Who Gets My Tax Dollars? ppt

That means that no matter where the income is earned, if you are a resident of Canada, you are required to pay tax to the Canadian government on that income.. The first is a Part XIII wi

Who Gets My Tax Dollars?

A Tax Guide for US Professionals and Consultants Doing Business

Copyright © Kathie Ross 2010

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This ebook is licensed for your personal enjoyment only This ebook may not be re-sold or given away to other people If you would like to share this book with another person, please purchase an additional copy for each person If you're reading this book and did not purchase it, or it was not purchased for your use only, then please return to Smashwords.com and purchase your own copy Thank you for respecting the hard work of this

author

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Table of Contents

Chapter 1 Introduction

Chapter 2 Corporations with a Permanent Establishment in CanadaChapter 3 Corporations without a Permanent Establishment in CanadaChapter 4 Individuals with a Permanent Establishment in CanadaChapter 5 Individuals without a Permanent Establishment in CanadaChapter 6 Federal Goods and Services Tax And Provincial TaxesChapter 7 Use of Equipment in Canada

Chapter 8 Employees

Chapter 9 Subcontractors

Chapter 10 Using a Canadian Corporation

Resources- Forms and Guides

Resources - Glossary

Resources - Flow Chart Part II

Resources - Flow Chart Part III

Resources - CCA Classes

Resources - NAFTA Professional Categories

About the Author

* * * * *

Part I

Chapter 1 Introduction Canadian Tax

Canadian tax is based on residency Residents of Canada are subject to tax on their world wide income That means that no matter where the income is earned, if you are a resident of Canada, you are required to pay tax to the Canadian government on that income A person can be a factual resident of Canada or a deemed resident depending on residential ties and treaty tie-breaker rules (more on the treaty later)

Non-residents, on the other hand, are subject to tax only on Canadian source income This will normally fall into two types of tax The first is a Part XIII withholding tax on passive investments that are sourced to

Canada and the second is Part I tax on employment income in Canada, income from carrying on a business in Canada and the sale of taxable Canadian property

Part XIII tax is fairly straight forward It is simply a withholding of tax on the gross amount paid to the non-resident Part XIII only applies to passive income Passive income in Canada is the same as in the US – dividends, rent, royalties, etc All you need to remember is that if it is passive income you will have withholding at source and no Canadian income tax return to file

Part I tax on the other hand may have withholding at source (unless a waiver has been requested and received from the CRA) and an income tax return must be filed Employees working in Canada are subject to withholding and filing of a tax return regardless of whether the employer is Canadian or not A business being carried on in Canada must also file a tax return What type of tax return will depend on how the business is being run – through a corporation or an individual If you sell taxable

Canadian property, you must file a Certificate of Compliance at the time of the sale as well as filing your income tax return

SINs, ITNs and BNs

In order to file your Canadian income tax returns you will need a tax

number An individual will have either a social insurance number (SIN) or

an Individual Tax Number (ITN) In addition to the ITN a business will also need a business number (BN) A corporation will only need a BN The BN

is a 9 digit number followed by “RC000#” starting with 0001 For GST purposes you will have a business number with the suffix “RT000#” and for payroll the suffix will be “RP000#” For instance, if you BN number is

123456789 you might have 3 numbers: tax (123456789RC0001), GST (123456789RT0001) and payroll (123456789RP0001) You can register for a business number over the phone or fill out an RC1 Request for a Business Number

The Canada-United States Income Tax Treaty

It sounds like you could end up paying tax two different places – and paying double the tax Without the treaty, that is exactly what could

happen One of the main purposes of the treaty is to eliminate double tax The treaty helps you to figure out where you should pay tax and where to claim the tax credits or ask for a refund

The treaty will never cause you to pay tax you would not otherwise have to pay If something is non-taxable it will not become taxable because of the treaty It will however determine which country will tax certain income It will also limit the amount of tax each country can withhold on passive income

The treaty is divided into 31 Articles each dealing with a specific purpose Article 1 of the treaty determines who able to take advantage of the treaty

It is pretty clear You must be a resident in either Canada or the US in order for the treaty to be applicable

The second article describes which taxes are covered In Canada, only those taxes under the Income Tax Act are applicable In the US, the taxes under the Internal Revenue Code are included Other US taxes that are included in the treaty only to the extent of eliminating double tax are estate taxes, holding company taxes and social security taxes

Article 4 of the treaty is an important article It describes where you will be considered a resident Without the treaty, both Canada and the US could consider you to be a resident It could be based on ties to the country or simply because of deeming rules The treaty has some tie breaker rules to determine where you will be resident In Canada if you are considered resident of the US by virtue of the treaty then you will be treated as a non-resident for purposes of the Act Of course, if you are a US citizen you will still be subject to tax on your world wide income in the US

The first determining factor for an individual is that you are resident where ever you are liable to tax because of your residence or citizenship, place

of management or place of incorporation or any other criteria similar in nature That sounds simple enough, it also sounds like it’s pretty easy to

be resident in both the US and Canada So we have the tie breaker rules

If you are resident in both countries, you will be considered to be resident where your have a permanent home available If that doesn’t break the tie, you look to your personal and economic relations If you still can’t make a determination, your habitual abode is the tie breaker After that, it will be based on your citizenship In the event that it is still a tie the Competent Authorities will negotiate to break the tie

For corporations, deciding on residence is much easier If the company is incorporated in Canada it is resident in Canada If the company is

incorporated in the US it is resident in the US A company that is not

incorporated in either of the countries will be resident where the mind and

management of the company are located If that location is in either

Canada or the US, then the company may be able to take advantage of treaty protection against double tax

