Tax Implications of U.S. Companies Expanding to Canada

Allan Madan, CA
 May 24, 2010
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Many American companies today are looking towards Canada as one of the primary destinations for international expansion due to geographical proximity and Canada’s relatively strong and stable economy.

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However, there are significant tax issues to take into consideration.  If you are a US based corporation and are planning on expanding to and doing business in Canada, then this article is a must read. I will address the tax implications for US companies expanding to Canada

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You are carrying on business in Canada, if you manufacture, sell goods or services, dispose of real estate or resources in Canada.

US Companies Carrying on Business in Canada – tax implications

Any person (individual or corporation) that is carrying on business in Canada is required to file a Canadian tax return, under Canada’s laws. “Carrying on Business” is a very broad term and therefore encompasses most activities that US businesses engage in with respect to Canada.  In fact, a sale made to a Canadian customer even if the sale was initiated and concluded in the US, could be considered as ‘carrying on business in Canada’ According to the Canadian Income Tax Act, a US company is carrying on business in Canada if that company:

1. Produces, grows, mines, creates, manufactures, fabricates, improves, packs, preserves or constructs anything in Canada; 2. Solicits orders or offers anything for sale there through an agent or servant, whether the contract or transaction is completed inside or outside of Canada; or 3. Disposes of certain resource properties or Canadian real estate.

Thus, the threshold for what constitutes “carrying on business in Canada” is very low. US companies expanding to Canada must examine their activities to determine if they are carrying on business in Canada, and if they are, those companies will be required to file a Canadian income tax return.

If you are an American business you may also need to obtain an extra-provincial license, please see our FAQ’s for more information regarding extra-provincial license.

Liability for Tax in Canada – for US Companies

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Tax liabilities for American companies including withholding tax are generally reduced as a result of the Canada-US Tax Treaty

The potential liability for income tax in Canada is an important tax consequence for US companies expanding to Canada. US companies that expand to Canada are liable for Canadian income tax if they: – Carry on a Business in Canada – Dispose of Taxable Canadian Property (e.g. real estate or shares of private companies) However, the Canada-US Tax Treaty provides relief for some US companies that carry on business in Canada.

According to the Canada-US Tax Treaty, only those US companies that carry on business in Canada through a permanent establishment are required to pay income tax on the business profits earned through that establishment. A permanent establishment includes a fixed place of business (such as an office), or an agent in Canada that has the authority to bind contracts on behalf of the US Company. A permanent establishment also includes a contract in Canada that lasts for six months or longer in any 12 month period.  Thus, US businesses should examine their contracts with Canadian customers to see if they are caught by this ‘six month rule’. Once you have determined that a permanent establishment exists, you must calculate the profit attributable to the Canadian permanent establishment.In this calculation, you should include:

  • Canadian sales
  • Canadian direct expenses
  • Overhead from the US office relating to Canada

For more information on permanent establishments please see our article on what is classified as a permanent establishment in Canada.

Regulation 105 Witholding Tax

–         American corporations doing business in Canada are subject to a withholding tax. Regulation 105 of the Income Tax Regulations requires businesses to withhold 15% (additional 9% in Quebec) of fees, commissions, and any other amount paid to non-resident contractors for services rendered in Canada.  This tax is not a final tax but is meant as a tax installment against a potential tax liability. –         There is the potential for what is known as ‘cascading’ payments where a client pays a middleman, which in turn pays your company.  Therefore, a withholding tax is applied at each level of transaction. –         There is an additional withholding tax equal to 25% known  as “Part XIII tax”  which is applied on the following payments made to non-residents

  • Dividends
  • Rentals and royalty payments
  • Pension payments
  • Old age security pension
  • Canada Pension Plan and Quebec Pension Plan benefits
  • Retiring allowances
  • Registered retirement savings plan payments
  • Registered retirement income fund payments
  • Annuity payments
  • Management fees

As part of the Canada-US Tax Treaty, there is a reduction in the 25% tax rate on dividends, royalties, pensions and annuities.  For more information on these reductions please consult this chart.

