2023-0964101I7 Tax issues for cross-border employees

Principal Issues: Where a cross-border employee's employment duties for the year are carried out partially in the U.S. and partially in Canada, (1) are the FICA contributions made in respect of duties exercised in Canada eligible for a foreign tax credit, and (2) how would this affect the deductibility of any 401(k) contributions made in that year ?

Position: (1) only FICA contributions made on employment income relating to the duties performed while the individual was physically present in the U.S. would qualify for foreign tax credit; (2) only 401(k) contributions attributable to the services performed while the individual was physically present in the U.S. would be deductible in computing taxable income in Canada.

Reasons: (1) the words of Article XXIV:2 of the Canada-US Treaty; (2) the words of Article XVIII:10 of the Canada-US Treaty.

Author: Tu, Grace
Section: s.126, Paragraph 2(b)(iii) of Article II, Article XVIII:10, 11, and Article XXIV:2 of the Canada-US Treaty.

Jess Johns
International Tax Division                                             2023-096410
International and Large Business Directorate              Grace Tu
Compliance Programs Branch

April 11, 2023

Dear Jess Johns:

Re: Hybrid work arrangement for Canadian-resident cross-border employees

We are writing in response to your request regarding certain income tax implications concerning Canadian residents who work for a United States (“U.S.”) based employer and who either commute to the U.S. or stay in Canada to perform their employment duties (the “cross-border employees”).

The existence of cross-border employees is not new. However, the number of Canadian resident cross-border employees that perform employment duties from Canada rose due to the COVID-19 pandemic travel restrictions imposed by the Canadian and U.S. governments. In response to the exceptional and unprecedented situation caused by the travel restrictions, the Canada Revenue Agency (the “CRA”) issued a document called “Guidance on international income tax issues raised by the COVID-19 crisis” (the “Guidance”) in which Canadian resident employees who so chose were provided with the option of generally being taxed in Canada on the same basis as if they had been reporting for work in the U.S. The option was granted only for the year 2020 and was subsequently extended to 2021.

You indicated that while the Guidance provided relief to cross-border employees only in respect of their 2020 and 2021 income tax obligations due to the provisional nature of the travel restrictions, many of these individuals and their U.S. based employers are continuing to use hybrid work arrangements.

Accordingly, you ask :

1. If a cross-border employee exercises a portion of their employment duties from Canada in the year but makes contributions under the U.S. Federal Insurance Contributions Act (the “FICA contributions”), are the FICA contributions made on income earned in respect of the periods where the employment duties were exercised in Canada eligible for a foreign tax credit in Canada?

2. If a cross-border employee performs employment duties in a year partially in the U.S. and partially in Canada, how would this affect the deductibility of a contribution made to a plan governed by section 401(k) of the US Internal Revenue Code?

Our comments

This technical interpretation provides general comments about the provisions of the Income Tax Act (Act) and the Canada-US Income Tax Convention. It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist in making that determination.

Question 1

Residents of Canada are generally taxed on their worldwide income. For many, this includes income earned from business, property, or employment in another country. In most cases, income earned abroad will be subject to taxes in the jurisdiction where it is earned. To ensure that foreign income is not subject to double taxation, the Act provides for a foreign tax credit whereby the tax paid to the government of a foreign jurisdiction reduces Canadian income tax otherwise payable.

FICA contributions paid by an individual who is a Canadian resident pursuant to the Act and the Canada-U.S. Income Tax Convention (the “Treaty”) may also be eligible for a foreign tax credit (footnote 1) , provided that such contributions are paid on income sourced (“arisen”) in the U.S.

Employment income is generally considered sourced (“arisen”) in the country where the cross-border employee performs the duties of employment giving rise to such income. Where such duties are performed partly when the cross-border employee is physically present in Canada and partly when the employee is physically present in the U.S., in determining the amount of employment income that “arose” in the U.S. in a given year, an apportionment of the total employment income of the year received from an employer based on the ratio of total working days of the year performing the duties of employment for that employer while physically present in the U.S. is generally reasonable.

Only the FICA contributions made on employment income relating to the duties of employment performed by the cross-border employee while physically present in the U.S. would qualify for a foreign tax credit.

Question 2

Contributions made by a cross-border employee to a U.S. 401(k) plan in respect of an employment are deductible in computing the individual’s Canadian taxable income, provided that certain conditions are met (footnote 2) . One of the conditions is that the contributions have to be attributable to the services “performed” by the individual in the U.S.

Similar to the response to question 1 above in respect of determining the FICA contributions paid on income that arises in the U.S., determining the amount of 401(k) plan contributions that is attributable to the services performed by a cross-border employee in the U.S. for an employer is generally based on the ratio of total working days of the year performing employment duties for that employer while physically present in the U.S. The amount of the 401(k) contributions for a year that is deductible in computing taxable income in Canada generally equals the proportion of the total of such contributions that is equivalent to the proportion of the number of working days that is attributable to the related employment services performed by the cross-border employee for that employer while physically present in the U.S.

Finally, it is important to note that the Treaty essentially limits the 401(k) deduction to the individual’s RRSP contribution room (footnote 3) .

We trust our comments will be of assistance.

Yours truly,

Nicolas Bilodeau
Section Manager
For Division Director
International Division
Income Tax Rulings Directorate

FOOTNOTES

Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:

1 Article XXIV:2 of the Canada-U.S. Income Tax Convention.

2 Articles XVIII:8 and XVIII:10 of the Canada-U.S. Income Tax Convention.

3 Article XVIII:11 of the Treaty.

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