The treaty also sets out rules on how double tax will be eliminated This can become very complicated when you are dealing with a resident of Canada who is a citizen of the US But for the most part the treaty simply directs that the country of residence will give a tax credit up to the amount

of tax that is permitted to be withheld or charged under the treaty

The treaty is treated differently in Canada and the US In Canada the legislation that enacts the treaty ensures that the treaty will override the Income Tax Act In the US treaties and other legislation are equal and can override each other So that means that whichever is enacted later in time

is the controlling legislation

LLCs and Other Hybrids

A hybrid is an entity that is considered differently by each country

Between Canada and the US there are a number of hybrid entities Most are due to the ‘tick the box’ rules in the US that allow an entity to elect their entity classification

In Canada, the courts have decided how an entity will be looked at for tax purposes So, you look at how the entity is structured in the laws of the state or country where it is established Then you look at the Canadian law

to decide how the entity should be taxed in Canada

In the US, a number of entities have the opportunity of electing a different tax classification than their structure An S Corp can elect to be taxed as a flow through as can an LLC Certain partnerships on the other hand can elect to be taxed as corporations

The newest protocol to the treaty includes some changes to the rules for LLCs and hybrids If you are operating your business through an LLC, it allows any income, profit or gain to be considered to be the income of the entity to whom it is flowed to if the tax treatment is the same as if it was directly received So, for example, if the income would be taxable only in the US if you earned it directly, it will also be taxable only in the US if earned in the LLC However, if the tax treatment is not the same there will

be no be treaty protection and you may be subject to double tax If you want to use and LLC, or if you have an LLC that is owned by both a US resident and a non-resident, you should talk to an accountant

knowledgeable in cross border tax for further advice

An S Corp is also a hybrid but the S Corp is specifically covered in the treaty A special election can be made with the Canadian competent

authority to have the S Corp income taxed as FAPI This will eliminate the timing issues but, again, the decision should not be made without further discussion with an accountant knowledgeable in cross border tax

The differences between the two countries can result in both intended and

unintended tax consequences If you are doing your own tax returns and not planning on getting expert advice, I would suggest you stick to having the same entity classification across the border.

Permanent Establishment

Each country has its own rules regarding what constitutes a permanent establishment or a PE The treaty also determines some rules for what will

or will not be a permanent establishment A PE is a fixed place of

business through which the business is wholly or partly carried on A fixed place of business may also be where no premises are available for the business but the enterprise has some space at its disposal

Canada has published guidelines on what it will consider to be a PE based

on three main factors There must be a place of business, the place of business must be fixed and the non-resident must be carrying on business wholly or partly in that place of business While it seems straight forward

on the surface, there are many factors that must be looked at to make a determination

The treaty offers some guidance to ensure that some business operations will be a PE and others that will not

Permanent establishments include a place of management, a branch, an office, a factory, a workshop and a mine or oil and gas well If you have one of these places, you have a PE A building or construction site will only be a PE if it lasts longer than 12 months The same holds true for the use of an installation or drilling rig or ship

If someone can conclude contracts on behalf of your company or business

in Canada then you will have a PE in Canada However, if that person is

an independent broker or agent and that is their business, you will not have a PE because of their efforts on your behalf

Some facilities can be set up in Canada without creating a PE Facilities used only for the storage or display of goods, or to store merchandise belonging to you but being used only for processing by someone else, or activities that are strictly preparatory or auxiliary in nature will not be

classified as a PE

The simple existence of a subsidiary or parent corporation will also not create a PE for the first corporation

There is an overriding rule in the new protocol that is effective as of

January 1, 2010 If services are provided by an individual, and that

individual is in Canada for 183 days or more, the business will have a PE

in Canada Or, if more than 50% of the revenue of the enterprise are from the service in Canada, you will be considered to have a PE in Canada Note that this rule does not require that the income be earned by an

individual, only that the individual be providing the services in Canada The treaty also stops you from spreading out the work between different people because if the work is done with respect to the same project and

the customers are resident or have a PE in Canada, then you will be considered to have a PE in Canada.

Example Linda Wilson

Linda is just starting her consulting business She received two contracts this year – one in the US and one in Canada She will receive $5,000 for her contract in the US and $10,000 for the contract in Canada She will only be in Canada three days to do consulting work Under the old rules, Linda would not have a PE in Canada However, because more than 50%

of her gross business income is related to work done in Canada, under the new rules Linda will have a PE in Canada and must allocate her income and expenses accordingly

Seminars and Lectures- are you an artist?

There are special rules for how much tax is paid by an artiste If you are providing lectures or seminars, you might have to determine whether you should be classified as a business consultant or an entertainer

If you are presenting at seminars or lecturing you may be considered an artiste or an entertainer as opposed to a business consultant This

classification results in a different tax treatment under the treaty so it is wise to know where you fit While you may not consider yourself an

entertainer, the CRA may determine that you are based on the services you are providing

Although the determination of whether or not you are an entertainer is made on a case-by-case basis, some of the things to think about are:1) Is the lecture/seminar being advertised to the general public

2) Is an entrance fee being charged

3) f it is a training session, is there an exam required for participants

4) Do the participants receive a certificate upon completion

5) Are there any pre-requisites for attendees

If you are considered to be an entertainer and have a permanent

establishment in Canada refer to Chapter 2 (corporations) or Chapter 4 (individuals)

If you are and entertainer and receive more than $15,000 Canadian in a calendar year (including reimbursement of expenses), you will be taxable

in Canada on that income regardless of whether or not you have a PE Again, you should use chapter 2 or chapter 4 as applicable

If you receive less than $15,000 Canadian in a calendar year including reimbursement of expenses and do not have a PE in Canada, your

income will be taxable only in the US Refer to chapter 3 (corporations) or

5 (individuals) for further information

Work Permits

Whether or not you need a work permit depends on the type of work you are doing

If you coming to Canada to do public speaking, you will not need a work permit Public speaking includes giving seminars or academic speakers at

a university or college If you are not doing public speaking you will need

to determine what category you fall into

As a business person you may be classified in four main categories:

- Business visitor

- Professional

- Intra-company transferee or

- Traders and investors

A business visitor includes carrying out activities relating to research, manufacture marketing, sales, after sales service and general service If you fall into this category you do not need a work permit to enter Canada.However, if you are providing services in one of the more than 60

professional occupations you will need to have a work permit However, you are not subject to Humans Resources Services Development Canada (HRSDC) confirmation That means you can apply for a work permit at the point of entry or an application can be made at a visa office before coming

to Canada You must have proof of citizenship, confirmation of the

contract and details of the position and educational qualifications

(including copies of degrees, diplomas, etc.)