Canadian Treaty Based Tax Return for US Companies

US firms that are carrying on business in Canada but do not have a permanent establishment in Canada are not liable for Canadian income tax and must file a tax return in Canada. In such a situation, the tax return to be filed is referred to as a “Treaty Based Tax Return”, and is in substance an information-type return that does not compute or levy tax.

Failure to file a Canadian Treaty Based Tax Return could result in penalties of up to $2,500 for each return for each year. It’s also a wise idea for a US corporation that carries on business in Canada to file a Canadian Treaty Based Tax Return, in order to assert its position that it is not taxable in Canada, because it does not have a Canadian permanent establishment. Consider filing this return as a type of “insurance.”  Filing this treaty based exemption will also provide a refund of any tax withheld.

Canadian Subsidiary of US Corporation – tax implications

Canadian corporations have a relatively low tax income rate of approximately 28% (combined federal and provincial income tax). Therefore, US companies often opt to create a Canadian corporation for their Canadian operations, rather than operate through a branch.

In addition, repatriation of profits from the Canadian subsidiary corporation to the US parent corporation is an important tax implication of expanding to Canada. One way to repatriate profits to the US is through dividends. Dividends paid by Canadian corporations to their US parent corporation are subject to Canadian withholding tax of only 5%. Interest paid by Canadian corporations to their US parent corporation is no longer subject to withholding tax pursuant to the Canada-US Tax Treaty. It is therefore a good tax planning point to capitalize Canadian corporations with debt. Canadian branch operations of a US company also have significant downside risks:

  • The Canadian branch does not have limited liability protection
  • Branch tax of 25% is levied by the CRA.  Branch tax is calculated as 25% of the decrease in the net assets of the branch.  Thus, a Canadian branch that distributes most of its retained earnings to the US head office will pay a significant amount of branch tax.

Employee Taxation

Withholding Taxes

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American companies with operations in Canada as well as their employees are subject to withholding tax

American corporations that use non-resident employees in Canada are also responsible for withholding tax.  This tax is only applicable to the portion of the wages that was earned in Canada.  Much like the withholding tax for US Companies, the withholding tax for employees can also be refunded by filing for a regulation 102 waiver.  The Regulation 102 waiver can only be received if the US Based Corporation has proven that it does not have a permanent establishment in Canada by first obtaining the Regulation 105 waiver.

American employees working in Canada are still subject to American payroll taxes including social security, Medicare, state disability insurance.  The US company will have to continue to pay unemployment insurance premiums even for these American employees based in Canada. Some American employees who are based in Canada may not have to pay for Social Security and Medicare but will be subject to the Canadian equivalent which includes the Canada Pension Plan and Canadian Employment Insurance.  The Canada and the United States have arrangements which allow contributions made to the CPP to transfer over to the American Social Security.

Additional Taxes

The Canadian wages that a Canadian-based American employee earns is also subject to regular Canadian income tax unless:

  1.  The Canadian wages are under $10,000, or
  2. The employer does not have a permanent establishment in Canada and the employee is physically present for a duration of 183 days or less within any 12-month period.

Different types of corporations are also subject to different tax consequences.  S Corporations for instance are at a severe tax disadvantage.  For more information on this subject, please consult our article on the tax advantages and disadvantages for S Corporations in Canada

Voluntary Disclosure

A large number of US companies fail to comply with these requirements as well as forget to completely file their returns.  Therefore they are hit with large penalties plus accruing interest. Luckily, the Canada Revenue Agency has a Voluntary Disclosure Program (VDP) which provides penal relief for US companies and individuals as long as all other criteria set out are met.  For more information regarding this program, please consult our article on voluntary disclosure program for Canadian taxpayers.

As a US corporation planning to expand to Canada, it’s a wise idea to set-up a subsidiary Canadian corporation because of the tax and legal benefits.

Disclaimer

The information provided on this page is intended to provide general information. The information does not take into account your personal situation and is not intended to be used without consultation from accounting and financial professionals. Allan Madan and Madan Chartered Accountant will not be held liable for any problems that arise from the usage of the information provided on this page.

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Comments 35

  1. Hi, Alan that was a very informative article. I was wondering what is the difference between a branch and a subsidiary for tax purposes?

