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How International Athletes are Taxed in Canada: CRA Claims John Tavares, Captain of the Toronto Maple Leafs, Owes $7 Million – Tavares vs. The King, 2024-212(IT)G

posted 4 weeks ago

The captain of the Toronto Maple Leafs and NHL all-star John Tavares is no stranger to the limelight. Tavares has been a key member of the Leafs since signing with them in 2018. He has guided the team to its first tournament trip in the second round in almost twenty years, and in 2020, he handed former Zamboni driver David Ayres his only NHL loss. However, Tavares’s well publicized appeal to the Tax Court of Canada in January 2024 caught the attention of tax professionals across North America in addition to Canadian news outlets. The CRA claims that Tavares owes approximately $7 million in taxes related to his decision to sign with the Leafs in 2018; this amount is under dispute.

Superstar athletes in North America have had their compensation packages investigated more and more in the mainstream media in recent years. The biggest contract in professional sports history, at $700 million over ten years and deferring roughly $680 million in income to be paid out beginning in 2034, was signed by MLB outfielder Shohei Ohtani in 2023. This deal was met with controversy. A team would undoubtedly decide to give larger bonuses or postpone paying salaries for strategic reasons. Professional teams may have more flexibility to budget for operations in the current operating year and to make plans around wage caps and league luxury taxes if salary payments are recharacterized and restructured. Income tax is also always a factor, as it should be in any prudent business transaction.

With Tavares’ appeal, the CRA has a great opportunity to legally argue how professional athletes’ pay is structured in Canada. The result may have a significant effect on athletes and sports teams in Canada as well as any American businesses looking to enter the Canadian market. The financial agreements made in Canadian professional sports could be affected by this case in the long run, and it might also set precedents for similar agreements in the future.

The purpose of this article is to analyze the legal framework that surrounded Tavares’ defense and the complexities that led to his appeal against the Canada Revenue Agency (CRA). First, this will provide a brief summary of the laws governing the taxes of athletes in Canada, as well as the relevant sections of the Canada-United States Tax Treaty. It will then go into summary form regarding the facts raised in Tavares’ appeal and the arguments made by his Canadian tax lawsuit lawyer. The article will close with a comprehensive analysis of Tavares’ case and some shrewd advice on tax efficiency for handling Tax Court of Canada settlements. It will additionally investigate how Tavares’ appeal might inevitably be directed toward a public hearing by these regulations. This article aims to clarify the complexity underlying Tavares’ tax dispute by offering a thorough analysis of the situation. It also provides light on potential resolution techniques and broader consequences within the Canadian tax law.

Taxation of Athletes Residing in the USA under Canadian Law

The concept of tax residency is an important concept in understanding the taxes of athletes in Canada. Under Part I of the Income Tax Act, a tax resident in Canada is subject to taxes on their worldwide income. On the other hand, non-residents are often only subject to taxes on a limited range of income that originates in Canada. It’s crucial to understand that assessment of personal and economic ties to Canada determines tax residency rather than citizenship or nationality. This is not the case in the United States, where all citizens, regardless of residency status, are liable to taxes. As it affects their tax responsibilities on profits from contests, sponsorships, and other sources within Canada, athletes find that defining their tax residence becomes crucial. Navigating these complexity generally requires skilled guidance in order to maintain compliance with Canadian tax regulations and maximize tax planning methods for athletes participating or earning revenue in the nation.

According to paragraph 2(3) of the Income Tax Act, an individual who is “employed in Canada” is liable to pay taxes on such employment income as a tax resident or as a non-resident. Generally speaking, when someone works within Canadian borders, they are considered to be “employed in Canada.” This regulation is supplemented by Section 115 of the Income Tax Act, which declares a non-resident to be employed in Canada in cases when services are provided outside of the country’s borders but there is a substantial economic connection between the two. A non-resident individual receiving a “signing bonus” is expressly considered to be working in Canada by paragraph 115(2)(c.1) of the Income Tax Act, and the amount of the bonus is fully taxable employment income. If this law didn’t exist, a non-resident athlete would not be required to pay Canadian taxes and a Canadian team might deduct the expense of providing the athlete a bonus. The law is crucial to preventing the erosion of the Canadian tax base since athletes frequently transfer between teams in the United States and Canada during North American leagues.

