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Many Canadian public companies engage in activities in the United States for a variety of reasons. Unfortunately, this is often done with little thought to potential tax implications on either side of the border, which can lead to some unpleasant surprises. Tax filings to report cross-border relationships and transactions can be quite stringent, especially with the IRS – and the resulting penalties can be significant. Some advance planning can help avoid some nasty pitfalls.
A Canadian public company is engaged in the exploration of mineral property interests in the United States, and incorporates a subsidiary to hold the mineral property title. The Canadian parent flows funds to the U.S. subsidiary to fund exploration, and for ease of funds transfer between the two companies, the U.S. subsidiary holds a U.S. dollar denominated bank account with a Canadian bank. The resulting inter-company loan quickly builds into several million dollars in the first year of operations.
Even though no income taxes may be owing, this scenario requires numerous tax filings in both Canada and the U.S. Management of companies in exactly this situation have been shocked to learn that the IRS and CRA can go back many years and assess significant penalties for incomplete or missed filings.
In addition to the Canadian parent company’s T2 Corporation Income Tax Return, Canadian filing requirements in this scenario would include:
T106 – Information Return of Non-Arm’s Length Transactions with Non-Residents As the cumulative transactions with the non-resident subsidiary exceed $1M per year, the Canadian parent is required to file this return with a supplementary slip for the U.S. subsidiary. The T106 is due six months after year end, and late filing penalties can range from $100 to a maximum of $2,500 per slip per year, depending on how late the return is filed.
T1134-B – Information Return Relating to Controlled Foreign Affiliates As the U.S. subsidiary would not be considered dormant or inactive, the Canadian parent is required to file this form each year. The T1134-B is due 15 months after year end, and late filing penalties can again range from $100 to a maximum of $2,500 per year.
T2 – Corporation Income Tax Return – Non-Resident Corporations If the U.S. subsidiary is deemed to be carrying on business in Canada, it will also be required to file a T2, which is due six months after year end. As no taxes would be owing from a subsidiary with no taxable income, late filing penalties range from $100 to a maximum of $2,500 per year.
In addition to the Form 1120 U.S. Corporation Income Tax Return to be filed by the U.S. subsidiary, filing requirements in the United States for this scenario would include:
Form 5472 – Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business The U.S. subsidiary is required to file this form with its Form 1120, which is due on the 15th day of the third month after year end, unless extended. If assessed, the penalty for late filing starts at US$10,000 per year.
Form TD F 90-22.1 – Report of Foreign Bank and Financial Accounts The U.S. subsidiary is required to file this report for its bank accounts held in Canada on a calendar basis, regardless of the company’s year end. The form is due to be received by the U.S. Department of Treasury on or before June 30 of the following year. If assessed, penalties for failure to file or late filing of this form can be particularly onerous. If the failure is considered non-wilful, a civil penalty of up to US$10,000 applies per account for each year. If the failure is considered wilful, penalties can be the greater of US$100,000 or 50% of the highest balance in the account for each year the form has not been filed, for each bank account. Failure to file the Form TD F 90-22.1 can also carry criminal penalties including a fine of US$250,000 and up to five years in jail. If the violation occurs while violating another law (such as tax law), criminal penalties are increased to US$500,000 and up to 10 years in jail.
Form 1120-F – U.S. Income Tax Return of a Foreign Corporation The Canadian parent should also consider whether it has any exposure to U.S. federal or state tax as a result of its activities with its subsidiary. Even where a Canadian parent has little or no activity in the U.S., it may be prudent to file the Form 1120-F to claim protection from U.S. taxation under the terms of the Canada-U.S. tax treaty.
In addition to U.S. federal filing requirements, depending on the state where the U.S. subsidiary operates, it may have additional state filing requirements and may be subject to a minimum corporate tax.
Even one year of missed filings can become very expensive. Unfortunately, this scenario has become all too common with Canadian public companies, and often multiple years will pass before management realizes any filings are required or the consequences of late filing, resulting in significant accumulated penalties. In recent years, the IRS has become much more aggressive in collecting these penalties possibly due to the weakened U.S. economy and diminishing US coffers.
With the right advice, Canadian public companies can avoid expensive penalties on either side of the border, whether through prudent planning or by taking advantage of voluntary disclosure programs offered in Canada and the United States. MNP’s
cross-border tax group specializes in these and other issues encountered by public companies. For further information or to find out how we can help, contact your
local MNP advisor.
This article has been prepared for informational purposes only and is not intended for any other purpose. We do not assume any responsibility or liability for losses occasioned by you in reliance on this information. We would be pleased to discuss with you the issues raised within the context of your particular circumstances.
Related Topics:U.S. Tax; International Tax
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