virtually every aspect of the individual’s lifestyle as well as a close reading of the treaty, case law, commentary and administrative guidance. Overlooking this analysis however is far more painful and can leave executors with surprise tax bills in two jurisdictions and a scramble to obtain relief.
