Chartered Professional Accountants of Canada 277 Wellington Street West Toronto ON CANADA M5V 3H2 T. 416 977.3222 F. 416 977.8585 www.cpacanada.ca Comptables professionnels agréés du Canada 277, rue Wellington Ouest Toronto (ON) CANADA M5V 3H2 T. 416 977.3222 Téléc. 416 977.8585 www.cpacanada.ca September 25, 2014 Brian Ernewein General Director, Tax Policy Branch Finance Canada 140 O Connor Street, 17 th Floor, East Tower Ottawa, ON K1A 0G5 Dear Brian: Subject: Regulation 105 I am writing on behalf of American Chamber (Amcham) and CPA Canada concerning an issue that has been raised by our organization and many of its members over the years, and that is the compliance burden of withholding tax pursuant to Regulation 105 of the Income Tax Act. The attached submission is by Amcham. CPA Canada and several of its members were also contributors to this submission and we fully support the comments and recommendations made therein. The tax community has spoken with a common view for many years on the unnecessary burden imposed by this regulation. We believe that it is time that the government addressed the concerns, and we hope that the recommendations in the attached report will receive serious consideration. In addition to Finance I have copied senior officials at CRA who I am hopeful will be supportive of taking steps to reduce unnecessary administrative burden which is consistent with the CRA s Red Tape initiative. Yours very truly, Gabe Hayos Vice President, Taxation Cc: Andrew Marsland, Senior Assistant Deputy Minister, Finance Canada Alex Maclean, Director, Tax Legislation, Finance Canada Rick Stewart, Assistant Commissioner, CRA Ted Gallivan, Deputy Assistant Commissioner, CRA Mickey Sarazin, Director General, CRA
Required Withholding from Amounts Paid to Non-Residents Providing Services in Canada Simplification Executive Summary Canadian tax withholding requirements on payments to non-residents for services rendered in Canada pursuant to regulations 105 result in administrative and financial hardships to companies engaged in cross border business. Although the withholding can be avoided with an approved waiver, the waiver process is unreasonably complex and burdensome. If the payer fails to properly withhold the taxes, significant penalties can be imposed. These complexities, burdens and penalties hinder cross border business and harm the Canadian economy. The American Chamber of Commerce of Canada (AmCham Canada) recognizes that Canada Revenue Agency ( CRA ) needs a provision to ensure that taxes are properly obtained from nonresident persons doing business in Canada. However, AmCham Canada recommends simplified waiver procedures that provide relief to both the payer and non-resident payee for services in Canada, while also ensuring the proper collection of Canadian taxes. Recommended Simplified Waiver Procedures and Penalty Reduction: 1. Adopt a waiver procedure similar to the United States where withholding can be eliminated if the non-resident provides an information form to the payer and no advanced approval is required from the Internal Revenue Service ( IRS ). Example: In the USA a non-resident company can avoid the 30% US withholding tax on payments for services rendered in the US if the non-resident company provides the payer with a form W-8BEN-E claiming exemption from tax pursuant to the treaty. Similarly, a non-resident (and non-us citizen) individual can avoid US withholding taxes on payments for services rendered in the US, if the employee or independent contractor provides the withholding agent (payer) with a completed form 8233 claiming exemption from US federal income tax pursuant to the treaty. No advanced approval from the Internal Revenue Service is required. However, the payer must have no knowledge of ineligibility for the treaty relief. Example: In Canada a Canadian Non-resident can avoid the withholding tax under part XIII by using form NR301.