Under its domestic laws, the bonus that an athlete who resides in the United States and earns from a Canadian sports team is probably also taxed in the United States. There are two main tax systems in place to avoid double taxation in both nations. First, a bilateral treaty known as the Canada-U.S.A. Tax Treaty was signed by Canada and the United States of America. It lays out guidelines for deciding which nation has the primary authority to tax employment income and under what conditions. Second, athletes can claim a deduction for taxes paid in one country to balance taxes in another, since both Canada and the United States of America give a foreign tax credit.

Tavares’s appeal is significantly impacted by these methods. First of all, as per Article XV of the Canada-U.S.A. Tax Treaty, Canada retains the authority to tax residents of the United States of America on employment income in cases where the employee is compensated by or on behalf of a Canadian resident (such as Maple Leafs Sports and Entertainment).

An American sports star’s employment income and signing bonus are taxable in Canada when they sign with a Canadian team. Given that Canada’s marginal tax rates are often higher than those in the USA, this might provide a problem for Canadian teams looking to sign overseas players. There are ways to prevent double taxation, though, such claiming a foreign tax credit claim in the US for taxes paid in Canada. Even still, well-paid players may be discouraged from opting to play for Canadian teams by the high tax rates in Canada. These high tax rates may have a major effect on the financial incentives for athletes thinking about moving north of the border, given the large wages in North American sports. When it comes to selecting a team in the extremely competitive world of professional sports, athletes often base their selections heavily on tax implications.

Under the Canada-U.S.A. Tax Treaty, Canada and the United States of America have jointly negotiated a signing bonus tax treatment that is beneficial in order to give relief. In general, whether an employee is paid by or on behalf of a Canadian resident (such as Maple Leafs Sports and Entertainment), Canada retains the right to tax U.S. residents on employment income under Article XV of the Canada-U.S.A. Tax Treaty. However, Article XVI(4) limits Canada’s ability to impose taxes of 15% of the gross amount of any “inducement”—that is, a signing bonus—paid by a Canadian resident to an athlete who resides in the United States. In order to lower the amount of U.S. taxes that would otherwise be owed by that athlete, a foreign tax credit is probably available in the United States for that withholding tax.

Athletes who reside in the United States and get a signing bonus in exchange for performing to play for a Canadian team are guaranteed favorable tax treatment due to this treaty-reduced rate. Additionally, it strongly encourages players to get a larger percentage of their salaries as bonuses in order to lessen Canada’s allegation that such compensation should be taxed. The cornerstone of Tavares’ recently filed appeal with the Tax Court of Canada is this regulation.

Details about the Appeal

Tavares’s professional Canadian tax lawyer’s Notice of Appeal outlines the essential elements of his continuing tax issue in a clear and concise manner. Tavares, who was born in Mississauga, Ontario, joined the New York Islanders in New York City in 2009 and started his NHL career. His relocation signaled a big change in his situation, and as of January 1, 2010, he was no longer considered a resident of Canada. In 2018, Tavares made history by opting to sign a historic seven-year contract with the Toronto Maple Leafs, a move that marked his return to his native Canada. Tavares had reached free agency. The agreement stated that the athlete would get USD $650,000 per year for the first season of the NHL in 2018–2019, and that each additional season would bring an additional USD $910,000 per year for the next six years. 

Remarkably, the deal came with a sizeable signing bonus of USD $70,890,000, of which USD $15,250,000 would be paid out on July 1, 2018, the day before Tavares moved to Canada to play for the Leafs. Tavares’ salary package includes a sizeable signing bonus, which emphasizes the significance of the incentive in relation to his overall tax status. Tavares’ tax burden is complicated due to the complex interactions between his Canadian heritage, his time spent living abroad, and his ultimate decision to return to Canada for professional purposes. 

