Written by Brent Robinson | Davis Martindale
For many US companies, it’s a natural progression to the Canadian market given the proximity and relative ease of entering the Canada marketplace. However, understandably businesses tend to focus on operations first, and dealing with the tax repercussions comes later. Often foreign companies have already begun operating in Canada either directly from their home country, through a branch in Canada, or through a newly incorporated entity in Canada without putting much thought into the tax implications. This article will focus primarily on the Goods and Services Tax and Harmonized Sales Tax (“GST/HST”), Regulation 105 withholding tax, and income taxes for non-resident corporations and their Canadian branches. While many of the examples are specific to US businesses, the comments generally apply to all foreign businesses.
Much like the Value Added Tax or VAT framework in the EU and Australia, GST/HST is essentially a consumption tax on the consumer. It differs fundamentally from sales and use taxes in the US, especially at the business to business level.
A business must collect, and remit to the Canada Revenue Agency (“CRA”), GST/HST on the sale of their products or services, and is given credit through an input tax credit (“ITC”) for the GST/HST the business itself pays on materials and supplies used or consumed in the business. Where sales occur down a chain of businesses, the framework ensures that there isn’t a multiplication of tax, such that it’s just the end consumer that eventually bears the GST/HST cost.
When foreign companies sell products or provide services in Canada, a fact based analysis is required to determine whether they will be required to register for GST/HST. The CRA provides detailed commentary and examples to assist with this determination and therefore it has been left out of this article for brevity. It is important to note that when a company is required to register for GST/HST it does not necessarily mean that they will be subject to income tax in Canada.
The federal government recently enacted a new GST/HST regime on digital products and services which became effective July 1, 2021. Under these rules, certain foreign businesses that were not historically required to register for and collect GST/HST are now required do to so, under a separate, simplified regime. Basically, they are required to charge GST/HST on their digital products and services provided to customers that are not themselves registered for GST/HST. Unlike the general GST/HST regime, these foreign businesses are not be eligible to claim ITCs. As the most common example of the impact of these new rules, foreign businesses that provide streaming services to residential consumers are now required to charge GST/HST.
Regulation 105 of the Income Tax Regulations (the “Regulations”) requires the payer to deduct and remit to CRA 15% of the gross amount of any fees, commissions, or other amounts paid to any non-resident person providing services in Canada. Unlike some other taxes on non-residents, this is not the non-resident service provider’s final tax liability in regard to their Canadian services income. It is a withholding tax that is applied against their actual income tax liability when they file a Canadian tax return. This withholding requirement is not predicated on whether the non-resident is carrying on a business in Canada, or whether their activity in Canada is treaty exempt. It is required for all payments.
It is important to note that the person paying for the services, whether they are a Canadian resident or not, is liable for this withholding tax. Consequently, failure to withhold and remit can result in the payer being assessed the tax, along with related penalties and interest. Since it is a withholding tax, the payer cannot recover it from CRA. The payer would have to recover it from the non-resident service provider as an overpayment on their contract.
Fortunately, there is a waiver process to alleviate the cash flow burden caused by the withholdings where it can be demonstrated that the non-resident would not otherwise be subject to Canadian income tax. The non-resident service provider can apply for a Regulation 105 waiver on a contract-by-contract basis, subject to certain exceptions, in order to have the requirement for the payer to withhold 15% waived entirely (also known as a general waiver).
For greater certainty, this waiver is not available to a non-resident with a permanent establishment in Canada and thus subject to income tax. For example, if a US person is providing construction services in Canada, and the contract relates to a construction project that has exceeded the 12 month threshold under the Canada-US Tax Treaty such that the US person has a permanent establishment in Canada for that particular project, then the general Regulation 105 waiver is not applicable for that contract. In these circumstances, a second type of Regulation 105 waiver, called an income and expense waiver, is available. This type of waiver allows the non-resident service provider to estimate the amount of profit they will earn related to that permanent establishment in Canada, with certain limitations on the allowable expenses. The withholding tax is then calculated as the applicable corporate tax rates applied to the profit estimate, as opposed to a flat 15%.