Recommendation: that a form system similar to the US forms W-8 BEN-E and 8233 as well as Canadian form NR301 be implemented for withholding under Regulation 105. 2. Remove the waiver and the withholding tax and replace it with a requirement to get a business number ( BN ) and provide a deposit or security similar to the GST. 3. Reduce the penalties for wash transactions similar to the GST ITC wash penalty. Currently the penalty for non-compliance with Regulations 105 for a payer (typically a Canadian company) is assessment of the full amount of the missed withholding plus penalties and interest. Given that the withholdings would often have been refundable to the non-resident this seems too high in consideration of the zero loss of tax revenue. We propose that a wash penalty replace this gross penalty. An example of a wash penalty can be found in the GST law and regulations. The concept is that when a transaction that would have been a wash is discovered there is a penalty of 4% of the wash amount. So for example if a Canadian company failed to remit withholding taxes on $100,000 of services rendered the penalty would be $600 ($15,000 X.04) plus interest as opposed to $15,000 ($100,000 X.15) plus penalties and interest. Background and Discussion Regulation 105 Regulation 105 of the Income Tax Act of Canada reads as follows: 105. (1) Every person paying to a non-resident person a fee, commission or other amount in respect of services rendered in Canada, of any nature whatever, shall deduct or withhold 15 per cent of such payment. There is also a waiver available to regulation 105 (R105) that mitigates the requirement to withhold. However, the waiver process requires a complex waiver application followed by a lengthy waiting period for CRA approval. Payments made before receiving the waiver are not exempt from the withholding. Consequently, many businesses do not apply for the waiver. In addition to regulation 105 there is a similar regulation number 102 instructing employers to withhold from non-residents who are in Canada. Regulation 102 is not specific to non-residents
but captures non-residents. There is also a waiver process for regulation 102. It is not the subject these recommendations but it does act in concert with regulation 105 in some circumstances illustrated below. Explanation of the issue The issue is complex. Non-residents that provide services to Canadians are frequently not liable for Canadian income tax, because the liability is overridden by a tax treaty. The clause in many treaties that overrides is the business profits clause. The services rendered in Canada that are subject to regulation 105 are frequently part of a business profit that is exempt from taxation in Canada per the applicable tax treaty. For example in the Canada US tax treaty paragraph Article VII 1. The business profits of a resident of a Contracting State shall be taxable only in that State unless the resident carries on business in the other Contracting State through a permanent establishment situated therein. If the resident carries on, or has carried on, business as aforesaid, the business profits of the resident may be taxed in the other State but only so much of them as is attributable to that permanent establishment. The liability for tax and the liability for withholding are two different concepts. The liability for tax under Part I of the Act covers non-resident businesses that have permanent establishments ( PE ) in Canada. By virtue of this connection to Canada, the non-residents are subject to Canadian income tax. Without a PE or Canadian employer, the liability is frequently eliminated by provisions of an income tax treaty as seen in the example article VII from the USA Canada treaty. The important concept is that liability to withhold is not necessarily a function of liability for tax. The liability to withhold exists under Regulations 105 even if there is no income tax liability for a non-resident providing service to Canadians. The result is that many non-residents that have no liability for tax under Part I or Part XIII or any other part of the Income Tax Act are liable for tax withholding under Regulation 105. This withheld tax is frequently fully refundable by the CRA after receiving a properly completed tax return. Although a waiver can avoid the withholding, the waiver process is long and not readily accessible to non-residents.
