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David Turchen, CPA, CA, CPA (WA) MNP LLP Abbotsford
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Gerard Roddis, CPA, CA MNP LLP Abbotsford
Many Canadian businesses likely already have or are considering accessing customers in the U.S. There are many reasons why this is attractive, including a much larger consumer market, a history of a stable currency to receive payments, and the relatively open border policy to cross-border trade.
The combination of these and other factors leads many Canadian businesses to believe that the U.S. tax consequences, including filing obligations, should be as inviting. However, this is not the case.
Aside from the U.S. federal tax consequences to consider, there are 52 individual states which independently decide their own rules on who, what, and how to tax activities they deem to be subject to their jurisdiction. In many cases, even the failure to timely report an activity in the U.S. can cause significant penalties which could hamper or even cripple the business.
For U.S. federal income tax purposes, a corporate entity is either “domestic” or “foreign.” A Canadian corporation as a foreign entity is generally only subject to U.S. federal income tax on income from U.S. sources; from certain non-business income; and from income that is effectively connected with the conduct of a trade or business in the U.S.
In most cases, a Canadian business performing services for U.S. customers will indeed be creating U.S. effectively connected income which, under domestic law, is subject to U.S. federal income tax at graduated rates. It is important to note that the permanent establishment determination, a key component of U.S. tax regulations, is complex and a much broader consideration than just services performed in the U.S.
U.S. Federal and State Income Tax Obligations
Whether the Canadian corporation indeed has a permanent establishment or not affects its U.S. federal payroll obligations and impacts the Canadian employee’s own personal federal income tax consequences.
On the individual front, U.S. persons are typically U.S. citizens and / or resident aliens (persons with a U.S. permanent resident card). U.S. persons must report their worldwide income on their U.S. federal income tax return regardless of where they reside. At the state level, most U.S. states have an income tax-based system and laws determining residence and taxation of residents and non-residents, which may not allow for foreign tax credits for taxes paid to Canada. This can lead to double taxation. As such, careful consideration of the state tax status of the employee is required.
The determination of residency, under Canadian domestic tax law, is not as clear cut compared to the mechanical tests for U.S. federal income tax purposes. The rules involve a statutory calculation and also a common law approach. Canadian income tax issues for both employer and employee to consider include:
Most workers who are already defined as employees in Canada will likely also be considered employees for U.S. federal employment purposes. Regardless, careful consideration is advised where arrangements were intended to create a contractor relationship as they may not be respected by the U.S. Internal Revenue Service (IRS).
Withholding Obligations of Employers
As an employer, federal and state withholding obligations will vary according to a number of issues, including amount of time spent in the two countries, the work activity and the status of the employee. Employees who are non-resident aliens working in the U.S. are subject different withholdings than U.S. persons, and penalties for failing to comply with tax rules for either – including timeliness - can be onerous.
The decision to send employees to the United States is a complex one. Many Canadian employers don’t realize the potentially significant increase in compliance burdens to themselves and their employees until it is too late. As highlighted in this blog, the failure to file, pay, deposit, or comply with U.S. federal obligations can be costly to both the employer and the employee.
Furthermore, certain rules are cumbersome to administer. Consider the issue of the deemed permanent establishment rules and the “rolling PE test.” The compliance obligations in the U.S., including federal income tax and payroll obligations, can inadvertently become late due to lack of information available to make a proper determination.
Because of this complexity it is critical a qualified professional be contacted well in advance of the potential engagement to ensure that all U.S.-based obligations are addressed.
Gerard Roddis, CPA, CA MNP is a Partner and the International Tax Services Leader for the B.C. region.
David Turchen, CPA, CA, CPA (WA) is a Partner and a U.S. Tax Specialist in MNP’s Abbotsford office
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Related Topics:International Tax
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