Social Security Tax Nightmare –
Canada’s New Rules Increase Tax and Assignment Costs
In the past, Canadian resident assignees working overseas could claim a foreign tax credit for social security tax paid in another country. Unfortunately, in some cases this is no longer possible, due to a recent Canada Revenue Agency (CRA) change in position on the issue. Assignment Managers are cringing at the thought of escalating international assignment costs as the social security tax nightmare begins.
Social Security Agreements
When an assignee is sent overseas, a number of scenarios can arise regarding social security issues. The assignee might experience an interruption of home country coverage while he/she contributes to the social security scheme in the assignment host country. Alternatively, the individual might be able to continue social security contribution in the home country while abroad, and avoid social security contribution in the host country. Or, the assignee might be forced to contribute to both countries’ schemes for the same assignment period.
Fortunately, through social security agreements, continuity of coverage in the home country is assured during periods of temporary posting abroad, and the possibility of having to contribute to two countries’ schemes is diminished. Such protection is only guaranteed, however, for a limited period abroad and if certain conditions are met. For example, if an individual is to be sent on a three-year assignment to the US, he/she may remain covered by the Canada Pension Plan, and may be exempted from United States Social Security Tax and Medicare Tax (FICA).
Social security legislation usually requires contributions and/or residence for a minimum number of years before a person is eligible for pension benefits. Social security agreements and conventions are in place to eliminate situations of lost pension benefits. Under these provisions, periods of contribution in Canada and the other country can be totalized – added together – to meet pension benefits.
Certificates of Coverage
Ordinarily, an employer would apply for a Certificate of Coverage from CRA to ensure that an assignee is covered under the social security laws of Canada for the term of the assignment. This Certificate of Coverage entitles the assignee to an exemption from contributions under the laws of the host country.
The cost savings to the assignee and the employer are significant and may amount to $35,000 for each of the employer and assignee sent to the US over a five-year period.
What are the recent changes?
The CRA has recently revised its position on how social security taxes are viewed. It no longer recognizes social security tax as a “non-business tax” for the purposes of foreign tax credits. In the past, the CRA has recognized US Social Security Tax, as well as German and French contributions, as qualifying in this regard.
The Supreme Court of Canada recently defined the word “tax” to be “a levy, enforceable by law imposed under the authority of a legislature, imposed by a public body and levied for a public purpose.” According to this definition, social security payments cannot be considered taxes levied for a public purpose, since economic benefit is eventually derived through the contributions. As a result, the CRA no longer recognizes social security taxes as payments eligible for foreign tax credits.
A significant exception to this involves countries with whom Canada has an Income Tax Treaty in which there is a specific clause allowing foreign tax credits for social security payments. Fortunately, this is the case with the Canada – US Income Tax Treaty.
How does this affect international assignments?
The CRA’s new position on social security tax threatens to significantly increase the cost of some assignments. Canadian resident assignees who work in locations which do not have a social security agreement with Canada, or who do not apply for a Certificate of Coverage, may have to contribute to the social security system in the host location. Unless the Income Tax Treaty between this host country and Canada specifically provides for social security taxes to be creditable as foreign tax credits in Canada, the employer’s costs will increase in terms of higher Canadian taxes. The “tax on tax” effect of this cannot be overlooked. In cases where the assignee is personally responsible for his Canadian taxes, the employer may have to offer some compensation in order to mitigate the risk of assignees turning down certain assignments.
What can be done?
To achieve realistic expectations of the implications of social security taxation, it is important to be aware of the social security tax rules in the host country and the existence of any Social Security Agreements and Income Tax Treaties with Canada. An experienced tax service provider can assist in this regard, providing a realistic view of the social security tax consequences to both the employer and the assignee.
At CompassTAX™, we help our clients plan to save social security taxes. To this end, we have a Social Security Tax Organizer available for planning purposes. Contact us at (403) 531-2200 or www.compasstax.ca for assistance in dealing with this assignment issue.