As advisors, we are well aware that residents of Canada are taxed on worldwide income. This includes the obvious sources of income, like salary, professional or business income, but it also includes investment income, whether those investments are managed here, in a Canadian bank or brokerage account, or held offshore in an overseas account.
But what about pension income that your client may be receiving from a foreign government or former overseas employer, that was earned or accrued during a period before they ever became resident in Canada? For example, newer Canadians who have recently immigrated to Canada may have accumulated years of service spent working for a foreign employer and building up their pension entitlement before becoming a resident of Canada. They may be surprised to find out that in nearly all such cases, foreign pension income is taxable in Canada. And if they have not budgeted for this come tax time, they could end up owing a whack of taxes when they file their Canadian tax return.
Let’s take a look at a recent tax case (Reyes v. Canada, 2019 FCA 7) that delved into the taxation of foreign pension income.
The case involved a former government worker who came to Canada from Colombia in 2007 and has been a Canadian resident ever since. In 2014, he began receiving pension benefits from Colombia. When he filed his 2014 and 2015 Canadian income tax returns, he reported receiving the Colombian pension amounts, but claimed offsetting deductions from income equal to the Colombian pension amounts for each year — approximately $70,000 for 2014 and $24,000 for 2015.
The CRA reassessed the taxpayer denying these deductions on the basis that his foreign pension income was taxable in Canada. The taxpayer objected and originally went to Tax Court in 2017, where he lost, with the Tax Court concluding that the Canada–Colombia tax treaty entitled Canada, as the country of the taxpayer’s residence, to tax the taxpayer’s Colombian pension benefits. Early in 2019, the taxpayer appealed this decision to the Federal Court of Appeal, arguing that the Tax Court erred in its interpretation and analysis of the tax treaty.
The appellate court found that the wording of the tax treaty “is clear in entitling the state of residence to tax pension income arising in another state, and…applies even where the pension is on account of government service.”
Nonetheless, the taxpayer fruitlessly attempted a variety of arguments in an effort to persuade the court that his foreign pension should not be taxable, including citing the Vienna Convention on the Law of Treaties, the Organization for Economic Co-operation and Development’s Model Tax Convention on Income and on Capital and the International Covenant on Economic, Social and Cultural Rights.
The taxpayer futilely tried to argue that the Universal Declaration of Human Rights (UNDHR) “precludes the taxation of pension income because he has an internationally enshrined ‘right to social security.’” The appellate court was not persuaded by this argument, saying that “like the UNDHR, the Covenant does not deal with taxation per se and it could not have had any impact on the interpretation of the (treaty).”
The court thus concluded the Colombian pension income was fully taxable on the taxpayer’s Canadian income tax returns. This decision serves as an important reminder to our clients about the need to budget for the Canadian taxes on any foreign income received to avoid a nasty surprise come April.