The other two categories are employee categories (see that chapter for further information)

Paying Tax and filing tax returns

Part II of this book includes instructions on what you will have to file and when you will have to file it Part III includes information that may be

needed for all situations For an easy way to determine what chapters you need to read based on your specific situation, you can use the flowchart at the end of this document

Refer to the resources section at the end of this document to see what forms and guides you will need as well as further reading for this chapter.Return to Table of Contents

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Chapter 2 Corporations with a Permanent Establishment in Canada

Corporations that have a PE in Canada are required to pay taxes on

income earned in Canada under the treaty The business profits are to be calculated as though the business in the PE is a separate business from the remainder of the business in the US

When you get paid

You will be subject to a withholding amount under Regulation 105 of the Act Regulation 105 imposes a 15% withholding on the gross amount of the payment The withholding is required regardless of whether the payer

is a resident of Canada or a non-resident If a payment is made that is partly for work done in Canada and partly for work done in the US, a

reasonable allocation must be made If no allocation is made the whole amount will be subject to Canadian withholding

You will not be eligible for a reduction to the withholding amount based on treaty exemption as the treaty requires that this income is to be reported in Canada However, assuming you have expenses, you may be eligible for

a reduction based on the fact that your expenses may be claimed against the revenue to be reported In order to get a reduction to the withholding amount you must have received a waiver from the CRA You may apply for a waiver based on income and expenses That means that you will request a reduction in the withholding amount required based on your estimated net income rather than the gross income that is being paid If the waiver is granted, the payer will withhold 15% on the lesser amount

To apply for a request for a waiver you will need to fill out a form R105 and send it to the Tax Services Office nearest the location where your work is being done Waiver requests should be sent to CRA 30 days before the commencement of service or 30 days before the payment whichever is earlier

You may also need to make instalment payments to CRA based on your prior year’s taxable income (though you won’t have to worry about this your first year) If this is the case, you will receive a notice from the CRA that tells you the amount of the instalment required If the CRA has not made the calculation for you, reduce the tax instalments required by any Regulation 105 that has been withheld during the year in order to avoid double withholding

Example—Jones Consulting, Inc.

Michael Jones does business through his C Corporation, Jones

Consulting, Inc He has negotiated a contract to provide services in

Canada The contract is a one-year contract and he is renting an office in Toronto As soon as the contract has been signed Michael fills out an R105 He calculates the corporate income and expenses and provides copies of his incorporation documentation, the contract and estimated

expenses Michael knows he is likely to be granted a waiver as the net income earned in Canada will be significantly less than the gross fee he will receive Once Michael receives a confirmation from CRA that his waiver has been approved, he provides a copy of the waiver to the client

so that a lesser amount of withholding is necessary That means that Michael has additional cash in his pocket to pay expenses

Michael also uses the 1120-W to reduce the estimated tax owing to the IRS based on the expected foreign tax credit However, he must be

careful to calculate the expected foreign tax to be paid based on the

amount of Canadian tax that will be paid at year end – not on the amount withheld

Reporting Business Income

Canadian income tax rules do not vary significantly from the US income tax rules The capitalization of assets, personal expenses, business use of vehicle rules are very similar in nature But there are some specific

differences that you should be aware of when calculating your Canadian business income

First of all, remember to report your income and expenses in Canadian dollars You may use the average exchange rate for the year This will save you from calculating the exchange rate on all of your income and expenses on the dates earned and then re-calculating when the amount is paid

Revenue

Remember that you must report all revenue earned in Canada If the revenue to be received is as a result of a combination of work done both in the US and in Canada you must make a reasonable allocation of that income

The accrual method of income is required for taxes in Canada Income must be reported when it is earned, regardless of when it is received.Fringe benefits must be included in income earned in Canada if they relate

to the Canadian portion of the business—regardless of where those

benefits are received A free flight from Houston to Tahiti may be a taxable benefit in Canada if the reason for the flight was for work done in Canada

Expenses

Expenses are calculated for purpose of taxable income in Canada in generally the same manner as calculated for the IRS Expenses that are ordinary and necessary for the work being done in Canada can be

deducted

The allocation of personal versus business expenses are treated in the same manner as in the US The expense must have been laid out to earn

income in Canada in order to be deducted from revenue reported in

Canada

Whether or not something is an expense or capital (an expense can be written of in one year but capital written spread out over several years) is similar to the rules you are familiar with for US tax purposes Ask yourself the following two questions:

1 Does the expense result in a lasting benefit (i.e did you buy a computer that will last a couple of years or a flash drive that you expect to use for one year)

2 Does the expense maintain or increase the value of the equipment or property [i.e did you repair your hard drive (expense) or purchase an upgraded faster/better hard drive (capital)]

The rule for prepaid expenses is the same as the rule for US tax

purposes You cannot deduct an expense that is paid in advance It must

be deducted when it, or the underlying asset, is used

If you are planning to advertise your business, you should be aware that only certain types of advertising will be deductible in full on your Canadian income tax return Any advertising with a US broadcaster cannot be

deducted against Canadian income and advertising in a periodical could

be restricted to 50% or 80% depending on the type of periodical

Meals and entertainment expenses are deductible at 50% which is the same as the US tax adjustment required Club dues are not deductible if the main purpose of the club is dining, recreation or sporting Expenses paid to a golf course – even if they are paid for the restaurant are not deductible Any fees relating to the use of a yacht are not deductible.Some vehicle expenses, such as lease expenses are restricted for

passenger vehicles If you use your corporate vehicle for personal use as well as corporate use, you will have to calculate a stand-by charge taxable benefit for your personal income tax