Why this is an issue AmCham Canada considers the withholding tax a barrier to trade. The liability for withholding under Regulations 105 rests with the payer (most frequently a Canadian company CANCO ) not with the non-resident service provider (an entity or employee). This has some consequences. The examples that follow are based on actual business experiences. 1) The CANCO can be uninformed and end up with a liability that is detrimental to their business. The uninformed CANCO can incorrectly pay the full amount without withholding the regulation 105 amounts from the NRCO or employee. The CANCO is then liable for the regulation 105 amounts even though they have already paid it to the non-resident. This liability seems unfair since the withholding may be fully refundable to the non-resident if the non-resident files a tax return. So the Canadian government is assessing a liability on an amount if the paperwork was done correctly would have been a Wash. Example 1: CANCO a Canadian resident corporation selects a supplier of consulting services for its IT department. The supplier is NRCO a non-resident. The NRCO sells $100,000 of consulting services mostly delivered remotely. The CANCO does not withhold 15% tax under Regulation 105. NRCO does the service and is paid $100,000. CRA audits and assesses CANCO for failure to remit and collects 15% from CANCO. The business result is that CANCO sees this as a penalty and changes business practice to refuse to do business with non-resident suppliers. As a result CANCO does not purchase the best available services for its business and suffers in the International market place. The reality is that any business that purchases from outside Canada is also just as likely to sell outside of Canada and the poor non-resident supply experience makes it harder to be a competitive vendor in an international market. 2) If the CANCO is informed and does withhold the regulation 105 amounts, the non-resident service provider can fail to recover taxes withheld and end up with a reluctance to do business with Canadians. The non-resident will have a lower understanding of the tax rules in Canada
than a resident and can incorrectly view the withholding as non-refundable. They then fail to apply for a refund and instead incorrectly attribute Canada as a higher cost place to do business. This higher cost can compel them not to do business with Canadians. Example 2: CANCO a Canadian resident corporation selects a supplier of consulting services for its IT department. The supplier is NRCO; a non-resident. NRCO sells $100,000 of consulting services mostly delivered remotely. The CANCO does withhold 15% tax under Regulation 105. NRCO does the service and is paid $85,000. NRCO does not understand why they were short paid and refuses to do further business with CANCO. The business result is that NRCO sees this as a penalty and changes business practice to refuse to do business with Canadian customers. As a result the door is closed to NRCO expanding its business to Canada and opening a branch that would pay Canadian income taxes and generating employment in Canada. Similar to Example 1, this also restricts the access of CANCO and other Canadian businesses to the specialized services offered by NRCO going forward. Example 3 USCO is a US based international company that contracts with USSUBCONTRACTOR, an unrelated consulting company to provide management consulting services for USCO s international operations. USSUBCONTRACTOR sends employees around the world to provide the consulting services. Ten employees of USSUBCONTRACTOR travel to Canada for 30 days to provide consulting services to CANSUBCO, a wholly owned subsidiary of USCO. USCO charges CANSUBCO a portion of the fee paid to USSUBCONTRACTOR through a head office charge. Subsequent to a CRA examination of CANSUBCO s head office expense allocation, CRA assesses CANSUBCO regulation 105 withholding on the payment to USCO for the Canadian consulting services plus a penalty. CRA also charges USSUBCONTRACTOR regulation 102 withholding on the compensation paid to the ten employees of USSUBCONTRACTOR. Since all of the assessed taxes would likely qualify for treaty relief pursuant to articles VII and XV, the assessments, penalties and administrative complexities could easily be
avoided with a simple exemption system. Instead, the assessments, penalties and administrative complexities hinder international business. 3) Since the withholding is not the final tax, many foreign governments (including the United States) will not allow a foreign tax credit for the withholding tax. The tax may not be creditable until a return is filed and the proper tax paid. Recommended Simplified Waiver Procedures and Penalty Reduction: The recommended simplified waiver procedures and penalty reduction is listed above in the executive summary. Below is a more detailed discussion of the simplified procedures used in the United States, which if adopted in a similar fashion would relieve most of the barriers to trade inherent in the reg. 105 provisions. Generally a payer of fixed, determinable or periodic income from US sources must withhold 30% tax if paid to a foreign individual ( non-resident alien ) or other foreign entity. If the payment is for remuneration for services rendered in the US, the withholding is not the final tax. Rather, the US source income must be reported on a US tax return as income effectively connected with the conduct of a US trade or business. If eligible, the foreign person can claim the benefits of a treaty to exempt the income from taxation. The withholding can be avoided as discussed below. Also the employer of a non-resident alien individual, who performs services in the US, is required to withhold federal income taxes on the US source compensation income at graduated rates. The employee is then required to file an income tax return and, if eligible, claim exemption from tax pursuant to the treaty. The withholding can be avoided as discussed below. Form W-8BEN-E 1 - This form can be filed by a foreign entity, who receives compensation income for services rendered in the US. The form is filed with the 1 Previously, the entity filed form W-8BEN, but now due to FATCA the form is split in two with entities required to file form W-8BEN-E after 2014.
