‘Anywhere but Canada’: How a tax ruling could hobble pro teams north of the border

When John Tavares was a child, he’d sit on the couch beside his father in his family’s home in a Toronto suburb and watch their favorite team play.

The Maple Leafs colored the boy’s imagination. Like many kids in the area, he hoped to one day wear a blue and white jersey — to become a hometown hero.

On July 1, 2018, the opening day of NHL free agency, it happened. The star center signed a seven-year $77 million contract with the Maple Leafs.

After the blockbuster signing was announced, Tavares shared on social media a photo of himself as a child, sleeping in Maple Leaf sheets.

“Not every day you can live a childhood dream,” he wrote beneath the image.

But the nostalgic sentiment carried fine print. A key part in Tavares’ decision to sign with Toronto was the belief that a provision in the U.S.-Canada tax treaty commonly used by professional athletes would essentially allow him to pay a lower tax rate on a initial $15M signing bonus.

Six years later, as the Leafs’ captain enters the final year of that contract, Tavares faces an $8 million tax bill for his homecoming.

Tavares has disputed the Canada Revenue Agency’s assessment. It’s one of several ongoing cases challenging ways that pro athletes have traditionally navigated higher tax rates north of the border.

Millions of dollars lay in the balance. The outcome of the CRA’s challenges could have serious implications for professional athletes currently playing in Canada, and a long-term impact on the appeal of Canadian teams trying to lure players across the border, says Robert Raiola, a director of the sports and entertainment division with PKF O’Connor Davies, an accounting, advisory and tax firm.

“I always say when somebody is a free agent, players should not only look at the ‘gross’ value of the deal, but also the ‘net’ value of the deal,” he says.

If they do, the numbers often point to a player going, Raiola says, “anywhere but Canada.”

If you’re not an expert in international tax planning, here is a brief overview on how pro athletes playing in Canada are taxed — as explained by Mark Feigenbaum, a tax litigator and partner at KPMG Law LLP, who specializes in athlete tax planning.

A “U.S. person” is subject to tax on their worldwide income. That applies if you’re a U.S. citizen, a green card holder, or meet the criteria defined by a formula for residency.

In Canada, you’re considered a resident for tax purposes if you spend 183 days of the year in the country, or if you have facts and circumstances that tie you to Canada. Residents are subject to tax in Canada on their worldwide income.

If you play for the Toronto Maple Leafs and are a Canadian resident for tax purposes then you will be taxed more than 53 percent on your worldwide income, including any bonus and salary. Playing for a Canadian team while a tax resident of Canada would make you exempt from federal tax (and most state tax) in the U.S.

If you play for the Leafs, but are a tax resident of a U.S. state — like Florida — then you pay income tax in the U.S. Florida has no state income tax, so you would pay just the federal tax at a 37 percent rate. You would pay tax in Canada on a portion of your earnings based on the number of days you are in Canada, and then get a credit in the U.S. for the Canadian taxes paid, subject to limitations.

When J.P. Barry negotiates for his clients with teams in markets with lower tax rates, that difference is always aggressively pointed out. Along with an offer, a team will provide breakdowns of what it would be like in a higher tax-rate and cost-of-living market like Toronto.

“They’re using it as a tactical advantage,” says Barry, managing director of CAA Hockey.

Here are a few hypothetical examples of the difference, based on recent marquee signings.

Boyhood dreams aside, Tavares’ decision to sign with his hometown club was also heavily influenced by what was commonly understood about a U.S.-Canada tax treaty provision under which bonuses are taxed differently than the rules described above.

This is where Tavares’ disagreement with the Canadian tax authorities takes shape.

Under that provision, a bonus paid from a team in one country to a resident of another is taxed at 15 percent to the country of the team paying the bonus. The athlete still must pay full income tax where they are a tax resident, but they are then eligible to receive a foreign tax credit for that 15 percent.

So for players who are considered a U.S. person, that bonus is taxed in the state where they live. To stick with the Florida example, that means the player pays 37 percent on the bonus. But if he is a Canadian tax resident, he’ll pay approximately 53 percent. (Before the accountants hit the comment section, yes, this is a rough total before factoring in deductions, foreign exchange rates, or escrow).

