Grain Sales, U.S. Federal Tax and What Might Constitute Permanent Establishment

This is part four of a five-part series that originally ran in the Western Producer October 22nd, 2015.

Grain producers should consider if their sales will likely be considered effectively connected income in the U.S. and taxable at graduated U.S. federal corporate rates.

As a foreigner, all income from sources within the U.S. connected with the conduct of the trade or business is taxable. This applies whether or not there is any connection between the income and the trade or business being carried on in the U.S., during the tax year.

Absent any other relief, many cross border transactions would be taxable for U.S. federal income tax purposes. Thankfully, the U.S.-Canada treaty can help you prevent this from happening. With proper compliance by you the IRS will only be able to collect tax from you if your activities arise to a level which creates a permanent establishment in the United States.

Should you be deemed to have created a permanent establishment, you face having to pay up to 35 percent tax (or 39.6 percent for sole proprietor) on all shipments each year you have been deemed to have a permanent establishment. If you file the return late, you could face penalties of US$10,000 (for a Canadian corporation) or US$1,000 (for an individual) to the IRS. If the IRS audits you and determines that you should have been filing and paying tax, you may lose the right to deductions against the income. This would cause disastrous results.

Permanent establishment exists typically with a fixed place of business in the U.S., but can also exist if certain agents (including yourself!) are wrapping up contracts in the U.S. on behalf of your business on a regular basis. Farmers who regularly enter the U.S. to sell their product (even if they only take orders,) are probably creating a precedent for permanent establishment. The key test is determining what is regular or ‘habitual.’

There can be issues with farmers, or their agents, who enter the U.S. for a total of more than 182 days where the sales of more than half their product to U.S. based customers arose from those activities.

Many of the test requirements rely on facts and circumstances which can be unique to each business and transaction. As such, a permanent establishment determination is not always clear cut. Many farmers who live near the border could be flirting with the designation as they often cross the border, although most likely aren’t creating a permanent establishment in the U.S.

The rules around permanent establishment are especially tricky as the rules around individuals, partnerships or corporations are rather nebulous. For reference, partnerships can add more complexity – more than one entity or person might need to file.

Even if the activity does not rise to a level of a permanent establishment, the IRS still requires a formal disclosure that the activity is exempt from U.S. federal taxation. To avoid the potentially stiff penalties noted above for failure to file in time, make sure you have filled in and filed the appropriate form.

The only way to avoid the IRS is to be 100 percent sure you are selling to a Canadian (not a Canadian-based) company and the transaction is completed in Canada – meaning the contract is signed, you are paid in full IN Canadian dollars and the grain is still in Canada.