Those who renounce their U.S. citizenship and those who have severed ties with Canada and become non-residents risk being taxed twice: once for assets they owned, giving up tax residency, and another time when they sold their assets.

The double taxation issue is primarily resolved for expats living in Canada but not (as far as I know) for residents of other countries.

What is the double taxation problem?

Let’s first talk about what double taxation is. This is because both countries want to tax you, and neither country cares whether the other taxes you or not.

Two countries claim you.

If you are a taxpayer in two different countries, both countries will enforce their tax laws against you and insist on your right to enforce a tax on your income.

Example

You are a dual U.S./Canada citizen. You live in Canada. The U.S. will tax you since you are a U.S. citizen. And you will be taxed by Canada since you are a Canadian tax resident.

Usual Solution: Foreign Tax Credit

Double taxation is usually resolved through foreign tax credits. For example, you will receive income from Canada, pay taxes to Canada, and then report the same income to the U.S. You will file Form 1116 to claim a foreign tax credit to offset the U.S. tax liability.

Example

You are an American citizen. You live in Canada. In 2017, the income you earned was taxable in both countries.

You pay Canada $100 in income tax on this income.

Because of this income, you are taxed in the United States. But the U.S. allows you to deduct the tax you owe the IRS on the $100 you pay to Canada.

This is called a foreign tax credit in our tax law, and you can claim it on Form 1116.

Problem: Timing and Procurement Mismatch

Suppose a person renounces Canadian tax residency on the Canadian side. In that case, they will pay an exit tax on the deemed disposition of all their assets on the date they renounce their Canadian tax residency.

On the U.S. side…nothing, because no actual sales took place.

He will sell the assets in a few years, reporting the capital gains to the United States.

While foreign tax credits can be carried forward for up to 10 years, capital gains for U.S. residents are U.S.-sourced income, and foreign tax credits can only be claimed on foreign-sourced income. This will lead to double taxation.

Double Taxation Resolution in the case of the U.S. / Canada

The Canada/U.S. Income Tax Treaty addresses this issue. It can be said. But only for expat-induced gains, not losses.

How the problem is solved

The treaty solution is simple: “fake” a taxable event arising in the U.S. where the alien’s tax law matches the election under Canadian tax law, making a “fake” sale for Canadian tax purposes.

This places taxable events (under both tax regimes) in the same tax year. Both countries tax you, allowing you to use the foreign tax credit method to ensure no double taxation.

Example

You are an American citizen. You live in Canada.

You own land in Canada that you bought for $1,000,000 years ago. Now it’s worth $2,000,000.

You renounced your 2017 U.S. citizenship and are an insured alien. Therefore, for our tax purposes, you have a long-term capital gain of $1,000,000.

Under Canadian tax law, you chose to use an income tax treaty to force a “pretend” sale of the land, so you also have a capital gain of $1,000,000 in Canada for income tax purposes in 2017.

You can now use the foreign tax credit system to ensure that capital gains of $1,000,000 are only taxed once.

Yes, you pay taxes as if you sold the land but still own the land. But now, your acquisition cost in Canada is $2,000,000.

Only the appreciation in value beyond that amount will be taxed in Canada when you sell the land later. Of course, you will not pay U.S. taxes because you will no longer be an American taxpayer.

Treaty language

Article XIII, paragraph 7, of the Income Tax Treaty between the United States and Canada (as amended by the 2007 Protocol) states:

“Where at any time an individual is treated for the purposes of taxation by a Contracting State as having alienated a property and is taxed in that State by reason thereof, the individual may elect to be treated for the purposes of taxation in the other Contracting State, in the year that includes that time and all subsequent years, as if the individual had, immediately before that time, sold and repurchased the property for an amount equal to its fair market value at that time.”

Have a question? Contact Olivier Wagner.