Just as in the US, equipment used in Canada cannot be written off in the year it is purchased but must be allocated over a number of years In most cases, the Capital Cost (basis) of the property is calculated the same as you would for equipment in the US The amount of deduction that is

permitted each year is called Capital Cost Allowance or CCA CCA in most cases will be on a declining balance basis with a limitation of 50% in the first year of use When you are finished using your equipment in

Canada and it is sold or removed from use the rules become very different than US calculations These rules are outside the scope of this book

Books and Records

You must keep your books and records for tax purposes until two years after your corporation is dissolved If you keep records electronically, those records must be kept in “an electronically readable format” For

books and records pertaining directly to the income and expenses of the business in Canada, the records must be physically in Canada (including the electronic hard disk) unless you have received permission to keep those records outside of Canada To receive permission to keep the

records outside of Canada or permission to destroy records, write to the Tax Services Office nearest the location of your business

Example Brown Consulting, Inc.

Brown Consulting, Inc was completing a contract in Canada During the contract, travel was required and the cost for meals was $1,500 One-half

of the meals expense of $750 is not deductible for Canadian tax purposes

If Brown Consulting, Inc had received a reimbursement the meals

expenses, they would include the reimbursement in income and would be permitted to expense the total amount of meals The adjustment for non-deductible expenses is made on Schedule 1 of the T2 (see below)

Filing Canadian Tax Returns

The withholding and installment payments you make are not your final tax payable You must file Canadian tax returns in order to determine the actual amount owing to the CRA

The first thing to do before you file your Canadian Tax Return is to

calculate your Canadian income and expenses You should treat the income and expenses from Canada as a separate branch If you have expenses that apply to both Canada and the US, you will need to allocate those expenses

Once you have calculated your expenses you will need to file a Canadian Corporation Tax Return (T2) and all the appropriate schedules This return

is due six months after the fiscal year end of your corporation However,

be aware than any tax owing for the year is due two months after the fiscal year end

Fill out a Schedule 1 to report any adjustments from your financial

statements to taxable income (i.e those expenses that are not deductible Use Schedule 8 to calculate the CCA that is deductible

You must also fill out Schedule 50 to indicate shareholder information and Schedule 19 since the shareholders are non-resident Other schedules can be used as needed (use page 2 of the T2 as your guide to additional Schedules needed)

Line 800 is used to record the withholding amount on revenue that the payer(s) have made and line 840 is used to record any installment

payments you have made

There are also schedules to that you must fill out that capture general accounting information The Schedule 100 provides the balance sheet information and the Schedule 125 provides the income statement

information Make sure that the net income on your Schedule 125 agrees

with the net income per financial statements on your Schedule 1.

Provincial tax

You do not have to fill out a separate return to calculate most provincial tax amounts Although you will have a PE in a province, use schedule 5 to allocate income to the appropriate province

For Alberta, you must file an AT1 and appropriate schedules to the

province of Alberta Quebec taxes must be filed separately using the 17-T and other applicable forms and schedules to the province of Quebec

US Income Tax Returns

Fill out your 1120 and include your worldwide income You must include all the income you earned in Canada

Use form 1118 to calculate the foreign tax credit The foreign tax paid to

be claimed includes the actual amount owing as calculated on the T2, not the amount withheld at source

Transfer Pricing

Both the IRS and the CRA have indicated that transfer pricing guidelines should be applied for permanent establishments And, changes to the treaty will require that profits should be attributed to a PE as if the PE was

a separate person This implies that transfer pricing must be calculated for any transactions between the branch and the rest of your enterprise Please see Chapter 10 for information on transfer pricing

Refer to the resources section at the end of this document to see what forms and guides you will need as well as further reading for this chapter.Return to Table of Contents

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Chapter 3 Corporations without a Permanent Establishment in Canada

US corporations that do not have a PE in Canada are not required to pay taxes on income earned in Canada under the treaty However, a tax return must still be filed

When you get paid

You may be eligible to a reduction to the withholding amount under

Regulation 105 of the Act Regulation 105 imposes a 15% withholding on the gross amount of the payment The withholding is required regardless

of whether the payer is a resident of Canada or a non-resident If a

payment is made that is partly for work done in Canada and partly for work done in the US, a reasonable allocation must be made If no allocation is made the whole amount will be subject to Canadian withholding

You may not be eligible for a reduction to the withholding amount based

on treaty exemption This is because, at the time of waiver, there may be

a possibility of a permanent establishment The CRA will not make a determination at the time of the waiver, so withholdings may be applicable Even if you fail to quality for a waiver under the treaty exemption, you may

be eligible for a reduction based on the fact that you will have expenses that may be claimed against the revenue to be reported

In order to get any reduction to the withholding amount you must have received a waiver from the CRA You may apply for a waiver based on the treaty or on income and expenses Waiver requests should be sent to CRA 30 days before the commencement of service or 30 days before the payment whichever is earlier

To apply for a waiver you will need to fill out a form R105 and send it to the Tax Services Office nearest the location where your work is being done

Example—Miller Consulting, Inc.

David Miller does business through his C Corporation, Miller Consulting, Inc He has negotiated a contract to provide services in Canada The contract is a short-term contract and David will be in Canada only at the offices of his client As soon as the contract has been signed David fills out an R105 to send to the CRA As well as completing the form, he

indicates in an attached note that he is eligible for exemption under Article XII of the Canada-US Income Tax Treaty He also provides copies of the contract and his incorporation documents David receives his confirmation from CRA for the exemption from withholding He provides his client with a copy of the waiver confirmation so that he will have no withholdings

Example – Davis Consulting, Inc.

