Tax treaty

What a treaty actually decides

Canada has tax treaties, also called conventions or agreements, with many countries. The CRA describes their main purposes as avoiding double taxation and preventing tax evasion. In general, a treaty defines who counts as a resident, often reduces the tax withheld on interest, dividends and royalties paid across the border, and sets out when income such as salary, self-employment income or a pension may be taxed in the other country.

A treaty does not create a single combined tax return, and it does not automatically apply itself. Domestic law still decides what is taxable in the first place. The treaty then narrows that result for residents of the partner country, or for you as a Canadian resident with income from there. Wording differs between treaties, so a rule for one country may not hold for another.

Where it shows up for Ontario residents

Most Ontario residents meet a treaty in one of three ways. First, a foreign pension or other income may be exempt from Canadian tax under a treaty, in which case the income can be reported and then offset by a deduction on line 25600. Second, tax paid to the other country may be recovered through the foreign tax credit, covered in its own entry. Third, if you pay interest, dividends, rent or royalties to someone abroad, a treaty may lower the withholding that applies.

In some cases a treaty can even change residency. An individual who is a Canadian resident but is treated as a resident of another country under a treaty is a deemed non-resident and follows the non-resident rules.

An illustrative example

Suppose, using round numbers, that an Ontario resident receives a foreign pension of $20,000 a year and the other country withholds tax from it. Whether Canada taxes that pension, and whether the foreign tax can be credited, depends on the treaty wording and the type of pension. If the treaty exempts it in Canada, the income is reported and then deducted. If it does not, the income is taxed in Canada and the foreign tax may support a credit. These numbers are illustrative only.

Common mistakes

A frequent error is assuming a treaty means no Canadian tax. Treaties usually reduce or exempt specific income, not everything. Another is including treaty-exempt income, or the tax withheld on it, in the foreign tax credit calculation as well. The CRA says income deducted on line 25600 under a treaty is not part of that calculation. Treaties are also negotiated and renegotiated over time, so check current terms before relying on them.

What to discuss with your accountant

Bring the country involved, the type of income, the foreign slips or statements, proof of tax withheld and any treaty forms a payer has asked for. Ask whether a treaty applies, whether the relief is an exemption, a lower rate or a credit, and what to attach if you claim it. If you pay people outside Canada, ask which documents the payer should collect first.