withholding agent (i.e. generally the payer of the compensation). The form is not filed with the IRS. A withholding agent or payer of the income may rely on a properly completed Form W-8BEN-E to treat a payment associated with the Form W-8BEN-E as a payment to a foreign person who beneficially owns the amounts paid. If applicable, the withholding agent may rely on the Form W-8BEN-E to apply a reduced rate of, or exemption from, withholding at source. The withholding agent is responsible for ensuring that all information relating to the type of income for which Form W-8BEN-E is submitted is complete and appears to be accurate. The agent may rely on the information and certifications provided on the form (including the status of the beneficial owner as an individual, corporation, etc.) unless the agent has actual knowledge or reason to know that the information is unreliable or incorrect. The agent has reason to know that the information is unreliable or incorrect if the agent has knowledge of relevant facts or statements contained in the withholding certificate or other documentation that would cause a reasonably prudent person in the position of the withholding agent to question the claims made. Form 8233 this form can be used by a non-resident alien individual who either provides services in the US in an independent capacity or in a dependent capacity (i.e. an employee) and is eligible to claim exemption from tax pursuant to an income tax treaty. The individual provides the completed form to the withholding agent. Within 5 days of acceptance by the withholding agent, the withholding agent forwards a copy to the IRS. The exemption from withholding is effective for payments made retroactive to the date of the first payment covered by Form 8233, even though the withholding agent must wait at least 10 days after submitting the form to the IRS to see whether the IRS has any objections. A withholding agent cannot accept form 8233 if either of the following applies: o The agent knows or has reason to know that any of the facts or statements on Form 8233 may be false, or o The agent knows or has reason to know, that the non-resident alien s eligibility for the exemption from withholding cannot be readily determined.
The US procedures simplify the waiver process, by putting the burden on the payer to collect appropriate information from the non-resident service provider and allow the payer to eliminate withholding as long as the payer is not aware of any false information being provided. This process provides a level of assurance of the validity of the tax exemption, while avoiding the complexities of advanced tax authority approval. Furthermore CRA already has a simplified waiver type process in place for Part XIII tax. A nonresident taxpayer submits a form NR301 to the Canadian Resident payer. The payer does not submit the form to CRA. Our recommendation could utilize this existing waiver process and expand it or duplicate it to cover Regulation 105 withholdings. Additional discussion of Regulation 102 Regulation 102 works very similarly to regulation 105 but applies to employees. Regulation 102 also has a waiver process. Regulation 102 infractions can happen at the same time as regulation 105 infractions. This is because a non-resident service provider that provides services subject to regulation 105 may use non-resident employees that are temporarily in Canada. These temporary employees can be subject to regulation 102. Here is an expanded example similar to example 2 above that illustrates the trap that can happen to the non-resident service provider Example A: CANCO a Canadian resident corporation selects a supplier of consulting services for its IT department. The supplier is NRCO; a non-resident. NRCO sells $100,000 of consulting services mostly delivered remotely. NRCO pays one of its employees $50,000 related to services physically performed in Canada. NRCO does not withhold regulation 102 amounts from the employee s salary. The CANCO does withhold 15% tax under Regulation 105. NRCO does the service and is paid $85,000. NRCO does not understand why they were short paid and refuses to do further business with CANCO. CRA examines the transaction and assesses NRCO Regulation 102 withholding and penalties for failing to withhold on the compensation paid to the NRCO employee. The business result is that NRCO sees this as a penalty and changes business practice to refuse to do business with Canadian customers. As a result the door is closed to NRCO expanding its business to Canada and opening a branch that would pay Canadian income taxes and generating employment in Canada. Similar to Example 1, this also restricts the access of
CANCO and other Canadian businesses to the specialized services offered by NRCO going forward.