The owner of the Toronto Maple Leafs, MLSE, gave Tavares a total of USD $11,395,792 on July 1, 2018. That sum was Tavares’ entire signing bonus minus USD $1,753,750 put in escrow as mandated by the NHL Collective Bargaining Agreement and USD $2,024,438 sent by MSLE to the Canada Revenue Agency, which was subject to a 15% withholding tax. On his 2018 U.S.A. tax return, Tavares declared his whole signing bonus and requested a foreign tax credit for the 15% withholding tax he had to pay in Canada on that amount. Tavares then said on his 2018 U.S. tax return that he had left the country and that starting in 2019, he had been filing tax returns in Canada as a resident. (From 2019 onward, his signing bonus and other employment income were fully declared and subject to Canadian taxes.)

Later on, Tavares’ 2018 tax year was the subject of an audit by the CRA. The Canada Revenue Agency (CRA) determined that Tavares’ 2018 signing bonus was not subject to Article XVI(4) of the Canada-U.S.A. Tax Treaty and that he was not qualified for the 15% lower treaty rate. Tavares’ 2018 taxation year was reviewed by the CRA in November 2022, and as a consequence, his taxable income in Canada increased by $17,771,862, resulting in $6,847,428 in total taxes owed. 

The tax assessment for Tavares’s 2018 taxes made by the Canada Revenue Agency (CRA) was objected to by his Canadian tax lawyers. Tavares’ Canadian tax lawyers decided to take the issue to the Tax Court of Canada in January 2024, prior to the completion of this current objection procedure. This choice was made as rather than waiting for the CRA’s decision. Tavares’ legal team pursued this line of action in an effort to achieve a more favorable conclusion through the court system and to accelerate the resolution of the dispute. Tavares’ proactive approach towards resolving the tax assessment issue is evident in this strategic action, which demonstrates the company’s commitment to ensure a reasonable and equitable conclusion that aligns with Canadian tax laws.

The Appellant’s Arguments in Front of the Canadian Tax Court

The Canadian tax litigation lawyer for Tavares has submitted a Notice of Appeal, but it does not provide a complete outline of the CRA’s position. A Reply outlining the Department of Justice’s legal stance has not been filed by the department’s tax counsel either. The Notice of Appeal is still instructive, though. The Tax Court of Canada will make all of these papers available to the public when they are or will be public records.

Tavares has primarily contended that the signing bonus he earned in 2018 should be subject to Article XVI(4) of the Canada-U.S.A. Tax Treaty. In his Notice of Appeal, he contends that the signing bonus was appropriately classified as a “inducement to sign an agreement relating to the performance of the services of an athlete” in order to be eligible for the lower tax rate under the treaty. surprisingly, the Notice of Appeal denies the claim that Tavares’ signing bonus was “salary, wages, or other remuneration in respect of an employment,” which would allow Canada to fully tax the sum in accordance with Article XV(1) of the Canada-U.S.A. Tax Treaty. In defense of this claim, the Notice of Appeal notes that Tavares received the bonus regardless of whether he was injured or sent to the minor leagues, nor did it matter if he ever played for the Leafs. This is in contrast to Tavares’ annual salary, which may be limited or decreased in light of his Leafs performance.

Inferred from the CRA’s legal stance is that Tavares’ 2018 signing bonus was a component of his salary and other pay, not a “inducement.” Tavares’ signing bonus, which is worth a total of USD $70,890,000 and is due over six years, is disproportionate to his whole salary of USD $5,230,000. This was undoubtedly taken into consideration by CRA when reaching its judgment.

How to accurately distinguish between an athlete’s normal wage and a “inducement” has been a topic of speculation among tax scholars for many years. Currently, the Tax Court of Canada has no recorded cases pertaining to the topic. Further advice on the subject and whether the amount of an athlete’s bonus is a significant element to be examined is also lacking from the CRA’s long-standing administrative stances. It is evident that there has to be a differentiation beyond the way in which the parties describe such payments in the contract. It will be up to the courts to determine whether or not Tavares’ signing bonus to yearly pay ratio matters when addressing this issue.

