Permanent Establishment for Short Term Contracts in the US
Allan Madan, CPA, CA
Imagine that you are a Canadian company sending an employee to the United States to fulfill a job order for a US customer. You feel that you know all about the Permanent Establishment rules and you are confident that as the employee is in the US on a temporary basis, his/her presence will not constitute a fixed place of business – resulting in no US tax liability.
Is this the end of the story? The answer is No. A 2007 amendment to the Permanent Establishment article in the Canada – US tax treaty has introduced a concept of ‘deemed permanent establishment’ which has caught countless number of companies off guard and in trouble with the tax authorities.
This article will discuss two additional ways that a business can find themselves having Permanent Establishment in the other country under the new ‘deemed Permanent Establishment’ rule.
What is the ‘deemed Permanent Establishment’ rule?
This rule is specific to the tax treaty between Canada and the US and the exact technical jargon can be found on Article V – Paragraph 9 a) and b). The rule states that if one of the two following criteria is met, the entity will be deemed to have Permanent Establishment in the other country and will be subject to business tax in that country on profit attributed to the Permanent Establishment:
Criteria #1 Service is performed by an individual (eg. employee) in the other country who is present in that country for more than 183 days in any 365 day period and during that period, more than 50% of the gross revenue of the entire business was derived from services performed in the other country
Criteria #2 Service is performed by an individual in the other country for at least 183 days in any 12 months period with respect to the same or connected projects for customers resident of the other country
Criteria #1
This criteria is fairly straight forward. For example, a Canadian company – CAN Inc. sends an employee to provide engineering consultation service for a US company. The contract requires the employee to be present in the US for at least 11 months and the fee for completion is $200,000. CAN Inc.’s gross revenue from all of its business operations during that time is $1M.
In the above situation, although the Canadian employee will be present in the US for more than 183 days in a 365 day period (ie. 11 months), only 20% of CAN Inc.’s gross revenue (ie. $200,000) was derived from services performed in the US. Therefore, this criteria will not be met.
Criteria #2
Unlike the first criteria in which an employee has to be present for 183 days, under this criteria, the period test of 183 days constitutes working days in any 12 months period. Therefore, days worked by the individual must be kept on record to determine whether the period test has been met.
Using the same example from Criteria #1, assuming that the employee has exceeded 183 working days during the 11 months present in the US, the criteria will be met as the service performed was with respect to one project (i.e. Contract to provide engineering consultation service) for a US resident. This means that CAN Inc. will now be deemed to have a permanent establishment in the US since the first day that the individual was present in the US.
What if CAN Inc. cleverly designs the contract with the US customer so that the individual will perform 2 separate contracts but perform the same type of work (i.e. engineering consultation) for 11 months under both contracts? CAN Inc. will still be deemed to have Permanent Establishment in this scenario under the provision ‘same or connected projects’.
If, legitimately, CAN Inc. enters into two separate contracts with the same US customer in which service provided are not connected wholly or geographically, then criteria #2 can be considered for each individual contract. For example, if one contract is for engineering consultation on installation of equipment in California, and another contract is for providing training for US employees in New York for the same US Company, each contract can be considered separately.
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.
ABOUT THE AUTHOR
ALLAN MADAN
CPA, CA
Allan Madan is a CPA, CA and the founder of Madan Chartered Accountant Professional Corporation. Allan provides valuable tax planning, accounting and income tax preparation services in the Greater Toronto Area.
Hello Allan,
I have an incorporated American company, and have just received a $150,000 seven month contract with a Canadian company. My business is an I.T. consulting firm, and we do not have a physical site in Canada. My company’s gross revenue is $350,000. During the seven month, I will be sending staff to reside in Canada and commute over Skype. I read in your article about the 183 day rule. Would it apply in my situation?
Hi Frank,
Based on the information you provided me, this contract will represent approximately 42% of your gross income. Since this is under the 50% limit, the first criteria is not met. However, there is the second criteria to consider. As your staff are spending more than the 183 days (approximate 6 months) in Canada, your company will be considered to have a permanent residence in Canada and must pay tax on the profit earned from the Canadian contract.
Regards,
Allan Madan and Team
Hi Allan, being Canadian and wanting to start a FBA Amazon Business where all my product is produced out of Canada but somewhere in the world plus the United States and brought to the Amazon Business to be sold, do I have to have a US Company or can I have a Canadian Company doing business in the US. I will not be residing there, I will not have employees residing there and I will be having contracts with Amazon and other companies to fulfill all the duties needed to sell my product. I do know I need an EIN but can I register my EIN with my Canadian Company.
Also, is all the information on your website relevant for today or is some information too old to use as advisement?
Thirdly, I would like to know your rate for consulting, and your rate for doing business for me. Most business I would like to do myself, but occasionally I will need a good border lawyer I am sure.
I am hoping you reply soon, please put as much of your reply here to help others but I would prefer a confidential email with the rates.
Hi Nicole,
Your Canadian company does not have a fixed place of business in the US. A warehouse for the storage and distribution of goods is not considered a fixed place of business. As a result, your Canadian company will not be liable for US profits tax on sales made to the US. However, your Canadian company should apply for a US EIN and file a treaty-based tax return (forms 1120F and 8833) to claim an exemption from US profits tax. This is an annual filing.
Finally, your Canadian company may be liable for State Tax and Sales Tax depending on the State(s) where it does business.
I will contact you separately about my rates.
Hi Allan,
I have a Canadian company and my US suppliers will dropship products in the US. Since I will have a US based bank account to pay my suppliers, is that a trigger for the US government to collect income tax? My business is completely online.
Thank you,
AC
Hi Andreina, having a US bank account and drop-shipping products to customers in the US does not create a permanent establishment for your Canadian company. As a result, your Canadian company will not be liable for US profits tax.