Generally, Canadian corporation or a Self-Employed Person engaged in US Trade or Business will owe US tax only if it has permanent establishment in the United States.
Determining US tax treatment is a two step approach.
Step 1. Determine if Canadian corporation or a Self-Employed Person is engaged in US Trade and Business (“USTB”) and has Effectively Connected Income (“ECI”) with the United States.
Unfortunately, the term “trade or business” is not defined in the US Internal Revenue Code. Under court cases to be considered trade or business activities should be considerable, continuous and regular. Examination of facts in each case is necessary. Consider the following:
• Whether profit-generating activities are physically conducted in the United States.
• Level of administrative activities in the United States. Usually ministerial activities (i.e. recordkeeping, payroll function, receiving correspondence) will not give rise to USTB.
• Purchase and/or Sale of Goods. Purchase of goods in the United States does not constitute USTB. If Canadian company sells goods in the United States it might be considered to be engaged in USTB considering the extent of profit generating activities conducted in the United States.
• Activities of Agents. As a general principle engaging independent agents does not constitute USTB. However, activities of dependent agents will likely give rise to USTB.
Under US tax laws foreign corporation and non-residents with USTB is subject to US net basis income tax. If Canadian corporation or a Self-Employed Person has USTB he can seek treaty protection under Canada – US Tax Treaty and avoid US tax liability. To claim treaty protection Canadian corporation or a Self-Employed Person should not have Permanent Establishment in the United States. Permanent Establishment is covered by Article V of the Canada – US Tax Treaty.
Determination of Permanent Establishment is done in Step 2.
Permanent Establishment includes:
• Place of management
• Branch or office
• Factory or workshop
• Mine, oil or gas well or other place of extraction of natural resources.
• Management or employees in with authority to conclude contracts in the name of Canadian company.
• Individual spends in the United States 183 days or more in any twelve-month period and during that period more than 50% of gross active business revenue of the enterprise consists of revenue derived from the services performed in the United States. NEW!
• Services provided in the United States for 183 days or more in any twelve-month period in respect to the same or connected projects for US resident or another foreign company with permanent establishment in the United States. NEW!
Permanent Establishment excludes:
• Facility for storage, display and delivery of goods or merchandise
• Maintenance of stock for storage, display and delivery of goods or merchandise
• Maintenance of stock of goods or merchandise for purpose of processing by another person
• Purchase of goods or merchandise for Canadian
• Advertising, supply of information, scientific research which have preparatory character for Canadian.
• Carrying business through an independent broker or an agent.
FILING REQUIREMENTS – CANADIAN CORPORATION IN THE UNITED STATES
If Canadian corporation has USTB and has no permanent establishment in the United States it has no US tax liability under treaty protection. However, Canadian corporation has to file certain tax returns with Internal Revenue Service in order to notify them of tax treaty position.
Failure to file these returns will result in loosing tax treaty protection and penalties up to US $10,000!
Tax returns to be filed:
In the United States:
1. 1120F – US Income tax return of a Foreign Corporation. Filed as Protective Return.
2. Form 8833 filed with IRS to disclose tax treaty position.
In Canada:
1. T2 – Canadian Corporate return
If Canadian corporation has USTB and permanent establishment in the United States it is liable for US Federal and state income taxes.
Tax returns to be filed:
In the United States:
1. 1120F – US Income tax return of a Foreign Corporation. Return includes income and expenses related to US operations on “proportionate basis”.
2. Form 8833 filed with IRS to disclose tax treaty position.
3. Form 5472, Information Return for 25% Foreign Owned Corporation and Related Party Transactions – to disclose dealings with the Canadian shareholder and/or related party. (Failure to file results in penalty US $10,000 per form!)
In Canada:
1. T2 – Canadian Corporate return. Foreign taxes paid in US will be claimed.
FILING REQUIREMENTS – CANADIAN SELF-EMPLOYED PERSON IN THE UNITED STATES
If Canadian self-employed person has USTB and has no permanent establishment in the United States he has no US tax liability under treaty protection. However, that person has to file certain tax returns with Internal Revenue Service in order to notify them of tax treaty position.
Failure to file these returns will result in loosing tax treaty protection and penalties up to US $10,000!
Tax returns to be filed:
In the United States:
1. 1040NR – US Non Resident Alien Income Tax Return. Filed as Protective Return.
2. Form 8833 filed with IRS to disclose tax treaty position.
3. Form 8840 – Closer Connection Exemption. To avoid taxation of world income in the United States.
4. Form 8233 – To prevent withholdings of income tax at source based on the tax treaty
In Canada:
1. T1 – Individual Income Tax Return with world income
2. CPT56 – to prevent paying Social Security and Medicare Taxes in the United States
If Canadian self-employed person has USTB and permanent establishment in the United States he is liable for US Federal and state income taxes.
Tax returns to be filed:
In the United States:
1. 1040NR – US Non Resident Alien Income Tax Return. Return includes income and expenses related to US operations on “proportionate basis”.
In Canada:
1. T1 – Individual Income Tax Return with world income. Foreign taxes paid in US will be claimed.
2. CPT56 – to prevent paying Social Security and Medicare Taxes in the United States
Information provided is very high level. Each case is different and should be carefully assessed. We discussed Federal level of taxation in the United States. State taxation rules are different in each state. Some states like California do not follow Federal Canada – US tax treaty. You may have a situation where company is protected from US federal tax liability under the treaty and is subject to a state tax. Also, US taxation of corporations significantly differs from Canadian taxation.
