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The owner of a Canadian processing plant who had been exporting pork products to the US for nearly a decade, was taken aback when, for the first time, he received letters from three different state tax departments inquiring about the company’s business activities in those states.
While many Canadian enterprises selling into the US concern themselves with federal tax requirements, it’s the 50 states that are particularly hungry for tax revenue these days. Increasingly, state tax authorities are sharing information with one another and with US Customs and Border Protection and the Internal Revenue Service (IRS) to identify potential sources of revenue. They are also increasing the number of audits and fines. Consequently, more Canadian companies are receiving letters, questionnaires, reassessments – and penalties – from US tax authorities.
Given that every state has different tax regulations that frequently change, you need to carefully assess filing and payment obligations when conducting or planning any kind of business across the border.
Fortunately, the pork processor had no additional tax obligations, but other Canadian manufacturers and exporters have not fared as well. Some have been subject to $10,000 fines annually for non-disclosure of each source of income and some have even had liens filed against their assets by US tax authorities.
First, some background. Canadian companies that conduct active business in the US are required to report and possibly pay federal tax based on income earned from this business. They’re frequently subject to state taxes too, and possibly local taxes.
Many owners mistakenly believe their companies aren’t subject to tax on US income unless it is earned through a permanent establishment in the country, such as an office or factory. However, as far as the IRS is concerned, if a business owner, executive or other employee travels to the US and authorizes contracts while there, the company has earned income through a permanent establishment in the US.
Moreover, the concept of a permanent establishment is only relevant for US federal income tax purposes. Canadian companies are often liable for US state taxes at a lower threshold - when the company has “nexus” (connection) with a state. Since nexus is not well defined and the threshold varies from one state to another, more Canadian enterprises tend to be subject to state taxes than federal taxes. In fact, the level of activity that could effectively connect income with an American trade or business can be quite low, including:
In some states, nexus may even be established when a Canadian company delivers goods with its own vehicles. Indeed, some state tax authorities have been known to seize delivery vehicles for nonpayment of taxes.
The states are not bound by the Canada-US Tax Treaty, which prevents double taxation on the same income. To claim the treaty exemption, a Canadian company with active trade in the US - even if it owes no taxes - must file a disclosure: IRS form 1120-F, US Income Tax Return of a Foreign Corporation.
If US tax authorities later determine that income was earned though a US permanent establishment and the form wasn’t filed, the company would lose valuable rights. For starters, it would be taxed on its gross income and no deductions would be allowed, plus the IRS could impose other hefty penalties.
Best not to risk it – especially with increasingly vigilant US tax authorities seeking new revenue. When your company has or plans active business in the US, here’s how you can reduce US taxes payable and the risk of penalties.
Keep in mind that the US – including each of its 50 states – is in a taxing state of mind. The onus is on Canadian companies venturing across the border to prepare the appropriate business and tax strategies. After all, you’re going there to make money, not to give it away.
Michael Shumate is the leader of the GTA region US corporate tax practice of MNP LLP and Glenn Fraser is the leader of the GTA region Food & Ag Processing team.
This article was featured in the March 2012 issue of Plant Magazine.
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