Regulation 105 can’t be circumvented by subcontracting to Canadian residents. Using the construction project example again, assume a non-resident has engaged Canadian subcontractors to execute the contract, and the non-resident doesn’t expect to ever set foot in Canada. The subcontractors would be considered to be performing services in Canada on behalf of the non-resident, and therefore any payments made from the customer to the non-resident will still be subject to Regulation 105. If the non-resident were to engage a non-resident subcontractor, they would introduce a second tier of Regulation 105 withholdings on the payments from the non-resident to their non-resident subcontractor.
Where a project involves both work in and outside of Canada, it’s prudent where possible to bifurcate the invoicing, pricing, and timing in order to isolate areas of the project where Regulation 105 applies. Otherwise, the entire project could be subject to Regulation 105.As much as possible, this division of pricing and invoicing should also be done when a project involves a combination of services in Canada and other items not subject to Regulation 105 withholding, such as the supply of goods used in a supply and install project, or the service provider’s travel expenses to get to Canada.
In all instances, the facts of each business arrangement in Canada involving a non-resident should be reviewed in detail to determine whether a Regulation 105 withholding is required and whether the eligibility criteria is met for a waiver. Due to the long list of exceptions, it should never be assumed that a Regulation 105 waiver will be approved.
In the event a Regulation 105 waiver isn’t available, the non-resident can file a treaty-based income tax return (if eligible) subsequent to its fiscal year to claim a refund for the amounts withheld.
Lastly, don’t leave a waiver application to the last minute. It can often take the CRA 2 to 3 months or more to approve a waiver. Until a waiver is issued, the payer must withhold and remit 15% of the full amount paid.
Non-residents can face a variety of filing obligations in Canada based on their activities. Generally, the first step is determining whether a non-resident is carrying on a business in Canada for income tax purposes (which is different than that for GST/HST purposes). ‘Carrying on a business in Canada’ is not specifically defined under the Canadian Income Tax Act (the “Act”), and is instead guided by common law. The common law tests generally involve a factual analysis of the business activities, including property owned/rented such as an office or warehouse, location of employees, control exercised in Canada, bank accounts, location of negotiations etc.
There is an extended meaning of carrying on a business in Canada in Section 253 of the Act that does provide specific examples of activities that constitute carrying on a business in Canada and that override common law principles. The activities, subject to certain exceptions, are:
- produces, grows, mines, creates, manufactures, fabricates, improves, packs, preserves or constructs, in whole or in part, anything in Canada;
- solicits orders or offers anything for sale in Canada through an agent or servant; or
- disposes of Canadian resource property, timber resource property, or real or immovable property located in Canada.
It should be noted that carrying on a business in Canada is not the same as having a permanent establishment in Canada; the bar is quite a bit lower. Where it can be determined that a non-resident person is carrying on a business in Canada, they are required to file a simplified Canadian income tax return, referred to as a treaty-based return. In this filing, the non-resident reports certain metrics relating to their business in Canada, and, where treaty-exempt, discloses the basis for that exemption under the applicable articles of the applicable tax treaty with Canada.
Where a non-resident is carrying on a business in Canada, further analysis is needed to determine whether a permanent establishment exists. This determination relies on the applicable tax treaty provisions. Using the example from the Regulation 105 discussion above, if a US corporation is involved with a construction project in Canada, with a presence in Canada exceeding 12 months, that construction project will constitute a permanent establishment under the Canada-US tax treaty. A permanent establishment results in compliance obligations similar to that of a Canadian corporation filing in Canada, however the tax calculations differ. The non-resident will be subject to federal and provincial tax based on the location of the permanent establishment, and it will also be subject to Part XIV tax, known as branch tax. Branch tax is calculated on the taxable income of the permanent establishment, and is intended to emulate the withholding tax that would apply to dividends paid by a Canadian corporation to a non-resident shareholder. For example, the branch tax applicable to a US corporation would be 5%, which is the withholding tax rate on dividends paid to corporations under the Canada-US tax treaty. Under the Canada-US tax treaty, the first $500,000 of taxable income earned in Canada relating to the permanent establishment(s) is exempt from branch tax.
As you can see from this discussion, there are a number of nuances and complexities to consider when a non-resident does business in Canada. The advice of the appropriate tax specialist(s) should be sought in order to navigate the rules.