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Tax Implications of Doing Business in Canada

This month, Thomas R. Chiavetta, a senior tax manager With Price Waterhouse, Rochester, New york, who has had extensive experience with clients doing business in Canada, reviews some of the tax considerations that companies should evaluate before entering the Canadian market. The Canadian marketplace provides many opportunities for U. S. companies. Canada and the Untied States share customs and a common language and a further incentive has been provided by the Canada-U.S. Free Trade Accord. However, before venturing into Canada, it is important for a U. S. company to understand the tax implications of such a move. This article reviews some of the important considerations. PERMANENT ESTABLISHMENT If a U. S. company creates a permanent establishment in Canada, it will have to pay Canadian federal income tax on the Profits connected with it. For a U.S. company, the CanadaU. S. Income Tax Convention of 1980 (the treaty) defines a permanent establishment as a fixed place of business through which the business of a resident of the United States is wholly or partly carried on. Among other things, a permanent establishment includes a place of management, a branch, an office, a factory or a workshop. The treaty also provides that a permanent establishment is created if a person, say a salesperson of a U.S. company, habitually exercises authority in Canada to conclude contracts in the name of the U.S. company. However, a permanent establishment is not created if the contracting authority is limited to storage, display or delivery of merchandise. The treaty provisions mean that a U. S. company can have a presence in Canada through an agent, such as a salesperson, without Creating a permanent establishment. Additionally, a U. S. company may store inventory in a warehouse in Canada without creating a permanent establishment; a salesperson working for a U. S. cOmPany in Canada may maintain inventory for any of the treaty specified purposes without creating a permanent establishment; a U.S. company may maintain an advertising office in Canada without creating a permanent establishment. As long as the U. S. company does not go beyond treaty exemptions, a permanent establishment is not created and it will not be subject to federal income taxes. FILING CANADIAN FEDERAL INCOME TAX If a U.S. company does business in Canada, say through the use of a salesperson, it should file a Canadian federal income tax return, even if the U.S. company determines that it is not liable for tax on the Canadian sales under the treaty. The Canadian Federal Income Tax Act (the act) provides that a nonresident corporation that carries on business in Canada is subject to income tax on its taxable income earned in Canada. The act provides that a corporation is considered to be carrying on business in Canada if it solicits orders or offers anything for sale in Canada through an agent or employee whether the contract or transaction is to be completed inside or outside of Canada or partly in and partly out of Canada. If a nonresident corporation is considered to be doing business in Canada, it is required to file a Canadian federal income tax return. However, the act provides a specific exemption for corporations for any amount that is declared exempt from income tax by any other enactment of the Parliament of Canada. The treaty is considered to be such an enactment. Accordingly, if a treaty exemption applies, the relevant income from doing business in Canada is not subject to Canadian federal income tax. OPENING A CANADIAN BRANCH If a U.S. company wants more of a presence in Canada than it would have through a sales force, it could open a Canadian branch. The taxable income of a Canadian branch is determined on the basis of a separate accounting, as if the branch is a separate person. The U.S. company may charge the branch for expenses that it incurs directly for the benefit of the branch. …