In heartbreaking fashion, the most exciting Blue Jays season of the last 22 years came to a close in October. As tax practitioners, we pondered what the tax effects might be for these players and what could entice them to either sign or re-sign with the Great White North’s only team.
With the Liberals raising taxes by 4% on income above $200,000, the rhetoric of high taxes as a reason we can’t attract free agents will again become the narrative. So, we must look to other methods within our current landscape to even the playing field.
How can the Blue Jays leverage Canadian tax rules to their advantage when enticing free agents to sign with the team? Here are some ways.
01 Avoid Canadian residency
Canada’s tax system is based on the concept of residency. A resident of Canada is taxed on his worldwide income, which would include his entire baseball contract. A non-resident (in the case of a major league baseball player) is only taxed on employment income that is physically earned in Canada. Therefore, if you remain a non-resident of Canada, you will not be taxed on any of your salary that relates to services performed outside of Canada. Fortunately for the Blue Jays, spring training and all road games are held outside of Canada. When reviewing the Blue Jays calendar of service, roughly 65% of their salary is earned from duties performed in the United States.
Therefore, it’s important that players do not obtain Canadian residential ties. Remaining a non-resident will effectively allow 65% of a contract to be non-taxable in Canada.
Even if residential rules are tripped in Canada, Canada has negotiated an extensive network of tax treaties with various countries from around the world that would allow a player to maintain residential ties in their home country (the United States and the Dominican Republic, to name two). The athlete must work with his advisor to ensure he meets these tests and that he is not considered a resident for tax purposes.
02 Use signing bonuses
Another way to limit the taxes paid in Canada and have salary taxed based on home country rates could be through signing bonuses. For Canadian tax purposes, the amount of the bonus is treated as ordinary employment income, and is taxable in the year received. However, when a U.S. resident athlete receives a signing bonus to play major league baseball (or any professional sport) in Canada, there is a special quirk in the Canada-United States income tax convention.
The treaty provides that a signing bonus paid by a Canadian team to a U.S.-resident athlete would be taxable in Canada, but that tax may not exceed 15% of the gross amount of the payment.
Therefore, assuming the athlete’s U.S. tax rate is above 15%, the bonus would effectively be taxable to the athlete at his normal U.S. rates.
03 Use Retirement Compensation Arrangements
A Retirement Compensation Arrangement (RCA) may be attractive for a player who is a non-resident and plans to return to his home country at the conclusion of his playing days.
There is virtually no immediate tax benefit for contributions to an RCA. A 50% refundable tax is applicable on the portion of player salary that is contributed and deposited into the plan. However, this can be an attractive vehicle for a player’s post-career financial planning.
If structured correctly, the athlete can withdraw funds from the plan upon retirement. The 50% refundable tax is returned on withdrawal and the player is simply taxed on the amount as pension income.
Assuming the athlete is not a Canadian resident, the pension amount withdrawn would be subject to a 25% flat withholding tax. If the player is resident in a tax treaty country, this tax may be reduced further (to as low as 15%). Effectively, the player will be taxable on the income contributed to his RCA based on his home country tax rate. Furthermore, if the country the athlete retires to does not tax income (e.g., Bermuda), the withholding tax could potentially be his only tax payable.
04 Use tax equalization payments
Multinational corporations typically use tax equalizations to entice workers to transfer to higher-taxed jurisdictions. The principle is that the employee should not suffer an economic or financial hardship (or, conversely, a windfall) as the result of his move to the new location. Effectively, an employer will compute what the employee’s take-home pay would have been had he stayed in his home country. The employer will then equalize, or gross-up, the applicable salary to compensate for those differences. An employee would therefore be indifferent as to which country he worked in. A player who wants to stay with the Blue Jays could perform similar calculations and negotiate a higher salary based on the tax situation of a particular country and state.
Tax tips for players residing in Canada
For players who already reside in Canada and will now be taxed at top rate as a result of the Liberal win (or have always been taxed at the top rate), there are some tax-saving considerations they should keep in mind. They can look to other credits and deductions to reduce their taxes: for instance, interest on investments, tax-efficient investments (assuming they align with their investment strategies and goals), donations and borrowing for investment purposes, rather than personal purposes.
Being mindful of investments and their tax-efficiency is crucial. Interest deductibility is also something to consider. They can also maximize interest deductions by structuring or arranging loans for business or investment purposes first (where the interest is deductible), and then for personal use (where the interest is not deductible). For traceability, it’s best to get separate loans for each purpose.
by Jeffrey Steinberg, CPA, CA, and Adam Scherer, CPA, CA, partners at Crowe Soberman in Toronto.