Presenter: Glen MacMillan, CPA Tax Partner, Adams & Miles LLP December 9, 2015 1
Canadian business income of a US company is taxable in Canada only if the US company has a permanent establishment ( PE ) in Canada. If there is no PE, there is generally no need for complex cross border restructuring. See Article V of the tax treaty between US and Canada for meaning of PE. Article V extends the meaning of PE well beyond a traditional bricks and mortar office location. Treaty rules can deem a PE even where there is no physical location in Canada. Canadian provinces respect the treaty s PE rules; a US company will not have a provincial PE if it does not have a PE under the treaty. 2
Permanent establishment means a fixed place of business through which the business of a [US Company] is wholly or partly carried on. Tax Court of Canada has ruled that, in order for the business of a US company to be carried on at a place, a US company must have the place at its disposal. The following criteria help determine whether a US company has a place at its disposal: (i) the use or control (or legal right to exercise control) of the premises (ii) the degree to which the premises are identified with the US company (e.g., signage) (iii) the degree to which the US company bears expenses in respect of the premises or equipment used at the premises (iv) whether the US company makes management decisions respecting the premises (v) what contracts were concluded at the premises (vi) what products of the US company are kept at the premises (vii) whether the US company has any Canadian employees (viii) whether the US company bears any risk of the operation of the premises (ix) whether agents of the US company are subject to detailed instructions or comprehensive control (x) whether the US company requires its agents to have home offices and stipulates what the home office must contain (xi) whether the US company requires its agents to meet with clients at their premises and client meetings are, in fact, held there, and (xii) whether officers, directors, or employees of the US company visit or have regular access to the premises The above criteria must be examined in totality. No one test is determinative. 3
The term permanent establishment shall include especially: (a) a place of management (b) a branch (c) an office (d) a factory (e) a workshop; and (f) a mine, an oil or gas well, a quarry or any other place of extraction of natural resources 4
A building site or construction or installation project constitutes a permanent establishment if, but only if, it lasts more than 12 months. The term installation project is not restricted to construction projects. A computer software project may constitute an installation project even if other services are provided (such as training), provided that installation is the primary and most important activity. 5
The use of an installation or drilling rig or ship in a Contracting State to explore for or exploit natural resources constitutes a permanent establishment if, but only if, such use is for more than three months in any twelve-month period. 6
A person acting in [Canada] on behalf of a [US company] - other than an agent of an independent status to whom paragraph 7 applies - shall be deemed to be a permanent establishment in [Canada] if such person has, and habitually exercises in [Canada], an authority to conclude contracts in the name of the [US company]. The authority to conclude contracts in Canada must be habitually exercised. A US company officer with signing authority may visit Canada without creating a PE as long as contracts are not concluded. Although concluding contracts in Canada must occur habitually, it is advisable that contracts never be concluded in Canada. 7
Beware the appearance of head office rubber stamping of contracts negotiated in Canada. Senior officers with unrestricted authority risk creating a PE even if they only negotiate contract terms in Canada. Is anyone at head office going to overrule, change or challenge terms of a contract negotiated by the president? Head office contract approval policies should be documented and followed, head office staff should perform credit checks on new customers, review billing and payment terms, etc. 8
Notwithstanding the provisions of paragraphs 1, 2, 5 and 9, the term permanent establishment shall be deemed not to include a fixed place of business used solely for, or a person referred to in paragraph 5 engaged solely in, one or more of the following activities: (a) the use of facilities for the purpose of storage, display or delivery of goods or merchandise belonging to the resident; (b) the maintenance of a stock of goods or merchandise belonging to the resident for the purpose of storage, display or delivery; (c) the maintenance of a stock of goods or merchandise belonging to the resident for the purpose of processing by another person; (d) the purchase of goods or merchandise, or the collection of information, for the resident; and (e) advertising, the supply of information, scientific research or similar activities which have a preparatory or auxiliary character, for the resident. 9
US company does not have a PE in Canada if it uses a public warehouse only for the storage, display or delivery of goods. The conditions must be strictly met; for example, if a US company stores spare parts at a Canadian warehouse and uses those parts to perform maintenance on customers' equipment, the US company is probably not protected by the warehouse exemption. Does the risk of having a PE increase if a warehouse is owned by the US company rather than rented from a third party? Many practitioners feel the risk of PE does increase, presumably because the warehouse may then be viewed as a fixed business location at the disposal of the US company for any purpose. 10
A [US company] shall not be deemed to have a permanent establishment in [Canada] merely because such [US company] carries on business in [Canada] through a broker, general commission agent or any other agent of an independent status, provided that such persons are acting in the ordinary course of their business. This exemption allows for the concluding of contracts in Canada by bona fide independent sales agents without creating a PE of the US company. 11
