U.S. Companies Doing Business in Canada - Tax Considerations
Todd C. Trowbridge
Arun (Ernie) Nagratha
Trowbridge Professional Corporation
25 Adelaide Street East
Toronto, Ontario M5C 3A1
Canada is a critical market for U.S. companies with the U.S. selling three times more goods to Canada than to China. Because of the proximity and size of the market, many U.S. companies look to Canada when expanding internationally. However, companies doing business in Canada have both corporate tax and employee personal tax withholding and reporting considerations. This article provides an overview of key corporate and individual tax considerations for U.S. companies doing business in Canada.
Corporate Tax Withholding and Reporting Obligations
If a U.S. company has employees performing services in Canada, it may be seen to be carrying on business in Canada. This result does not require a physical plant or office location, but can occur simply by soliciting orders or offering services for sale through an agent or employee. If a Company is deemed to be carrying on business in Canada, there will be corporate tax reporting requirements and potentially Canadian taxation. Where filing requirements are not met, significant penalties may result even where no tax is owed to Canada. Registration, collection and reporting requirements may also be necessary in many circumstances for Canadian Goods and Services Tax (GST) and Harmonized Sales Tax (HST).
A U.S. company rendering services in Canada is subject to a 15% tax withholding on their invoices under Regulation 105 of The Income Tax Act (and an additional 9% under Quebec tax law if services are rendered in Quebec). The Canadian customer is required to withhold and remit the tax to the Canada Revenue Agency (CRA) as well as file Form T4A-NR to report this tax withholding. The withholding is not a final tax but rather a tax instalment against a potential tax liability in Canada.
Under the Canada-U.S. Tax Treaty, a U.S. corporation carrying on business in Canada is only subject to taxation on income earned in Canada through a fixed place of business or permanent establishment (PE in Canada). Even if a U.S. Company providing services in Canada doest not have a factual PE, the Fifth Protocol of the Canada-U.S. tax treaty expands the definition of PE to provide the possibility of a "deemed" permanent establishment in Canada. A deemed PE would occur in a case where services are provided in Canada for an aggregate of 183 days or more in any twelve-month period beginning or ending in the year with respect to the same or connected project for customers who are either residents of Canada or who maintain a permanent establishment in Canada and the services are provided in respect of that permanent establishment.
If it is determined that the U.S. company does not have a factual or deemed PE in Canada, it can file a treaty based exemption with its Canadian corporate tax return in order to obtain a refund of the tax withheld on its invoices. Further, where a U.S. company will not have a PE in Canada in respect of their services, it may be possible to obtain a Regulation 105 waiver (in respect of the 15% tax withholding) in advance of providing their services in Canada in order to eliminate the cash flow impact of this tax withholding.
Individual Tax Withholding and Reporting Obligations
A U.S. company will have payroll withholding and reporting obligations for both Canadian resident and non-resident employees, in relation to employment exercised in Canada, even if it does not have a deemed or actual PE in Canada. There is potential for significant penalties and interest charges if the company is not compliant with the tax withholding requirements.
However, if applied and approved by the Canada Revenue Agency in advance, a Regulation 102 waiver may be obtained for employees resident in the U.S. that will ultimately be exempt from Canadian tax under the Canada-U.S. tax treaty. This waiver would eliminate the need to withhold and remit payroll taxes in respect of their employment in Canada.
A Regulation 102 waiver can only be obtained if the Canadian source remuneration is less than $10,000 or the employee is present in Canada for less than 183 days in any 12 month period beginning or ending in the fiscal year and the remuneration is not paid by or on behalf of a person who is a resident of Canada and is not borne by a PE in Canada. In order to qualify for a Regulation 102 waiver, the non-resident Corporation must first obtain a Regulation 105 waiver to prove it does not have a PE in Canada.
Where a waiver is not obtainable because the compensation is borne by a PE in Canada, or the employee does not otherwise meet the criteria for a waiver, the U.S. company will be required to meet the payroll tax withholding requirements. Also, the employee will have a Canadian personal tax return filing requirement if tax is due, a return is requested by the Canadian Revenue Agency (CRA), or if they wish to claim a refund of overpaid taxes.
If all the facts and circumstances would allow a company to obtain the waiver, but they do not do so, the company will be required to meet the payroll tax withholding requirements. In order to re-claim the taxes that have been withheld, the employee must file a Canadian tax return. This withholding requirement creates further complexities including funding the withholding (employer or employee), reclaiming the tax withheld as a refund, and coordinating the tax settlement with the employee.
The company is required to report Canadian source earnings and tax withholdings, if applicable, on Form T4 on an annual basis. Even if a Regulation 102 waiver is granted and no taxes have been withheld, T4 reporting is still required. Employees would need to apply for either an Individual Tax Number or a Social Insurance Number. There are potential penalties and interest for failure to file the annual T4 summary and distribute Form T4.
Canadian social security requirements (Canada Pension Plan and Employment Insurance) should also be reviewed. If the criteria are met for exemption from Canada Pension Plan contributions for an employee, a Certificate of Coverage should be applied for with the IRS. The Employment Insurance rules should also be reviewed to determine if the employee and Company are exempt from contributions.
Canada has a Voluntary Disclosure Program (VDP) that allows for the relief from penalties and interest for both corporations and individuals that have been non-compliant in the past. If the voluntary disclosure is accepted, the taxpayer is still required to pay the taxes owing plus interest. However, penalties would be waived if the VDP criteria are met and the Canada Revenue Agency accepts the VDP.
This article is meant to provide a brief summary of the withholding and reporting requirements in Canada for U.S. companies doing business in Canada. A thorough analysis should be done by companies either contemplating doing business in Canada or already doing business in Canada.
The information provided is for general guidance only, and should not be utilized in lieu of obtaining professional advice. Please see the following link for Circular 230 disclosure: http://www.gtn.com/circular-230-disclaimer.php