Patty Davis does business through her C Corporation, Davis Consulting, Inc She has negotiated a contract to provide services in Canada The

contract is a short-term contract and Patty will be in Canada only at the offices of her client Patty has had a number of short-term contracts over the last couple of years and has been denied a waiver under the treaty However, she knows that she can apply for a waiver under income and expenses As soon as the contract has been signed Patty fills out an R105 She estimates the corporate income and expenses while in Canada and provides copies of her incorporation documentation, the contract and estimated expenses Patty knows she is likely to be granted a waiver as the net income earned in Canada will be significantly less than the gross fee she will receive Once Patty receives a confirmation from CRA that her waiver has been approved, she provides a copy of the waiver to the client

so that a lesser amount of withholding is necessary

As Patty is planning on filing a corporate tax return to indicate that no ultimate tax is owning in Canada, she will not be able to reduce her

estimated tax owing to the IRS based on any expected foreign tax credit

Calculation of Income

As you will be filing a return claiming treaty exemption, there is no need to calculate your Canadian income and expenses separately from your US income

Filing Canadian Tax Returns

Although you may feel that no tax return is necessary because you do not have to pay tax That is not correct You must still file a Canadian tax return An additional reason to file – one of the most common reasons for being denied a waiver request is that you have not filed your tax returns when required

You will need to file a Canadian Corporation Tax Return (T2) and the appropriate schedules This return is due six months after the fiscal year end of your corporation

Fill out Schedules 91 and 97 to indicate you are applying for exemption under the treaty and provide the additional information required

Line 800 is used to record the withholding on revenue that the payer(s) have made Enter any withholding on this line and claim a refund

Provincial tax

You do not have to fill out a separate return for the provincial tax

requirements Use schedule 5 to allocate all the income to the outside of Canada

Municipal tax

No municipalities in Canada levy taxes on income

US Income Tax Returns

Fill out your 1120 and include your worldwide income You must include

all the income you earned in Canada

There is no foreign tax paid may be claimed because no taxes will be ultimately owing to Canada, therefore no foreign tax credit may be

claimed

Refer to the resources section at the end of this document to see what forms and guides you will need as well as further reading for this chapter.Return to Table of Contents

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Chapter 4 Individuals with a Permanent Establishment in Canada

US residents that have a PE in Canada are required to pay taxes on

income earned in Canada under the treaty The business profits are to be calculated as though the business in the PE is a separate business from the remainder of the business in the US

When you get paid

You will be subject to a withholding amount under Regulation 105 of the Act Regulation 105 imposes a 15% withholding on the gross amount of the payment The withholding is required regardless of whether the payer

is a resident of Canada or a non-resident If a payment is made that is partly for work done in Canada and partly for work done in the US, a

reasonable allocation must be made If no allocation is made the whole amount will be subject to Canadian withholding

You will not be eligible for a reduction to the withholding amount based on treaty exemption as the treaty requires that this income is to be reported in Canada However, you may be eligible for a reduction based on the fact that you will have expenses that may be claimed against the revenue to

be reported In order to get a reduction to the withholding amount you must have received a waiver from the CRA You may apply for a waiver based on income and expenses That means that you will request a

reduction in the withholding amount required based on your estimated net income rather than the gross income that is being paid If the waiver is granted, the payer will withhold 15% on the lesser amount

To apply for a request for a waiver you will need to fill out a form R105 and send it to the Tax Services Office nearest the location where your work is being done Waiver requests should be sent to CRA 30 days before the commencement of service or 30 days before the payment whichever is earlier

You may also need to make instalment payments to CRA based on your prior year’s taxable income (though you won’t have to worry about this your first year) If this is the case, you will receive a notice from the CRA that tells you the amount of the instalment required If the CRA has not made the calculation for you, reduce the tax instalments required by any Regulation 105 that has been withheld during the year in order to avoid double withholding

Example—John Smith Consulting

John Smith does business as an individual through his business John Smith Consulting He has negotiated a contract to provide services in Canada The contract is a one-year contract and he is renting an office in Vancouver As soon as the contract has been signed John fills out an R105 He calculates the income and expenses and provides the contract and estimated expenses He has filed his form 8802 with the IRS and has

received a copy of form 6166 He attaches a copy of form 6166 to his waiver request John knows he is likely to be granted a waiver as the net income earned in Canada will be significantly less than the gross fee he will receive Once John receives a confirmation from CRA that his waiver has been approved, he provides a copy of the waiver to the client so that a lesser amount of withholding is necessary That means that John has additional cash in his pocket to pay expenses John may also reduce the estimated tax owing to the IRS based on the expected foreign tax credit However, he must be careful to calculate the expected foreign tax to be paid based on the amount of Canadian tax that will be paid at year end – not on the amount withheld.

Reporting Business Income

Canadian income tax rules do not vary significantly from the US income tax rules Capitalization of assets, personal expenses, business use of vehicle rules are very similar in nature But there are some specific

differences that you should be aware of when calculating your Canadian business income

First of all, remember to report your income and expenses in Canadian dollars You may use the average exchange rate for the year This will save you from calculating the exchange rate on all of your income and expenses on the dates earned and then re-calculating when the amount is paid

Individuals reporting business or professional income in Canada are

normally required to have a December 31 year end While it is possible to elect to have a year end that is not December 31, you will be required to allocate your income and pro-rate the amounts The end result is the same – you will have to pay Canadian tax as if your year-end is December

31 So it is simpler to calculate your income and expenses on a calendar year basis

Revenue

Remember that you must report all revenue earned in Canada If the revenue to be received is as a result of a combination of work done both in the US and in Canada you must make a reasonable allocation of that income

The accrual method of income is required for taxes in Canada Income must be reported when it is earned, regardless of when it is received.Fringe benefits must be included in income earned in Canada if they relate

to the Canadian portion of the business—regardless of where those

benefits are received A free flight from Houston to Tahiti may be a taxable benefit in Canada if the reason for the flight was earned for work done in Canada

