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
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.
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.
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.