Many NHL contracts come with a fat bonus and a relatively small salary. In the upcoming season, for example, the Leafs’ Auston Matthews will earn a $15,925,000 bonus to go along with his $775,000 salary, according to Sportrac.

That bonus is a common structure for a professional athlete who is a resident of a lower tax jurisdiction in the U.S., says Kris Rossignoli, a partner at Cardinal Point Athlete Advisors who specializes in cross-border tax planning.

It was an integral factor for Tavares when he signed with Toronto, according to his Notice of Appeal filed in the Tax Court of Canada.

Tavares was born in Canada and grew up near Toronto. But when he played for the New York Islanders through the first nine seasons of his career, he paid U.S. federal and New York state income taxes. (Tavares filed his departing Canadian tax return saying he ceased to be a resident for tax purposes in 2010.)

The deal Tavares signed with the Leafs in 2018 was structured so that the majority would be paid as an annual lump-sum bonus, with a smaller portion as salary.

In the first year of his contract, Tavares was given a bonus of $15,250,000 and a base salary of $650,000.

From that bonus, Maple Leafs Sports and Entertainment paid $1.75M to escrow and just over $2M to the Canada Revenue Agency — 15 percent as required by the U.S.-Canada tax treaty. Tavares then received the balance of the signing bonus — roughly $11.4 million.

As a U.S. tax resident in 2018, Tavares paid United States federal tax and New York state tax, a combined 46 percent, on the gross amount of the bonus, less escrow. The foreign tax credit then applied in the U.S. for the Canadian income tax already paid.

In total, Tavares paid roughly $5.9 million in taxes on that initial bonus.

However, in late 2022, the CRA reassessed Tavares’ 2018 tax obligation, saying​​ he owes $6,847,428 in further taxes — plus more than $1.2M in interest. That interest would still accrue if Tavares had not paid the tax bill immediately.

In court documents filed in May, the CRA argued that Tavares was not entitled to the tax relief provided by the treaty for a couple of reasons.

The CRA said Tavares was actually a Canadian tax resident throughout 2018. He had residential ties to the country, he visited regularly, and demonstrated no evidence that he intended to permanently sever ties with Canada, they said. The CRA also said that Tavares was in Canada for more than 183 days in 2018, arguing that fact alone made him a tax resident. Tavares’ lawyers have not yet been presented evidence of this claim.

If the CRA prevails, Tavares would not be eligible for the relief provided by the U.S.-Canada tax treaty. (After 2018, Tavares filed his taxes as a resident of Canada and has paid federal and provincial taxes to the CRA every year since.)

The second argument the CRA makes potentially has wider implications for pro athletes with similar deals.

Tavares’ contract specifies that his bonus is dependent on him playing games to the best of his ability, reporting to training camp, and keeping in good physical condition. If Tavares retires, withholds his services, or leaves the Leafs without consent, he breaches his contract and would be forced to repay a portion of the bonus.

Because the specific obligations Tavares has under the contract are performed during the season, the Canadian tax authority says that money is actually not an inducement to sign a contract — but rather a payment for services provided.

That puts a target on non-resident athletes playing in Canada who have similar bonus structures.

The matter isn’t a question of whether Tavares intentionally skirted tax obligations, but rather how the provision commonly used by pro athletes in the U.S.-Canada tax treaty is interpreted, says David Chodikoff, a partner at Miller Thompson LLP, who specializes in international tax dispute resolution.

“This is a single-issue case,” says Chodikoff, who has been involved in hundreds of Canadian tax court cases in his career.

That issue centers on whether or not the income Tavares received as a bonus in the first year of his contract with the Leafs was employment income, or if it was an inducement to sign the contract.

So the argument is really over the U.S.-Canada tax treaty and its application — and whether it applies to Tavares’ circumstances, says Chodikoff.

If the CRA’s challenge in the Tavares case is successful, it will reframe how the provision for bonuses is applied more widely — and that’s likely why the Canadian tax authority is going after this case, Chodikoff says.

“I think the biggest reason they’re taking a run at this is the implications it could have on a much broader basis for other taxpayers,” Chodikoff says.