The fact that a [US company] controls or is controlled by a [Canadian company] or by a company which carries on business in [Canada] (whether through a permanent establishment or otherwise), shall not constitute either company a permanent establishment of the other. A Canadian subsidiary of a US parent will not, by itself, give rise to a PE of the US company. However, if a Canadian sales subsidiary does not operate independently of its US parent, the sales activities of the Canadian subsidiary could create a PE of the US company if the Canadian company is considered a dependant agent concluding contracts in Canada on behalf of the US company. 12
Polling question 1 13
Subject to paragraph 3, where a [US company] provides services in [Canada], if [US company] is found not to have a permanent establishment in [Canada] by virtue of the preceding paragraphs of this Article, [US company] shall be deemed to provide those services through a permanent establishment in [Canada] if and only if: (a) Those services are performed in [Canada] by an individual who is present in [Canada] for a period or periods aggregating 183 days or more in any twelvemonth period, and, during that period or periods, more than 50 percent of the gross active business revenues of the [US company] consists of income derived from the services performed in [Canada] by that individual; or (b) The services are provided in [Canada] for an aggregate of 183 days or more in any twelve-month period with respect to the same or connected project for customers who are either residents of [Canada] or who maintain a permanent establishment in [Canada] and the services are provided in respect of that permanent establishment. 14
PE is deemed to exist for cross-border service providers satisfying one of two tests. Under the first test, a PE arises if services are provided by an individual present in Canada for at least 183 days in any 12 month period and more than half of the enterprise s business revenue for the year is derived from those Canadian services. This test targets independent contractors who spend more than half their time in Canada and earn more half their income from Canadian clients. 15
Under the second test, a PE arises if: (a) services are provided in Canada for at least 183 days in any 12 month period; and (b) the services are provided with respect to the same or a connected project. This test targets US businesses contracts on a long-term basis. servicing Canadian 183 days can be met by one worker or any combination of workers Each day counts only once regardless of number of workers in Canada on that day. More than 183 workers in Canada on the same day no PE. One worker in Canada for more than 183 days deemed PE. 16
Services provided remotely from the US (or anywhere outside Canada) by telephone, computer, etc. are not relevant. Number of days counted in test # 1 includes all days a US individual is present in Canada (work days, weekends, holidays, etc.) Number of days counted in test #2 includes only days on which services are provided in Canada by workers of the US company. 17
These deeming rules are intended to tax revenue in the new information services based economy where physical office locations no longer exist. Some also see the rule to be in response to the Dudney case that CRA lost. Mr. Dudney was a US resident who spent 300 days in Canada in 1994 and another 40 days in 1995 performing services as an independent contractor for a single Canadian client. He worked entirely at his client s Canadian office location CRA tried to argue (unsuccessfully) that the client s office was Mr. Dudney s PE. Cross border service providers such as Mr. Dudney will now automatically have a PE in the other country. 18
Canadian employees should not be reimbursed by US company for any expenses related to a home office. Instead, estimate out of pocket home office expenses (typically not material anyways) and provide additional remuneration to cover these costs. Ensure employee does not try to claim home office expenses on personal tax return. Caution HR department about the risks of signing form T2200 Declaration of Conditions of Employment. T2200 includes a statement that the employer requires the employee to have a home office. T2200 is relied on by CRA to support reassessments that the employee s home office is the US employer s PE. Difficult to refute CRA s position if CRA has a T2200 signed by the US company. 19
Ensure a detailed daily log of location worked is maintained by all cross border workers. CRA auditors have become increasingly focused on the number of days a worker is present in Canada. New PE tests based on days present in Canada provide CRA auditors with numerical tests that they seem to be more comfortable with than many of the older subjective PE factors. 20
US companies providing services in Canada should ensure all invoices clearly identify the number of US work days and Canadian work days. CRA will take the position that all work days are Canadian unless documentation exists to show otherwise. 21
Polling question 2 22
All income and expenses reported on US return with no amounts allocable to Canada and no need to calculate foreign tax credits. A treaty based tax return must be filed within six months after year-end; usually a fairly straightforward return. $2,500 failure to file penalty. Canada does not grant tax return extensions. Possible GST/HST and other provincial sales tax registrations need to be considered since treaty PE rules do not apply to sales tax nexus tests. Canadian employer payroll compliance needs addressed if US employees are working in Canada. to be Regulation 105 backup withholding of 15% from payments for services rendered in Canada. 23
LLC issue: CRA s position is that an LLC is not itself directly entitled to treaty benefits because an LLC is not subject to tax in US. Only persons subject to tax in US may benefit from the treaty and claim exemption from Canadian tax under the PE provision of the treaty. S corporations are recognized by CRA as US taxpayers. Difficult to reconcile CRA s differing positions on LLC s and S corporations. CRA may be less concerned with S corporations because non-us persons cannot be S corporation shareholders. 24