Expenses

Expenses are calculated for the CRA in generally the same manner as calculated for the IRS Expenses that are ordinary and necessary for the work being done in Canada can be deducted

The allocation of personal expenses versus business expenses are

treated in the same manner as in the US The expense must have been spent to earn income in Canada in order to be deducted from revenue reported in Canada

Whether or not an expenditure is an expense that can be written of in one year or is capital in nature is similar to the rules you are familiar with

following in the US Ask yourself the following two questions:

Does the expense result in a lasting benefit (i.e did you buy a computer that will last a couple of years or a flash drive that you expect to use for one year)

Does the expense maintain of increase the value of the equipment or property (i.e did you repair your hard drive or purchase an upgraded faster/better hard drive)

Just as in the US, equipment used in Canada cannot be written off in the year it is purchased but must be allocated over a number of years In most cases, the Capital Cost (basis) of the property is calculated the in same manner as you would for equipment in the US The amount of deduction that is permitted each year is called Capital Cost Allowance or CCA CCA

in most cases will be on a declining balance basis with a limitation of 50%

in the first year of use See Resources for a full list of CCA classes and rates When you are finished using your equipment in Canada and it is sold or removed from use the rules become very different than US

calculations These rules are outside the scope of this book

The rule for prepaid expenses is the same as for US tax purposes You cannot deduct an expense that is paid in advance It must be deducted when it, or the underlying asset, is used

If you are planning to advertise your business, you should be aware that only certain types of advertising will be deductible in full on your Canadian income tax return Any advertising with a US broadcaster cannot be

deducted against Canadian income and advertising in a periodical could

be restricted to 50% or 80% depending on the type of periodical

Meals and entertainment expenses are deductible at 50% which is the same rate as is used in the US Club dues are not deductible if the main purpose of the club is dining, recreation or sporting Expenses paid to a golf course – even if they are paid for the restaurant are not deductible Any fees relating to the use of a yacht are not deductible

Some vehicle expenses, such as lease expenses are restricted for

passenger vehicles The maximum amounts change on a yearly basis and are posted on the CRA website

Books and Records

You must keep your books and records for tax purposes for six years after the later of when the return is filed or when the return is due You must remember that records for capital items must be kept for six years after the last year that it is used for tax purposes As most capital expenditures

go into a pool, unless your business is finished, all capital expenditure receipts should be kept indefinitely If you keep records electronically, those records must be kept in “an electronically readable format” For books and records pertaining directly to the income and expenses of the business in Canada, the records must be physically in Canada (including the electronic hard disk) unless you have received permission to keep those records outside of Canada To receive permission to keep the

records outside of Canada or permission to destroy records, write to the Tax Services Office nearest the location of your business

Example Patricia Brown

Patricia Brown was completing a contract in Canada During the year, travel was required and the cost for meals was $1,500 One-half of the meals expense of $750 is not deductible for Canadian tax purposes If Patricia had received a reimbursement the meals expenses, she would include the reimbursement in income and would be permitted to expense the total amount of meals The adjustment for other non-deductible

expenses is calculated before entering any amounts on the T2124 or T2032

Filing Canadian Tax Returns

The withholding and installment payments you make are not your final tax calculation You must complete and file Canadian tax returns in order to determine the actual amount owing to the CRA

The first thing to do before you file your Canadian Tax Return is to

calculate your Canadian income and expenses You should treat the income and expenses from Canada as a separate branch If you have expenses that apply to both Canada and the US, you will need to allocate those expenses

Once you have calculated your expenses you will need to file a Canadian Tax Return (T1) and the appropriate schedules This return is due June 15

of the following calendar year However, be aware than any tax owing for the year is due on April 30 of that year

Use a T2125 for the calculation of business and professional income This forms also includes the areas you will need to calculate your CCA, vehicle expenses and any office-in-home expenses that may be applicable

The gross and net income from the T2125 are transferred to the T1

General Income Tax form Do not use the T1 for non-residents as that is not applicable in your case

Any tax withheld is included on 437 of page 4 and any installment

payments you have made are included on line 476

Provincial tax

You do not have to fill out a separate return to calculate the provincial tax amount Although you will have a PE in a province, use form T2203 to allocate income to the appropriate province

However, if you are operating in Quebec under a name that does not include both your last name and first name you will be required to register

in the enterprise register and to file and Quebec income tax return

US Income Tax Returns

Fill out your 1040 and include your worldwide income You must include all the income you earned in Canada

Use form 1116 to calculate the foreign tax credit The foreign tax paid to

be claimed includes the actual amount owing as calculated on the T1, not the amount withheld at source

Transfer Pricing

Both the IRS and the CRA have indicated that transfer pricing guidelines should be applied for permanent establishments The newest protocol to the treaty requires that profits should be attributed to a PE as if the PE was a separate person This implies that transfer pricing must be

calculated for any transactions between the branch and the rest of your enterprise Please see Chapter 10 for information on transfer pricing.Refer to the resources section at the end of this document to see what forms and guides you will need as well as further reading for this chapter.Return to Table of Contents

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Chapter 5 Individuals without a Permanent Establishment in Canada

Under the treaty, individuals that do not have a PE in Canada are not required to pay taxes on income earned in Canada However, withholding

is still required unless a waiver is granted and a Canadian tax return must still be filed

When you get paid

You may be eligible to a reduction to the withholding amount under

Regulation 105 of the Act Regulation 105 imposes a 15% withholding on the gross amount of the payment The withholding is required regardless

of whether the payer is a resident of Canada or a non-resident If a

payment is made for work that is completed in both Canada and the US, a reasonable allocation must be made If no allocation is made the whole amount will be subject to Canadian withholding

