April 03, 2014
Does your company’s marketing strategy include doing business in Canada, understanding the Canadian tax system and knowing how the U.S./Canada treaty interacts with business? Canada has the same taxes as the U.S., but under a different name. Federal taxes, goods and service tax and provincial taxes all have an impact on companies that capitalize on doing business with our largest and closest trading partner. It is important to be aware of when some of these taxes might arise.
First, we’ll begin by examining how the Canadian government looks at your U.S. company and its activities in Canada. Second, we look to the treaty and what is considered to be a Permanent Establishment (PE) and the additional filing requirements placed on the company. Finally, we will discuss planning opportunities used by other companies to help reduce their tax burden.
How does the Canadian government look at your U.S. company?
You determine your Canadian tax exposure by applying a facts and circumstance test to your activities in Canada. The Canadian government has issued several examples to help evaluate the facts and intent of the company. A few of these factors are:
Is your only activity in Canada direct sales?
Do you use agents or U.S. employees in Canada?
Does the company purchase any goods or services in Canada, including tangible or intangible assets?
Where is your branch or office located?
Where are the services performed?
The Canadian Revenue Agency issued Policy Statement P-051R2 to help nonresident companies determine if they are, in fact, carrying on business in Canada, which can be found on their website at www.cra-arc.gc.ca. This statement includes 21 different scenarios, which are in-depth and explain why each is, or is not considered to be carrying on business within Canada and, therefore, required to file tax returns.
The U.S./Canada Tax Treaty
While a company in Canada may be considered to be carrying on business, it does not mean that income tax or Value Added Taxes (VAT) must be paid to Canada. The U.S./Canada tax treaty assists in determining the extent of required tax obligations. If a U.S. company is considered to have a PE in Canada (fixed place of business), then the U.S. company activities create a possible taxable event. The rules for what constitutes PE are located in the treaty under Article V and provide examples of what exactly triggers PE to the U.S. company. PE involves questions of facts, to determine if there is a fixed place of business within Canada or if an agent is working there on behalf of the company. Therefore, while all the company’s operations may remain in the U.S., PE (and therefore tax liabilities) may arise solely out of an agent regularly operating in Canada on behalf of the company.
A PE will trigger possible income tax withholdings or other tax liabilities. Planning before this occurrence is beneficial. However, it may be difficult to immediately measure the extent of the activities until business is transacted. There are still planning opportunities available to help reduce the possibility of double taxes on income earned from your Canadian operations. Intercompany transactions, such as leasing arrangements or management fees used to reduce the taxable income, will be scrutinized using transfer pricing formulas as established by regulation and case law. If you own a pass-through entity, you may want to consider the use of a Canadian Unlimited Liability Company (ULC) and the U.S. disregarded entity elections. This allows for the use of any losses that may occur in the initial years of Canadian operations. Using global tax planning methods can assist companies with either tax deferral of their Canadian profits or minimization of possible double tax on profits.
Eide Bailly and HLB’s international network of accounting firms and business advisors can help you meet your international goals and provide local assistance in more than 100 countries, including Canada.