LLC issue: Is it possible to have a PE and not have a PE in Canada at the same time? Yes, if the entity is an LLC. For example, if a US LLC owned 50/50 by a US person and a non-us person carries on business in Canada, the LLC may claim PE exemption on only that portion of earnings attributable to the US member. The LLC would be liable for Canadian corporate tax on the portion of its earnings attributable to the non-us member. 25
If a taxable PE exists, one must then decide between: Reporting Canadian earnings annually in US and optimizing foreign tax credit, or Leaving the earnings in Canada and deferring US tax until earnings are repatriated to US. Often a tendency to assume that maximizing foreign tax credit flow to the US tax return is the best objective but this is not always true. It can be advantageous to avoid flow-through of the Canadian PE earnings and tax to the US tax return. If the US company is a C corporation that can claim indirect foreign tax credits, US company may be indifferent to branch versus subsidiary analysis. 26
Advantageous if: US parent wants to repatriate Canadian profits on an annual basis. Canadian business has been started from scratch by the US company and there is no acquisition debt or purchase price of an existing Canadian business. Canadian business does not require substantial ongoing cash investment to facilitate growth. Disadvantage: Immediate taxation of Canadian earnings at US tax rates which are generally higher than the Canadian corporate rates. 27
When advantageous: US company acquires an existing Canadian business. Faster recovery of the parent s acquisition cost and/or repayment of acquisition debt by using the Canadian earnings taxed at only 26.5% (in Ontario). Also advantageous if Canadian business requires reinvestment of earnings into the business to finance growth, asset acquisitions, etc. Disadvantages: US income tax and NIIT will be payable in future when the Canadian earnings are repatriated to the US parent as dividends. Loss of foreign tax credit flow through of Canadian income tax. 28
Simple to implement. Easy to start up and shut down and generally recommended in early stages of expansion. Losses flow through to parent as well as foreign earnings and foreign taxes. Eligible for branch profits tax exemption on the first $500,000 of branch profits. 29
Disadvantage: CRA auditors seem to struggle with understanding the concept of a head office allocation of costs charged to the branch LLC issue: Treaty reduced rate of branch tax of 5% is only available on portion of LLC s branch earnings that are allocable to US corporate members (i.e., S or C corp. members); US individuals and non-us members pay 25% branch tax. 30
ULC is treated as a corporation for Canadian purposes, disregarded for US purposes. As a Canadian corporation, some compliance is simplified; e.g. no requirement to post security bond for GST/HST. No 15% backup withholding on payments to ULC for services rendered in Canada. Watch for 15% withholding on payments by ULC to US company if ULC subcontracts the Canadian work to US company. 31
Additional annual costs to maintain. Foreign reporting of related party transactions may arise. Some payments to parent may not be eligible for treaty reduced rates; such as interest, royalties and management fees. Dividend payments require a legally cumbersome two step earnings capitalization transaction in order to access 5% treaty rate. Withholding tax on dividends requires additional compliance with CRA. 32
LLC issue: LLC parent of ULC is not entitled to the 5% reduced rate of withholding tax on dividends. Domestic rate of 25% applies to dividends paid by ULC to LLC. 33
Set up a Canadian controlled foreign corporation ( CFC ). Same Canadian income tax rates as a branch and ULC. As a CFC, US tax is deferred until dividends are paid to US parent. Ensure the 3.8% NIIT on dividends from CFC is factored into the after-tax analysis if a CFC is being considered. 34
Canadian CFC may be recommended when a Canadian target company is being acquired. Canadian CFC acquires target stock and repays the purchase debt with tax-free dividends from target. Dividends between target and CFC are not subject to Canadian or US tax. Purchase debt repayment is accelerated because the is no US tax on target s earnings. 35
Withholding tax rate on dividends is based on US residency status of LLC s members. Dividends paid to LLC subject to withholding tax as follows: 5% US corporate members, 15% US individual members, 25% all others. Example: LLC owned one-half by US corporation, 25% by US individual, 25% by UK company. Withholding tax rate on dividends = 12.5%. 36
Currently, a US employer that sends workers to Canada is supposed to register as an employer with CRA and remit employee withholdings to CRA. There is no de minimus exempt payroll amount allowing an employer to self-determine if exemption applies. Payroll withholding requires worker to obtain a tax ID number and file a Canadian return to recover income tax withheld even though in most cases the worker is exempt from Canadian income tax on employment income under the treaty (e.g., in Canada less than 183 days and no employer PE, less than $10,000 gross wages earned in Canada, etc.) Current process requires employer to apply for an employee waiver (a cumbersome and confusing process that many have regretted getting caught up in). In spite of all this compliance, there is no net tax to Canada. 37
A new waiver process is supposed to become available starting in 2016 that allows a US employer with no PE in Canada to apply for certification as a qualifying non-resident employer. Certification allows the employer to self-determine exemption of all qualified non-resident employees from Canadian payroll withholdings. Employee must not be present in Canada for more than 90 days in any 12 month period. Certifications are to be valid for up to two years. 38
New form, Non-resident Employer Certification is not yet on CRA s website. 2016 is three weeks away and CRA has still not released the application form. Is this delay an indication that CRA s history of cumbersome administration of its waiver program will continue or an indication CRA wants to get it right this time? There are no announced streamlined procedures for waivers for the company itself. 39
Polling question 3 40
Questions? 41