2013-0495091E5 Reimbursement of employee’s foreign tax

Principal Issues: Whether the reimbursement of an employee's foreign tax liability is a taxable benefit.

Position: Yes.

Reasons: Wording of the Act confirmed by case law, an employee's tax burden is a personal expense.

Author: Moore, Eli Kae
Section: 5(1), 6(1)(a), 115, Regulations 100, 102

XXXXXXXXXX
                                                                                                                                           2013-049509
                                                                                                                                           Eli Kae Moore

September 11, 2014

Dear XXXXXXXXXX,

Re:  Reimbursement of employees’ foreign tax payments

We are responding to your email of June 28, 2013, we also acknowledge our further email and telephone conversations of June 28, 2013 (XXXXXXXXXX/Argento), in which you inquired about the taxability of particular reimbursements paid to employees working abroad.  In your email you describe the following situation:

*     A Canadian employer sends some of its employees to work in Country A for a period of XXXXXXXXXX years.  Canada does not have a tax treaty with Country A. 

*     Under the tax laws of Country A, the employees would be considered resident of Country A, either due to their presence in the country for more than 183 days in a year, or because Country A would consider them to have their principal home in the country for the year. 

*     The employees would, therefore, be required to remit income tax payments to Country A in respect of their worldwide income on a monthly basis. 

You have requested our comments concerning the Canadian employer reimbursing the employees, on a monthly basis, for their taxes paid to Country A.  Specifically, you wish to know whether these foreign tax reimbursements would be taxable to the employees under Canada’s Income Tax Act.

This technical interpretation provides general comments about the provisions of the Income Tax Act and related legislation (where referenced).  It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination.  The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R5, Advance Income Tax Rulings.

Our Comments

Residency

The taxability of the foreign tax reimbursements made to an employee would depend on whether the employee is a resident of Canada for tax purposes.  Residency for tax purposes is discussed in Income Tax Folio S5‑F1‑C1: Determining an Individual’s Residence Status, which is available on the CRA website. 

It is important to note that residency for tax purposes is not the same as residency for immigration or nationality purposes.  As discussed in S5‑F1‑C1, unless an employee has sufficiently severed their residential ties with Canada they would continue to be considered resident, or ordinarily resident, in Canada for tax purposes and their worldwide income would be subject to Canadian tax under the Act.

Non-residents of Canada are generally only taxed on their Canadian source income, including income from employment in Canada.  As discussed at paragraph 1.57 of Income Tax Folio S5‑F2‑C1: Foreign Tax Credit, the location of an individual’s employment is considered to be the physical place where he or she normally performs the related duties.  In the situation you described, if an employee is not a resident of Canada for tax purposes at the time they receive the foreign tax reimbursement, then the reimbursement would not be taxable under the Act as it would not be an item of income from employment in Canada.  In addition, in the situation you have described, subsection 115(2) of Act would not deem an employee to be employed in Canada.

Unless specified otherwise, the remainder of our letter assumes that an employee being reimbursed for their foreign taxes paid to Country A is a resident of Canada for Canadian tax purposes (i.e., they are  a resident of both Canada and Country A for each country’s respective tax purposes).

Taxability of reimbursements in respect of personal taxes

The reimbursement of an employee’s foreign taxes would be a taxable benefit for an employee, as a general matter under subsection 5(1), or more specifically under paragraph 6(1)(a) of the Act.  This is because the foreign taxes would be a personal expense of the employee and, when reimbursed by the employer, they would constitute a benefit or other form of remuneration stemming from the employment relationship.  The taxable nature of reimbursements in respect of an employee’s personal tax obligations was confirmed in the case of Gernhart v. the Queen in which Judge Bonner of the Tax Court of Canada wrote: “It is, I think, self-evident that a benefit in the form of a direct addition to the wealth of an employee is received when an employer discharges an income tax burden which would otherwise fall on the employee in his or her personal capacity.”(endnote 1)

Withholding and reporting obligations

In addition to being taxable under subsection 5(1) or paragraph 6(1)(a) of the Act, the monthly reimbursement of the foreign taxes would be considered “remuneration” as defined in subsection 100(1) of the Income Tax Regulations (the “Regulations”).  Therefore, the employer would be required to withhold a portion of the reimbursement payments in accordance with section 102 of the Regulations.  The employer would also be required to file form T4 and T4A information returns under section 200 of the Regulations in respect of an employee’s total employment remuneration, regardless of whether or not the employee was resident in Canada for tax purposes.  An employee who received a reimbursement for foreign taxes paid and who was a resident of Canada for tax purposes would also be required to report the income on their annual T1 return as required by paragraph 150(1)(d) of the Act.

Voluntary Disclosure Program

If an employer or an employee in a situation like the one you described discovers that they are in breach of their reporting or withholding requirements, they may wish to consider correcting their tax affairs through the Voluntary Disclosures Program as set out in Information Circular IC00‑1R4, Voluntary Disclosures Program, which is available on the CRA website.  By correcting their affairs through the Voluntary Disclosures Program they may be provided with relief in respect of applicable interest and penalties.

Availability of foreign tax credits / deductions

Any taxes paid to Country A by an employee in respect of income earned from their employment in Country A would be considered foreign non-business-income taxes for the purposes of subsection 126(1) of the Act.  This would include the situation you describe where the employer reimburses an employee for their taxes paid to Country A.  Therefore, an employee would be eligible to claim a foreign tax credit (an “FTC”) in respect of those taxes.  An employee would also be able to claim an FTC for other non-business-income taxes paid in respect of non-business-income from sources in Country A. 

Even though an employee would be taxed on their worldwide income by both Canada and Country A, the availability of a Canadian FTC would only be available in respect of income from sources in Country A.

More information on FTCs and deductions in respect of foreign non-business income taxes can be found in S5‑F2‑C1, and in Interpretation Bulletin IT-506, Foreign Income Taxes as a Deduction From Income, both of which are available on the CRA website.

We trust our comments will be of assistance.

Yours truly,

Lori M. Carruthers CPA, CA
International Section III
International Division
Income Tax Rulings Directorate
Legislative Policy Regulatory Affairs Branch

ENDNOTES

1  96 DTC 1672, [1996] 3 CTC 2369 (TCC), aff’d 98 DTC 6026, [1998] 2 CTC 102 (FCA), leave to appeal to SCC refused.

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