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  • Writer's pictureLewis Grunfeld, CPA

Guide to the US Canada Tax Treaty

Updated: Dec 30, 2023

Understanding the US Canada tax treaty is crucial for American living in Canada and Canadians who have US source income. This comprehensive guide breaks down the treaty's provisions, offering clarity on how it affects personal taxation and helps avoid double taxation.

Executive Summary

  • ​The US Canada Tax Treaty offers mechanisms to prevent double taxation.

  • The treaty includes a "Savings Clause" that maintains the US right to tax its citizens as per its domestic laws which means most treaty benefits do not apply to US citizen.

  • US-sourced passive income, such as interest, dividends, and pensions, may be taxed at reduced rates or exempted for Canadian non-US citizens.

Relief of Double Taxation

The US Canada tax treaty provides mechanisms for relief from double taxation, ensuring that income earned in one country by residents or citizens of the other is not taxed twice. Specifically, the treaty allows U.S. citizens and residents to credit the income tax they pay to Canada against their U.S. tax obligations. Conversely, Canada offers a credit for U.S. taxes paid against the Canadian tax liabilities of its residents.


The Savings Clause

Every tax treaty of the United States, including the one with Canada, includes a provision known as a "Savings Clause." This clause ensures that the U.S. retains the ability to tax its citizens as per its domestic tax laws, irrespective of the stipulations outlined in the treaty. As a result of this clause, for U.S. citizen expats, the majority of the benefits and reductions offered by the treaty do not apply.

Expert Tip: It's crucial for U.S. citizens to familiarize themselves with the savings clause exclusions in the US Canadian Tax Treaty to accurately determine which tax benefits they can utilize.

Tax Residency and the Tie-Breaker Rules

The United States and Canada each have their own criteria for determining who is a resident for tax purposes. It's possible for someone to meet the residency requirements of both countries simultaneously. To prevent the problems that dual residency could cause, the U.S. Canadian Tax Treaty provides a series of tie-breaker rules. These rules help to decide which country has the primary right to tax the individual's income.

  • Permanent Home Test: The first consideration is whether the individual has a permanent home available to them in one of the countries. If a permanent home is available in only one country, that country is generally considered the individual's country of residence for tax purposes.

  • Habitual Abode Test: If the individual has a permanent home in both countries or in neither country, the treaty looks at where the individual has a habitual abode; in other words, where they live regularly. This could be where they spend more time or where they have a regular presence.

  • Nationality Test: If the individual has a habitual abode in both countries or in neither, the next factor considered is nationality. If the person is a citizen of only one of the countries, that country is typically considered their country of residence for tax purposes.

  • Mutual Agreement Procedure: In the rare case that the individual is a citizen of both countries or of neither, and the above tests do not resolve the issue of residency, the competent authorities of the United States and Canada will determine the individual's residency through a mutual agreement, taking into account the person's facts and circumstances.

Taxation of US-Sourced Passive Income

Passive income from U.S. sources, which is not tied to a U.S. trade or business, is taxed at a flat rate of 30% if earned by a non-resident alien. However, the US Canadian tax treaty may lower this rate or totally exempt it from US taxation for certain types of income. We've summarized some of the tax treaty rates in the table below. It's important to note that that these rates generally do not apply to U.S. citizens due to the savings clause mentioned earlier.

​Tax Rate

Treaty Article Citation

​Interest

0%

XI(1) \ 5P6(1)

​Dividends - Paid by U.S. Corporations

15%

X(2) / 5P5(1)

Dividends - Qualifying for Direct Dividend Rate

5%

X(2) / 5P5(1)

Pensions and Annuities

15%*

XVIII(1) / 3P9; 5P13

Social Security

0%

XVIII(5) / 4P2(2)

*The 15% rate does not apply to a lump-sum payments.


Personal Service Income Earned While Temporarily Present in the US

Generally, income received from work performed in the US would be considered US source income and would be subject to US taxation. However, the US Canadian tax treaty lists certain exemptions where taxes rates are reduced or even eliminated. It's important to note that these exceptions generally do not apply to US citizens because of the savings clause mentioned earlier. We've summarized some of these exceptions in the table below:

​Income Type

​Maximum Presence in U.S

Required Employer or Payer

Maximum Amount of Compensation

Treaty Article Citation

​Employee

No limit

Any U.S. or foreign resident

$10,000*

XV

Contractor

**See note below

Any contractor

No limit

VII

​Public entertainment

No limit

Any U.S. or foreign resident

$15,000

XVI

*Amounts above $10,000 are also exempt if the following conditions are met:

  • The individual was in the U.S. less than 183 days in any calendar year

  • The employer is not a U.S. resident and has no fixed base in the U.S.

**Exempt as long as no permanent establishment has been created. A permanent establishment is created when an individual stays for over 183 days in the US and, during this period, the individual's services in that country account for more than half of the business's gross income.


Totalization Agreement

The United States and Canada have a totalization agreement in place, which is designed to avoid double taxation of their income with respect to social security taxes. It establishes clear rules about which country's social security system covers the employee. As a result, employees and their employers can only be taxed by one country's social security system at a time.


State Taxes and Tax Treaties

Numerous states within the United States impose income taxes on their residents. The adherence to U.S. tax treaty provisions varies by state—some may recognize them, while others may not.

​Expert Insight: Always check with a tax professional about how state tax laws interact with the treaty, as this can vary significantly from state to state.

Need Help Navigating the US Canada Tax Treaty?

At CPAs for Expats, we specialize in helping US expats stay compliant with their US taxes. Our low fees and 4.9/5 rating on independent review platforms attests to our commitment to excellence and client satisfaction. Contact us today, and let our tax experts simplify your life and taxes.




Frequently Asked Questions

Does Canada have a tax treaty with the US?

Does Canada have a totalization agreement with the US?

Do Canadian citizens pay tax on US capital gains?



Authored by Lewis Grunfeld, CPA

Lewis is a seasoned expert in international and U.S. expatriate taxation. With over 10 years of international tax experience, he specializes in applying tax treaties to benefit expats, handling complex tax scenarios and ensuring significant tax savings for his clients. Lewis's expertise in international compliance and U.S. expat tax returns has made him a trusted advisor in the expatriate community.

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