As a U.S. tax accountant in Canada, I have come across many Canadian online businesses that sell to U.S. customers who completely ignore the IRS (Internal Revenue Service). The U.S. is a global hub for international business. The result? America has one of the world’s most complicated tax codes with hidden traps everywhere.
As such, you should know your responsibility to the IRS before making sales to customers south of the border. This article will focus on common US tax issues facing many small to medium sized Canadian online businesses.
1. The U.S. Income Tax
Whether your company will have to pay tax to Uncle Sam on its U.S. sales comes down to the question “Does your business have a permanent establishment in the U.S.?” If yes, then you will be liable for U.S. tax on any profit attributed to your U.S. permanent establishment. If No, then you do not have a federal U.S. tax liability.
You can find my detailed description of what constitutes a permanent establishment in the following articles:
- Permanent Establishment In Canada (http://madanca.com/blog/permanent-establishment-in-canada/); and
- Navigating through the nuances of doing online business in Canada (Francis’ new article).
A note worthy of mention: as discussed on the second article above, if your business model is to deliver your goods to a distribution centre or similar facilities for the purpose of storage in the U.S. before shipping the goods to your customer, such facilities will not constitute a permanent establishment.
Let’s discuss your company’s tax filing responsibility under two scenarios:
A) Your Canadian company has a permanent establishment in the U.S.
Your company will first be responsible for reporting the income and expenses attributed to the U.S. permanent establishment on the Form ‘1120-F: U.S. Income Tax Return of a Foreign Corporation’. This form is due on the 15th day of the third month following the company’s year-end (e.g. For a December 31 year end, the return will be due March 15 of the following year). This form is very different from its Canadian counterpart (T2) and as such, consultation with a U.S. tax accountant in Canada is recommended.
If your company maintains books and records of its U.S. operations in Canada or anywhere outside of the U.S., the filing due date is automatically extended by 2 months. If you still need more time, you can
complete the form 7004 http://www.irs.gov/pub/irs-pdf/f7004.pdf by your due date to have the deadline extended for another 4 months (or 6 months if you do not qualify for the automatic 2 months extension).
The U.S. has a marginal tax system for corporations with the federal tax ranging from 15% to a flat 35% if your income exceeds approximately $18.33 million.
Furthermore, you will be liable for 5% branch tax on any earnings not reinvested in the U.S. (first $500,000 in aggregate profit is exempt from the branch tax).
Finally, you will also be liable for filing appropriate State and Local tax returns in the State in which your permanent establishment is in.
B) Your Canadian company does not have a permanent establishment in the U.S.
The fact that you are not liable for U.S. tax does not exempt you from filing the U.S. tax return. You will still be responsible for filing the Form ‘1120-F: U.S. Income Tax Return of a Foreign Corporation’ with the same due date and extension as mentioned above.
Additionally, you will have to complete ‘Form 8833 – Treaty-Based Return Position Disclosure Under Section 6114 or 7701(b)’ http://www.irs.gov/pub/irs-pdf/f8833.pdf to declare that your business does not have a permanent establishment in the U.S. and as such, is not liable for U.S. federal tax.
2. The U.S. Sales Tax
The administration of sales tax in the U.S. is extremely complex and is therefore, beyond the scope of this article. However, on a fundamental level, sales taxes are administered by each State and its subdivisions such as its locality and city. In general, vendors are required to collect sales tax if it has established a physical presence or ‘nexus’ in that state.
The confusing part is that the threshold for what constitutes a permanent establishment for income tax purposes above and nexus for sales tax purposes differs for each state. Therefore, your company may not have a permanent establishment anywhere in the U.S. but nevertheless, have nexus in several states. In this case, your company would be responsible for collecting sales tax on sales made in those states.
With the recent economic recession, all states are hungry for revenue and have begun to aggressively hunt down non-compliant businesses. As such, your company should first consult a US tax accountant in Canada before venturing into the U.S.
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.