    1. Hi Michelle,

      In terms of tax purposes, branches and subsidiaries are subjected to similar tax laws. Canadian branches of foreign corporations are subjected to income tax in the same ways as if it was classified as a subsidiary. One major difference is that permanent establishments under which branches fall also have to pay a ‘branch tax’. Branch tax is payable at the rate of 25% of the after-tax profits of the branch operations not being reinvested in Canada. Branch tax is roughly equivalent to the withholding tax, which would be payable on dividends paid by a Canadian subsidiary to its foreign parent organization. The rate is reduced under certain tax treaties to 10% or 15%. Under the Canada-U.S. Treaty, the rate has been further reduced in certain circumstances to 5% of after-tax profits. In addition, certain treaties, such as the Canada-U.S. and Canada-U.K. treaties, provide for an exemption from branch tax.

      Best Regards,

      Allan Madan

    1. Hi Shane,

      If you are classified as a branch then you will have to pay branch tax. So in order to avoid paying it is simply to convert or structure your company into a subsidiary or if you are located in either British Columbia, Alberta or Nova Scotia then you can structure into an unlimited liability corporation (ULC) which can avoid Canadian branch tax.

      Best Regards,

      Allan Madan and Team

  2. Hi Allan,

    I’ve heard that some recent changes in the US-Canada Tax treaty have severe repercussions for ULC’s? is that correct?

    1. Hi Huy,

      There was some provisional changes in 2008 limiting treaty protection for fiscally transparent entities on both sides of the border. This potentially denied treaty-reduced withholding tax rates on certain payments from a Canadian ULC to a US recipient. So many people were concerned that ULC’s were no longer viable options for US investors looking to create separate legal entities in Canada for investment or expansion purposes.

      The CRA however erased these doubts by making amendments which accepts the use of various repatriation strategies and multiple-shareholder UlCs to avoid the new treaty exclusions.

      Best Regards,

      Allan Madan and Team

  3. Hi Allan,

    What if during the course of my working in Canada I become a Canadian permanent resident and receive Canadian citizenship, would I be allowed a credit for the taxes that I paid when I was not a PR/citizen?

    1. Hi Charles,

      Unfortunately there are not many available options in terms of tax credit. Depending on your citizenship/residency of another country and if Canada had a tax treaty/arrangement then you could have received tax credits from that specific country as to avoid double taxation. If you specify your country, I could possibly further assess your situation.

      Best Regards,

      Allan Madan and Team

  4. Hi Allan,

    I run an online ebay business, if I make a sale to a Canadian customer, does that count as carrying on business and would I have to file a Canadian tax return?

    1. Hi Thompson, Assuming that you are an American based seller with no permanent establishment in Canada and are shipping the sold goods from the United States then you do not have to file a Canadian tax return. You however will have to disclose all of your income from your ebay business including your Canadian sales to the IRS.

      Best Regards,

      Allan Madan and Team

      1. I am also a US ebay seller with significant sales to Canadian customers. What if I have a contract with FedEx that gives me discount on shipping to Canada. Since FedEx has a permanent establishment in Canada, how would that affect me?

        1. Hi Chrissy,

          As long as you are not soliciting orders or offering anything for sale in Canada through FedEx then it will have no tax implications for you. FedEx are the ones that will be subjected to tax in Canada.

          Best Regards,

          Allan Madan and Team

    1. Hi J.J.,

      Unlike branches and subsidiaries, an LLC is not eligible for treaty benefits under the Canada-US Income Tax Treaty. However, in some circumstances it is possible for LLC’s to access some of the treaty benefits by using the look-through rule which requires Canada to extend Treaty benefits to a US resident where the following conditions are met. First, the US resident must be considered under US tax law to have derived Canadian-source income, profit, or gain through an entity, such as an LLC, that is not resident in Canada. Second, the US tax treatment of such amount is the same as if it had been derived directly by the US resident instead of through a fiscally-transparent entity.

      The look-through rule is meant to enable US resident members of a fiscally-transparent entity, such as an LLC, to access Treaty benefits for the amount of Canadian-source income, profit, or gain derived by the entity and proportionally allocated to the US resident members.

      The CRA’s long standing position is that an LLC is a corporation for the purposes of the Canada Income Tax Act, and the LLC must, therefore, pay Canadian taxes like any other corporation. The members of the LLC will not pay Canadian income tax on the LLC’s income even if the members are considered to earn the income under US tax law.