In the past, Canadian teams also reduced the tax burden on players they signed through a Retirement Compensation Agreement — a pension-like plan for pro athletes and other international high-income earners.

An RCA allows a player or his team to contribute a “reasonable” portion of salary — as determined by an actuary — into a trust that will pay out when the player retires. Canada taxes an RCA at 50 percent when the contribution is made, but provides a refund on distribution. The benefit is that the player can take a deduction when the contribution is made, deferring tax on a portion of their salary until the year the RCA is distributed.

A player who is a non-resident of Canada for tax purposes could use a Retirement Compensation Agreement to significantly reduce their taxes while they are a member of a Canadian team.

But as with the Tavares case, the Canadian tax authority is also scrutinizing RCAs. Three former Toronto Blue Jays are locked in court battles with the government over millions of dollars, after the CRA disputed their use of the tax-deferral strategy.

In the past few years, Jose Bautista, Josh Donaldson and Russell Martin all received reassessments rejecting some of the RCA deductions they initially claimed on their Canadian income tax filings.

All three were non-residents of Canada when they played for the Blue Jays. In the cases involving Martin and Donaldson, the tax authority argued that the players should have been taxed at a higher amount than they were — based on a disagreement over whether deductions on contributions should be applied before a division between income earned in Canada and the United States, or afterward.

The outcome would mean increasing Martin’s income by more than $5 million and Donaldon’s by more than $2.5 million in the years it was earned.

The appeals from Martin and Donaldson were argued before the Tax Court of Canada in July 2023. The players are still awaiting a decision, says Marie-France Dompierre, a Montreal-based tax litigation lawyer at Davies, Ward, Phillip & Vineberg LLP, who represents both former Blue Jays. It’s not uncommon for decisions in Canadian tax court to take well over a year.

In Bautista’s case, the government rejected the $16 million he claimed in deductions through contributions he made to his RCA.

“The result of these cases could significantly impact the taxation of non-resident athletes playing in Canada,” says Feigenbaum, who is one of the lawyers representing Tavares in his case and could not comment on it specifically. “That’s a wild card.”

It could take several years before a final decision is determined in any of these cases. A decision in the tax court of Canada, either way, will probably face an appeal.

But the outcome is likely already being felt.

Strictly from the point of view of trying to lure players to Canadian teams, the optics of Canada’s tax authorities targeting professional athlete contracts isn’t great, says Raiola, the New York-based athlete tax advisor.

Not every player walks into a situation where they have competing offers. But when Barry speaks with clients about these decisions the issue of taxes is always front and center. His team at CAA’s hockey division provides a summary that includes tax analysis, housing prices, and overall cost of living for each potential market.

“We break it down to the nickel, analyzing location to location,” he says.

But of course, it’s not just about money.

Chris Slawson, a director at Cardinal Point Athlete Advisors, works directly with players and agents to prepare clients before they dive into contract talks. Take-home pay, obviously, is important, but players also weigh issues like lifestyle, family, expenses and endorsement opportunities. Advisers like Cardinal Point also analyze tax rates. And of course, there are key factors like team competitiveness, how a player fits into a roster — or even the appeal of playing for a team they grew up cheering for.

“I just don’t think it’s a matter of ‘taxes are high in Canada, so we’re not going there,’” says Slawson.

While the ongoing tax court battles aren’t likely to be front of mind for most, some players might see the CRA’s scrutiny on these tax strategies as an added strike against the already high tax rates in Canada.

“I think it comes down to Canada’s cost of living, Canada’s taxes,” says Barry, adding that from that standpoint, expensive markets like Toronto and Vancouver are at a particular disadvantage.

If the CRA successfully challenges ways that athletes have commonly used to reduce their tax obligation, even the appeal of playing for the team you used to dream of might carry a little less weight.

“It’s a significant enough difference that even if you wanted to play in Canada, when an agent, or financial advisor, or accountant points out how much the difference is in income, you might want to reconsider that decision,” says Raiola. “The stakes are high.”

(Illustration: John Bradford / The Athletic. Tax rate figures courtesy of Cardinal Point Athlete Advisors. Photos: China Wong, Claus Andersen / Getty Images)