You may not be eligible for a reduction to the withholding amount based

on treaty exemption This is because, at the time of waiver, there may be

a possibility of a permanent establishment The CRA will not make a determination at the time of the waiver, so withholdings may be applicable Even if you fail to quality for a waiver under the treaty exemption, you may

be eligible for a reduction based on the fact that you will have expenses that may be claimed against the revenue to be reported

In order to get any reduction to the withholding amount you must have received a waiver from the CRA You may apply for a waiver based on the treaty or on income and expenses Waiver requests should be sent to CRA 30 days before the commencement of service or 30 days before the payment whichever is earlier

To apply for a waiver you will need to fill out a form R105 and send it to the Tax Services Office nearest the location where your work is being done

Example—James Wilson Consulting

James Wilson does business as an individual He has negotiated a

contract to provide services in Canada The contract is a short-term

contract and James will be in Canada only at the offices of his client As soon as the contract has been signed James fills out an R105 As well as completing the form, he indicates in an attached note that he is eligible for exemption under Article VII (this is the article on business profits) of the Canada-US Income Tax Treaty He also provides copies of the contract and his form 6166 received from the IRS after he filed his form 8802 James receives his confirmation from CRA for the exemption from

withholding He provides his client with a copy of the waiver confirmation

so that he will have no withholdings

Example – Barbara Taylor

Barbara Taylor also does business as an individual She has negotiated a contract to provide services in Canada The contract is a short-term

contract and Barbara will be in Canada only at the offices of her client Barbara has had a number of short-term contracts over the last couple of years and has been denied a waiver under the treaty However, she

knows that she can apply for a waiver under income and expenses As soon as the contract has been signed Barbara fills out an R105 She calculates the business income and expenses and provides copies from

6166, the contract and estimated expenses Barbara knows she is likely to

be granted a waiver as the net income earned in Canada will be

significantly less than the gross fee she will receive Once Barbara

receives a confirmation from CRA that his waiver has been approved, she provides a copy of the waiver to the client so that a lesser amount of

withholding is necessary

As Barbara is planning on filing a tax return to indicate that no ultimate tax

is owing in Canada, she will not be able to reduce her estimated tax owing

to the IRS based on any expected foreign tax credit

Filing Canadian Tax Returns

Although you may feel that no tax return is necessary because you do not have to pay tax That is not correct You must still file your Canadian tax return An additional reason to file – one of the most common reasons for being denied a waiver request is when you have not filed your tax returns when required

You will need to file an Income Tax Benefit Return for Non-Residents and Deemed Residents of Canada (T1) and the appropriate schedules This return is due June 15 of the following calendar year

As you will be filing a return claiming treaty exemption, there is no need to calculate your Canadian income and expenses separately from your US income Although you may want to refer to how to calculate your Canadian source income in Chapter 4 in order to report the correct amounts that are exempt

Use a T2125 for the calculation of business or professional income

The gross and net income from the T2125 are transferred to the T1

General Income Tax form for non-residents

Deduct the full amount of business income you included above that is exempt from income in Canada on line 256 This will result in a taxable income of zero

Any tax withheld is included on 437 of page 4 and any installment

payments you have made are included on line 476

Provincial tax

There is no provincial tax and no forms to fill out

US Income Tax Returns

Fill out your 1040 and include your worldwide income You must include all the income you earned in Canada

You will not be above to claim a foreign tax credit as you will receive a refund on any amounts withheld at source

Refer to the resources section at the end of this document to see what forms and guides you will need as well as further reading for this chapter.Return to Table of Contents

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Part III

This section is applicable to all businesses and should be reviewed whenever you are conducting business in Canada It is applicable if you are a corporation or an individual and whether or not you have a

permanent establishment in Canada Use the flow chart at the end the document to determine which chapters to use in Part III

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Chapter 6 Federal Goods and Services Tax And Provincial Taxes

Goods and Services Tax (GST) is applicable on most services in Canada GST is a value added tax that must be charged when required and

remitted to the CRA Starting January 1, 2008 the GST rate is 5%

Harmonized Sales Tax (HST) is combined with the GST if the services are carried on in specific provinces and are calculated with the GST The HST rate varies depending on the province Other provincial taxes, if required, must be calculated for each province and remitted as appropriate See individual provinces for rates

Do you need to charge GST

If you are considered to be carrying on business in Canada you will need

to charge GST on services provided wholly or partly in Canada unless you are a small supplier (see below for definition of small supplier) In addition,

if you are considered a resident of Canada for GST purposes, you must charge GST on all services that are not zero-rated or exempt (again

unless you are a small supplier) The rules for GST are different than those for income tax although they follow the same general guidelines GST is not part of the treaty negotiated between Canada and the US, therefore you cannot rely on treaty provisions (such as PE requirements)

to exempt you from collecting and remitting GST

You may also register for GST on a voluntary basis This will mean that you must charge GST on your services but you may also claim Input Tax Credits on GST paid in Canada

Carrying on Business in Canada

Whether or not you are carrying on business is determined by a number of factors All the relevant facts are looked at – though some may be given more weight It is often the significance of the Canadian business to your overall business that will add weight and assist in making a determination

In other words, if your only income for the year is related to work done in Canada you will definitely be considered to be carrying on business in Canada Some of the factors that are looked at for the purposes of

GST/HST in relation to services are:

- The place where agents or employees are located

- The place of where services are performed

- The place where the contract is signed

- The place where contracts are solicited

- The location of a branch of office

- Any bank accounts in Canada

Residence and Permanent Establishment

For individuals residency will be determined using the definitions in the Income Tax Act but without allowing for any treaty overrides Factors that are looked at are length of visit, residential ties and regularly and length of visits.

