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Tax Residency VS Physical Presence: 4 Questions You Must Ask

John Richardson

An introduction to “tax residency.”

Most people equate residency with physical presence. The thinking is that “your residence is where you live”. There is no necessary correlation between where one lives and where one is a “tax resident”. Residence for tax purposes may be only minimally related to residency for immigration purposes. It is possible for people to live in only one country and be a tax resident of multiple countries. The most obvious example is “U.S. citizens residing outside the United States”.

The concept of “tax residency” is fundamental to all systems of taxation. The fundamental question at the root of all tax systems is: “what kind of connection to a country is required to assume tax jurisdiction over an “individual”, over “property” or over an “entity”?”

Asserting tax jurisdiction generally…

Different countries use different tests to assert their tax jurisdiction. The “jurisdictional test” used by a country reflects a policy consideration of what facts, demonstrate a sufficient connection to a country, that justifies the imposition of taxation over “individuals”, over “property” and over “entities“. The answers to these questions are imperfect and vary widely.

In general we see that patterns that include:

For property: If the property is located inside a country, that country will assert it’s tax jurisdiction over that property. (often imposing withholding on the proceeds of sale of real estate if there was a foreign seller)

For entities (corporations, trusts, etc.): a variety of tests that include: where the profits are earned, where the company is incorporated, where the management resides, etc. (U.S. corporations are currently subject to tax on their “world income”)

For individuals: A country will assert tax jurisdiction based on “residence” (however that is defined), “domicile” (usually does not require “residence”), “citizenship” (only the United States and Eritrea). “Residence” is defined by different countries in different ways. For example in Canada, those spending more than 183 days per year in Canada is a sufficient condition for establishing tax residency. But, spending 183 days in Canada is NOT a necessary condition for establishing tax residency. The United States has a “substantial presence” test that deems individuals who spend too much time in the United States to be “tax residents”. S. 7701(b) of the Internal Revenue Code defines the facts and circumstances that will convert “physical presence” in the United States into “tax residency”.

Asserting tax jurisdiction over individuals

Only the United States (okay and Eritra) equate “citizenship” with tax residency. All other countries assert tax jurisdiction over individuals based on either “residency” or the “legal right to reside” in the country (Permanent resident of Canada for example).

What kind of residential connection is required for a person to become a “tax resident” of a country? How many days of presence are required? Is there a minimum? Is there a maximum? Is residency defined by statute? Is residency a test of “facts and circumstances”? Is there a “deeming provision”? The OECD has adopted the CRS (“Common Reporting Standard”). The CRS illuminates the fact that different countries have different rules for what constitutes “tax residency” in that country. Furthermore, “tax residency” can be determined by treaties between countries. For example, in certain circumstances, the “tie breaker” rules in the Canada U.S. tax treaty, result in Green Card holders NOT being residents of the United States for tax (and FATCA) purposes.

“Tax residency” vs. “legal physical presence” or the “legal right to reside”

There is no necessary connection between “tax residency” in a country and “physical presence” (legal or illegal) in a country. One can be a “tax resident” (example U.S. citizens) and never have lived in the United States. One can be a Green Card holder who moved from the United States years ago, but still be considered a tax resident.

Some examples:

– Nonresident aliens (no legal right to reside in the U.S.) may or may not be NOT “tax residents” depending on the extent of their physical presence in the United States

– Illegal immigrants who live in the United States who meet the “substantial presence test” are “tax residents” even though they have no right to live in the United States.

– U.S. citizens are “tax residents” of the United States even though they may never visit the United States (and in some cases have never even been to the United States).

– Green card holders, who have moved from the United States, may be “tax residents” of the United States.

– one can physically move from Canada and still be considered to be a “tax resident” of Canada

– some states impose taxation based on the concept of domicile. One can move from one of those states, cease to be a resident, retain domicile and still be a tax resident of the state.

In summary: “Tax residency” is “residency” for the purposes of the jurisdiction to impose taxation. It may or may not be related to “actual residence” or the “legal right to reside” in a country. There is a difference between “residency” as defined by tax laws and “residency” as defined by immigration laws.

Ending “tax residency” – easier said than done

Moving” from a jurisdiction, without more, may or may not sever an individual’s “tax residency”. One can move from a country (or never have lived in a country in the case of U.S. citizens) and still be considered to be a “tax resident” of the country.

In some cases notice of emigrating from the country may be required. Often this is in the form of a final tax return. In some cases, a special “Departure Tax” may be imposed. Canada has reasonably clear and comprehensive requirements for a taxpayer’s obligations to the Canada Revenue Agency when one moves from Canada and ends “tax residency”.

in order for U.S. citizens to sever their “U.S. tax residence”, they are required to relinquish or renounce their U.S. citizenship. The United States imposes “Exit Taxes” on many U.S. citizens who relinquish (or renounce) their U.S. citizenship. They are required to file an final “Expatriation Statement” in the “form” (no pun intended) of “Form 8854”.

In order for U.S. Green Card holders to sever their tax residency with the United States they are required to conform to the specific procedures found in S. 7701(b) of the Internal Revenue Code. Green Card Holders who are “long term residents” may also be subjected to the S. 877A Exit Tax. Certain Green Card holders are required to file “Form 8854”.

In a world of “Global Mobility” and “Citizenship Shopping” it is important to consider:

  • What are the rules for how a country imposes “tax residency” on an individual?
  • Are there any tax treaties that could affect a country’s definition of “tax residency”?
  • What are the rules and procedures for how to sever your “tax residency” in a country?
  • Does the country impose an “Exit Tax” or “Departure Tax” if you take steps to sever your “tax residency” with the country?

The Reality of U.S. Citizenship Abroad

My name is John Richardson. I am a Toronto based lawyer – member of the Bar of Ontario. This means that, any counselling session you have with me will be governed by the rules of “lawyer client” privilege. This means that:

“What’s said in my office, stays in my office.”

The U.S. imposes complex rules and life restrictions on its citizens wherever they live. These restrictions are becoming more and more difficult for those U.S. citizens who choose to live outside the United States.

FATCA is the mechanism to enforce those “complex rules and life restrictions” on Americans abroad. As a result, many U.S. citizens abroad are renouncing their U.S. citizenship. Although this is very sad. It is also the reality.


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One thought on “Tax Residency VS Physical Presence: 4 Questions You Must Ask

  1. John R. Dundon II, EA says:

    GrEAt post! Thank you

Comments are closed.