Tavares shouldn’t have to pay double taxes on his income, no matter how things work out for him. Tavares’ reevaluation will be reversed if he succeeds in court. Tavares may consider resubmitting in the United States in order to pursue more international tax benefits, should the CRA be successful in its review. Tavares may use Article XXVI of the Canada-U.S. Tax Treaty in the event that the United States refuses to acknowledge jurisdiction. This would force the IRS and the CRA to work together to find a way to prevent double taxation. Tavares would be spared from paying taxes to both countries on his same income in this way. By guaranteeing a fair outcome for Tavares and tax officials alike, the treaty’s invocation promotes mutual collaboration between the United States and Canada regarding tax concerns.

Pro Tax Tip: Tax Court of Canada’s Principled Settlement Rules Likely Ensure a Hearing for Tavares’ Appeal

Both parties must agree on reasonable terms based on the relevant facts and legislation when settling a dispute at the Tax Court of Canada. This implies that the settlement ought to be fair and something that the Canada Revenue Agency (CRA) might actually accept. The law, however, cannot be altered or bent by the CRA in order to resolve a dispute. Therefore, it is not possible for the CRA and the taxpayer appealing their taxes to just decide on a settlement define without taking the relevant legislation into account. Their responsibility is to ensure that all settlements are fair and compliant with the law. This guarantees equitable and legal settlements and that all parties follow the same set of guidelines.

As a result, there may be minimal possibility for settlement in some tax lawsuit instances. For example, if the legal issue at hand is binary, such as an income/capital categorization of a single transaction, there is no middle ground to reach a clear agreement. If the number of legal concerns is inadequate and the issues are binary, settlement is almost certainly attainable.

The problem with Tavares appears to be binary. Tavares has claimed that the signing bonus was a “inducement” that qualified for a favorable tax rate under the Canada-U.S.A. Tax Treaty, while the CRA has claimed that the bonus was fully taxable in Canada. Additionally, Tavares’ contract makes it very clear which portion of his compensation was meant to be an annual wage or a signing bonus. Together, these elements limit the chances of a preemptive settlement for the Canadian tax litigation lawyer at Tavares and the Canadian tax counsel of the Department of Justice.

FAQ: Frequently Asked Questions

What was John Tavares’ appeal to the Tax Court of Canada about?

As part of his deal, John Tavares committed to play as captain of the Toronto Maple Leafs in 2018 and was given a $15,400,000 signing bonus that was due in the same year. Because Tavares did not reside in Canada in 2018, MSLE withheld 15% of his wages as taxes that were due to the Canada Revenue Agency (CRA) in accordance with Article XVI(4) of the Canada-U.S.A. Tax Treaty. Tavares’ 2018 taxation year was reevaluated by the CRA in November 2022 on the grounds that Article XVI(4) did not apply and that his whole signing bonus was taxable in Canada. Tavares filed an appeal of his reassessment with the Tax Court of Canada in January 2024, claiming that his bonus was properly taxed by MSLE in accordance with the provisions of the Canada-U.S.A. Tax Treaty.

Under the Canada-U.S.A. Tax Treaty, how are athletes’ employment salaries taxed?

Canada retains the ability to tax residents of the United States of America on employment income in cases where the employee is paid by or on behalf of a Canadian resident, as per Article XV of the Canada-U.S.A. Tax Treaty. However, Article XVI(4) restricts Canada’s ability to impose taxes at a rate of 15% of the gross amount of any “inducement”—that is, a signing bonus—that a Canadian resident pays to an athlete who resides in the United States.

If Tavares succeeds or defeats his appeal, what will happen? 

Tavares shouldn’t have to pay double taxes on his income whether he succeeds or defeats. Tavares will have his evaluation reversed if he wins in court. Tavares may be able to re-file in the United States in order to claim more international tax credits if the CRA is successful in having its reassessment upheld in court. Tavares may utilize Article XXVI of the Canada-U.S.A. Tax Treaty if the United States refuses to play hockey. This would compel the Internal Revenue Service (“IRS”) and the Canada Revenue Agency (“CRA”) to work together to find a workable solution so as to prevent double taxation.

Disclaimer

The information provided in this article is general in nature. It is current just as of the day it was posted. It might not be current because it hasn’t been updated. It is not to be relied and does not provide legal advice. Each tax scenario is different from the examples given in the article since it is specific to its own set of circumstances. You ought to speak with a Canadian tax lawyers if you have any specific legal queries.

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