Are you doing business in Canada or have plans to expand to Canada? Frequently, taxpayers are not aware that by selling into Canada, or providing services such as installation or marketing, they may be required to file returns and/or pay income taxes in Canada. Such taxpayers may also need to file a special disclosure if they claim benefits under the U.S.-Canada income tax treaty (the treaty).
U.S. companies that carry on business in Canada are subject to Canadian income tax unless a treaty exemption applies. The Canadian Income Tax Act broadly defines carrying on business. Typically, selling goods or services into Canada from the United States without conducting any other activities in Canada would not cause a U.S. company to be considered as carrying on business. However soliciting sales through an agent or employee in Canada, producing or manufacturing items in Canada, or providing services in Canada generally qualifies as carrying on business in Canada and will trigger a Canadian filing requirement.
While U.S. companies may be considered to be carrying on business in Canada, they may not be subject to Canadian income taxation if their activities are protected under the treaty. Under Article VII of the treaty, business profits of a U.S. company are exempt from tax in Canada unless the business is carried on through a "permanent establishment," in Canada which is defined in Article V of the treaty.
Common examples of a permanent establishment (PE) in Canada include having a fixed place of business like an office, place of management, or a construction or installation project lasting more than 12 months, or having a dependent agent with the authority to contract that regularly exercises such authority in Canada. Services not protected under the treaty include services provided by an individual present in Canada for more than 183 days in any 12-month period if more than 50 percent of total business revenue of the enterprise is derived from the services performed in Canada. In addition, services that are provided for 183 days or more in a 12-month period with respect to the same or connected project for customers who are residents of Canada also constitute a PE.
The treaty provides guidance for activities that will not cause the U.S company to rise to the level of a PE in Canada. The use of facilities used solely for the storage, display, or delivery of merchandise belonging to the U.S. company, such as renting space in a public warehouse, will not constitute a PE. A fixed place of business used solely for advertising or for the supply of information that is preparatory in character, for the U.S. company, does not result a PE. Carrying on business through a broker, commission agent or other agent of independent status, provided that they are acting in the ordinary course of their business, also does not cause a PE.
A U.S company carrying on business in Canada is required to file a treaty-based Canadian corporate income tax return, even if the activities are protected under the treaty. This informational return discloses the activities protected under the treaty. This return is due six months after year-end and the Canada Revenue Agency may impose late filing penalties.
Recently, an increase in notices have been sent by the Canada Revenue Agency to U.S. taxpayers requesting tax returns, even in cases where taxpayers have engaged in minimal activities in Canada. Accordingly, it appears that the Canada Revenue Agency is paying closer attention to U.S. companies doing business in Canada.