      Best Regards,

      Allan Madan and Team

  5. Hi Allan,

    I own an electronic commerce company that host websites for many different clients around the world including Canadians. My company is based in Argentina but my servers which are used to host the websites is physically located and housed in Canada. I have no Canadian office nor employees other then ones I contracted to set up the server. There is also no personnel needed to maintain the ongoing functioning of the servers. I have no Canadian bank account, payment is made in Argentina, and the contract for my services takes place outside of Canada. I also have no ties and would be classified as a non-resident. In this situation, would I be classified as carrying on business in Canada? Thank you in advance, I know this is a complicated matter.

  6. Hi Allan, I am a non-resident of Canada and have an engineering company based in Spain. My company provides services to many different countries around the world. For a job in Canada, I have been contracted by a Canadian company to perform work on an oil platform. This is my only contract in Canada, and I will be temporarily in Canada for a period of 1 week to do this job. My payment for this job will be outside of Canada.

    Would I be classified as carrying on business in Canada?

    1. Hi Guillermo,

      Generally you would not be classified as carrying on business in Canada since you have no major business operations physically in Canada outside of your temporary one week assignment. Though the number of the workers entering to do this contract might cause some problems, but if it is only you then there is not sufficient evidence to conclude that you are carrying on business in Canada.

      Best Regards,

      Allan Madan and Team

      1. Regarding this carrying on business issue, it seems that one condition is insufficient evidence to suggest that a person/company is carrying on business.

        1. Hi Timothy,

          carrying on business in Canada seems to be a really grey area, sometimes a single condition can warrant being classified as one while other times it won’t be. Since each case is different with many variables, it is ultimately up to the CRA and the Supreme Court of Canada to decide.

    1. Hi Arielle,

      Withholding tax and departure tax have no bearing on each other. Some assets may be subjected to both withholding and departure tax upon becoming a non-resident of Canada. While you may defer some departure tax, you will not be able to defer withholding tax. However it may be possible to reduce/receive tax credits for withholding taxes paid depending on your country of residence.

      Best Regards,

      Allan Madan and Team

        1. Hi Mahmoud,

          At this point in time, the CRA only accepts security for deferring on departure tax.

          Best Regards,

          Allan Madan and Team

  7. Hi,
    I quit as a regular employee and started my own company (INC.) in Aug 2014. I got paid as a contractor from Sep onwards of the same year but have not withdrawn any funds from my business acc during the FY 2014. Should I mention the business income while filing my personal IT return for the year 2014? Does it impact my personal income taxes for the FY 2014 in any way?
    Thanks

    1. Hi Sam,

      Assuming that you have incorporated your own company, any income earned by the company would be reported on the corporation’s corporate tax return (T2), rather than on your personal tax return T1.

      Depending on how you subsequently structure your compensation (for instance, salary versus dividend payments from your corporation), your earnings will be classified accordingly on your personal tax return.

      Please let us know if you have any further questions.

  8. I represent a US company that provides online service to Canadian customers. All work is performed in the US and I do not have a Canadian PE. Would Canadian regulation 105 apply on payments to the US entity?

    1. Hi Tom,

      No, regulation 105 will not apply because the services were not physically performed in Canada.

      1. Thank you. This was my assumption and I hope the Canadian companies understand this.

        Would the non-resident company have to register for GST?

        1. Yes, GST/HST must be charged to Canadian customers and an HST return should be prepared and filed with the Canada Revenue Agency (CRA). Also, your company should file a treaty based tax return with the CRA to claim an exemption from Canadian corporate income tax pursuant to the Canada-US tax treaty.

          We can take care of these filings for you.

  9. Hi Allan,
    If a US LLC wants to establish a subsidiary in Canada, is it correct that the US entity will be taxed for its worldwide income in Canada because of the Canadian subsidiary or is it just the worldwide income of the Canadian subsidiary that is subject to Canadian taxes?
    Thanks.

    1. hi Domtash,
      The Canadian subsidiary has to pay Canadian income tax on its worldwide income. The LLC is not liable for tax in Canada unless it earns Canadian sourced income.

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