For corporations not only the place of incorporation is important but also where the central management and control of the corporation is taking place

A partnership will be considered to be resident in Canada for GST/HST purposes if a majority of the members with management and control are resident in Canada

A permanent establishment includes all the factors listed in Chapter 1 for income tax; but also includes a fixed place of business of someone else

In other words if you are working at the offices of a Canadian company you will have a PE for GST purposes

As you can see, the above rules make it very easy for you to be moved from a non-resident to a resident or to having a permanent establishment

Small Supplier

You do not have to collect GST if you are small supplier A small supplier

is someone who has earned less than $30,000 in gross revenues in the last four consecutive calendar quarters When you are making this

calculation you must include your worldwide revenues, not just the

revenues related to Canadian services

You are automatically not a small supplier if you exceed $30,000 in one quarter In that case you will need to collect GST on the amount of

revenue that caused you to exceed the $30,000 mark

On the other hand, if it is because of the total income over the last four quarters that has caused you to exceed the $30,000, you will be a small supplier for that quarter plus one month

Example Linda Taylor

Linda is providing services for a company in Canada She knows she is carrying on business in Canada but wonders if she is a small suppler Her income from her Canadian contract only totaled $24,000 for the last year However, Linda also had contracts in the US that she completed in the US totaling $10,000 in the past year She must also add this income to her gross Canadian income to determine if she is a small supplier Since the total gross income from all sources is above $30,000, Linda cannot be a small supplier and must register for GST

Services to other non-residents

If you are performing services in Canada for another non-resident you may not have to charge GST as the export of services is normally zero rated However, there are a number of exceptions so you will need to do

further reading to be certain.

Seminars and other events with admissions

Even if you are a small supplier, if you collect admissions at a seminar or event you must charge GST

Example – James Taylor

James is providing a training seminar for a computer program he

developed James made all the arrangements, booking the conference rooms He charged participants an entry fee for the seminar Participants were able to register online for the seminar that took place in Calgary Although James will only earn $20,000 from this seminar, he is required to charge GST to each of the participants

cancellation, fill out NIL returns and send them to CRA

Security Deposit

This is a case where having a permanent establishment can be a good thing If you don’t have a permanent establishment for GST purposes (or if you only provide services through another person’s fixed place of

business), you must provide a security deposit to the CRA The security deposit is 50% of your estimated net tax (GST collected less ITCs) for the following 12-month period when you first register After that, the security deposit required is 50% of the actual net tax in the previous year There is

a minimum security deposit of $5,000 unless you meet the exception requirements

You will not have to provide a security deposit if your expected sales are less than $100,000 annually and your net tax is expected to be less than

$3,000 remittable and $3,000 refundable

Input Tax Credits

Input Tax Credits (ITCs) are simply the GST that you have been charged

by others If you are registered for GST, you may request a refund of any ITCs paid There are quick methods and simplified methods of calculating GST that may be used However, they often require many calculations and you are likely just a well off keeping track of what was paid

Filing and remitting GST

You will need to fill out a form GST34 to record your GST collected and

paid This form is not available as a download on the CRA website but will

be mailed to you by the CRA or can be ordered in bulk

The frequency of filing your GST returns, called reporting periods,

depends on your gross revenues If your gross revenues are less than

$500,000 the CRA will assign you an annual reporting period In this case, the revenue that you use to calculate is based only on the services

provided in Canada If your income is higher, the CRA will assign you a more frequent reporting period You may also elect to have a more

frequent reporting period by filling out a form GST20

For corporations and partnerships, the due date for the return is three months after the end of the period For individuals on an annual filing period the due date is June 15 however, any amounts owing must be remitted by April 30

There is an exception to the filing date rules If you have charged

admission fees, you must file a GST return and remit any GST due before you leave Canada regardless of the normal due date

Example – Linda Taylor

Linda’s income from Canada is only $24,000 That puts her into an annual filing date She is required to file annual GST returns She must pay any GST owing by April 30 of the next calendar year but has until June 15 to file her GST return

Example – James Taylor

James charged admission to his seminar Therefore he must file and remit his GST prior to leaving Canada at the end of his seminar

Books and Records

You must keep your books and records for GST purposes until six years after the end of the calendar year to which they refer If you keep records electronically, those records must be kept in “an electronically readable format” The records should be physically in Canada (including the

electronic hard disk) unless you have received permission to keep those records outside of Canada To receive permission to keep the records outside of Canada or permission to destroy records, write to the Tax Services Office nearest the location of your business

Provincial Income Taxes

New Brunswick, Nova Scotia, Newfoundland and Labrador are part of the Harmonized Sales Tax (HST) Ontario and British Columbia switched to HST as of July 1, 2010 All of the GST rules apply but the amount

collected and remitted will be larger because it includes the provincial tax portion No additional forms or remittances are required

On the opposite side, Quebec is responsible for collecting both the GST and the provincial sales tax The Quebec sale taxes follow the same

general rules as the GST Registration and remittance to the Quebec government will be required.

If you are working in Alberta, Northwest Territories, Nunavat or the Yukon Territory, you do not have to collect or pay any provincial sales tax

In British Columbia and Ontario prior to July 1, 2010, most services were not subject to provincial sales tax However, if the service related to the repair or maintenance of equipment or other tangible items it may have be taxable (this includes the setting up of temporary booths at trade fairs) If you were selling tangible items they may also be subject to the sales tax Although you would have been required to register and collect the

provincial sales tax on applicable services, as these taxes no longer exist, you are best to not try to correct it retroactively but register with GST General consulting is not taxable in Manitoba but many other services are taxable at 7% It is best to check for you specific type of service

Registration and remittance will be required if applicable

In Saskatchewan and Prince Edward Island, the onus is on the purchaser

to self-report any purchases from a non-resident

US Income and Deductions

As the GST and provincial taxes are not kept by you but remitted to the applicable governments, you do not include these amounts in your taxable income By the same rules, any ITCs you receive (or receive credit for on your GST return) are not included in expenses

Refer to the resources section at the end of this document to see what forms and guides you will need as well as further reading for this chapter.Return to Table of Contents

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