Going North of the Border: Selected Issues Facing U.S. Employers Seconding Employees to Canada
U.S. employers who send one or more U.S.-based employee to work on assignment in Canada will likely encounter, either directly or indirectly through their employees, a number of economic, tax and regulatory issues. This article, authored jointly by the global mobility experts at Alliott Group member firms Farkouh Furman & Faccio (New York, NY) and Hardy, Normand & Associés (Montreal, Canada) is meant to give a general overview of some of the more common issues that could arise in connection with seconding an employee to Canada. However, it is not meant to address the tax and compliance issues a U.S. employer will face from an entity perspective on account of its conducting business in Canada through a permanent establishment.
While on assignment in Canada, employees may receive various types of additional compensation, e.g. amounts paid for moving, housing, transportation, taxes on the purchase of goods and services and other incremental costs, as well as receipt of restricted stock, the payment of deferred compensation or the exercise of stock options.
Due to differences under Canadian and U.S. tax law as to the timing or the sourcing of income attributable to certain of these compensation events, an employee’s ability to credit Canadian taxes paid against a present or future U.S. income tax liability may be negatively affected without proper planning. For example, restricted stock is taxed at grant in Canada while in the U.S. it is taxable only when the stock is vested and there is no longer a substantial risk of forfeiture.
To avoid a situation in which an employee would generate foreign tax credits that could go unutilized before expiration, an employee could make a timely section 83(b) election to make the receipt of the restricted stock a taxable event for U.S. tax purposes in the year of receipt. In some cases, proper planning may involve deferring the compensation event until the employee’s assignment is completed.
The application of either U.S. or Canadian social security tax provisions on the compensation paid to an employee working on assignment in Canada is governed by the U.S.-Canada Social Security Agreement. This agreement generally provides that in certain instances where the Canadian social security tax provisions would otherwise apply, the U.S. social security tax provisions will in fact apply.
Generally, where an employee works for a U.S. employer in Canada and the expected term of the assignment is less than five years, the employee will be subject only to the U.S. social security tax provisions.
When employees are working on assignment in Canada and are receiving additional compensation as mentioned above, it is important to ensure assignees do not incur a greater tax burden than they would have had they remained in the US. The receipt of additional compensation (such as reimbursements for housing and moving costs) combined with higher Canadian income tax rates (up to 54%) generally will result in an employee incurring a larger combined (Canadian and U.S.) income tax liability. To compensate personnel for this additional income tax liability, the employer pays additional compensation based upon a calculation referred to as a ‘tax equalization’.
Generally, a company’s global mobility tax services provider will prepare the annual tax equalization calculation on the employer’s behalf.
For assignees working in Canada, contributions to U.S. qualified retirement plans generally are deductible for the employer and the employee for both US tax purposes and for Canadian tax purposes pursuant the U.S.-Canada Income Tax Treaty (‘Income Tax Treaty’). For Canadian tax purposes however, the assignee must not have performed services in Canada for more than 60 months and the deduction for contributions may not exceed the deductible limit under Canadian law.
In lieu of continuing to participate in a U.S. retirement plan, employees can participate in a Canadian retirement plan and will generally obtain a deduction for contributions to such a plan for both US and Canadian tax purposes under the Income Tax Treaty. Employees should be aware that certain Canadian savings plans that people may utilize as retirement plans, such as a Tax-free Savings Account (‘TFSA’) or a personal Registered Retirement Savings Plan (‘RRSP’) do not meet the definition of a qualifying retirement plan under the Income Tax Treaty and contributions to such plans are not deductible for U.S. tax purposes.
EMPLOYEE TAX & FOREIGN BANK AND FINANCIAL ACCOUNT REPORTING COMPLIANCE
Employees on assignment will be required to file both Canadian and U.S. income tax returns. The U.S. income tax return generally will be more involved than in prior years because in addition to the normal reporting, an employee will likely claim the foreign earned income and foreign housing exclusions and may have additional foreign tax credit reporting. The foreign earned income and foreign housing exclusions are special provisions in the U.S. tax code that allow a person who lives and works outside of the U.S. for a sustained period of time to exclude from gross income a certain amount of earned income ($103,900 in 2018 for the foreign earned income exclusion).
An employee on assignment may establish a local bank account and if the balance in that account plus any other non-U.S.-based bank or financial accounts exceeds $10,000 on any day in the tax year, the employee will have to file a report disclosing all foreign bank and financial accounts with the U.S. Treasury. Canada has similar foreign bank and financial account reporting requirements that apply to Canadian residents after their first year of residency if the aggregate cost of all non-Canadian foreign account assets exceeds CAD $100,000.
On terminating an assignment and moving back to the U.S., an employee may be subject to Canadian departure tax. This tax deems the employee to have disposed of all his assets (Canadian and foreign), except certain assets (e.g. Canadian real property), at fair market value. The resulting capital gain, if any, will be subject to tax at a maximum rate of 26.5%. If the employee resided in Canada for less than 60 months, the rules apply only to assets acquired while a Canadian resident. Payment of the additional tax may be deferred until the asset is actually sold if proper security is given to the tax authorities. Under the Income Tax Treaty, an employee may elect on his U.S. income tax return to recognize a deemed sale of property and source the gain to Canada so as to be able to credit the Canadian taxes paid on the gain.
FOR MORE INFORMATION
For more information on this topic or on the other global mobility related issues likely to affect U.S. employees going abroad, contact either Hunter Norton or John Gontijo at Farkouh, Furman & Faccio in New York City. For assistance in Canada, contact Isabelle Paré at Hardy Normand & Associés in Montreal.
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