Additional tax requirements for U.S. companies

U.S.-based business-owner clients who send staff into Canada may have Canadian tax exposure. The government views the presence of employees, or even contractors, in Canada as “carrying on business.”

In most cases, they probably don’t have a tax liability. But if they don’t register and file the appropriate returns, they could face serious penalties. There are three major areas to be concerned about:

• Goods and services tax
• Corporate income tax
• Employee taxation

This applies if your clients’ companies are corporations, partnerships, trusts, limited liability companies or sole proprietorships.

Goods and services tax

When a registrant charges a client GST, it remits payment to the government. When it pays expenses subject to GST, it gets an input tax credit equal to the amount paid (there some exceptions).

The tax goes by one of three names, depending on the province the company’s operating in. Some provinces have integrated their sales tax systems with the federal government’s GST. This Harmonized Sales Tax (HST) is administered federally, by CRA. In Quebec, it’s known as QST and handled by the Quebec government, requiring a separate return.

If your client isn’t Canadian, he or she may not be required to register for GST. But it’s often advantageous to register because it provides access to the input tax credit system.

Corporate income tax

Withholding

The first thing that happens when the company invoices for services rendered in Canada is that income tax is withheld at source. The company’s Canadian clients must withhold and remit 15% of any payments for services rendered in Canada. This withholding is not actual tax—it’s a payment on account of tax, which may be refunded. One major trap is cascading payments. If the company’s client pays a middleman, who then pays the company, withholding is required at each stage.

It’s possible to request permission from CRA to reduce or eliminate this withholding where it’s greater than the anticipated actual tax. Services rendered outside Canada are not subject to withholding or tax.

Actual tax

If the company has a Permanent Establishment (PE), it’s subject to Canadian tax. There are three main ways to have a PE:

• The company has an office or other physical place of business in Canada and
• The company has people working in Canada for more than 183 days in any 12-month period, working on a single project or a group of connected projects. Any portion of a day counts as a day, and any people in Canada on one day counts as a day.
• A two-part test: a. A person working for the company is present in Canada for more than 183 days in any 12-month period; and b. Canadian revenues exceed 50% of the company’s gross business revenue.

If your company has no PE, any withholding will be refunded.

Filing returns

A partnership operating in Canada must file a partnership return, and the partners must each file their own returns. A U.S. LLC is treated as a corporation, even if it’s considered a partnership in the U.S.

The effective corporate tax rate in Ontario is 26.5%. Rates in other provinces are similar. For accumulated profits more than $500,000, there’s a 5% branch tax on remittance of those profits.

One corporate tax return covers federal and provincial tax, except in Alberta and Quebec, which require separate returns.

Personal tax rates run from 20% to 50%, depending on income and the province in which work is performed.

In Canada, one personal tax return covers federal and provincial tax, except in Quebec, which requires a separate return.

Employee taxation

Withholding

When a foreign employer sends a foreign resident to work in Canada, it’s responsible for withholding tax. But only Canadian wages are subject to withholding.

Canadian wages are usually a pro-rated portion of an employee’s worldwide wages, based on the time worked in Canada. Again, this withholding is not actual tax—it’s a payment on account of tax, and may be refunded.

Payroll taxes

In most cases, employees who work primarily outside Canada continue to be subject to home country payroll taxes. For Americans, these taxes include Social Security, Medicare, state disability taxes, etc. The employee’s company will continue to pay regular Unemployment Insurance premiums.

In some cases, employees who become based in Canada will be subject to the Canada Pension Plan instead of Social Security and Medicare, and to Canadian Employment Insurance instead of the home-country equivalent.

As the employer, your client may be required to pay into provincial Workers’ Compensation.

Actual tax

To a U.S.-resident individual, Canadian wages are subject to Canadian tax, unless

• the Canadian wages are less than $10,000; or
• the employer has no PE in Canada and the employee is physically present 183 days or less in any 12-month period, beginning or ending in the calendar year.

Personal tax rates run from 20% to 50%, depending on income and the province in which work is performed. Services rendered outside Canada are not subject to tax.

When someone becomes a resident of Canada, her worldwide income is subject to Canadian tax.

Tax protection and equalization

For people who work in Canada, the total tax burden tends to be higher than for those who work only in the U.S.

Consequently, employers often equalize employees so they’re not out of pocket. The tax must be reimbursed, but all jurisdictions tax that reimbursement, leading to a recursive calculation.

Voluntary disclosure

It’s common for a company to become aware of these requirements after it’s been doing business in Canada for a while. There are penalties for failure to withhold, remit and file returns. CRA allows companies and people to voluntarily disclose failures to comply. Taxpayers should contact CRA first. They then file the required returns along with voluntary disclosure requests. This approach generally avoids penalties, and CRA often waives interest.

Kevyn Nightingale, CA, CPA (IL), TEP is a partner with MNP in Toronto and leads the Expatriate Taxation practice.