This article provides a general overview of the Canadian income tax framework relevant to non-resident multinational corporations doing business in Canada directly or indirectly through a partnership. This article does not cover the scenario where the non-resident corporations carrying on a business in Canada through a Canadian subsidiary.
Generally speaking, non-resident corporations may be subject to taxation in Canada but only limited to their Canadian source income. In most cases, a corporation incorporated outside of Canada is a non-resident of Canada. However, a foreign corporation with its central management and control exercised in Canada may be considered a resident of Canada under common law principles. In that case, the foreign corporation must refer to the income tax treaty signed between Canada and its home country to determine its residency status for Canadian income tax purposes.
It is a question of fact whether an income is an income from property or income from a business.
Non-resident corporations are subject to a 25% rate of withholding tax on Canadian sourced property income such as dividends, interest from related parties, rents and royalty income when received. However, an income tax treaty between Canada and the resident country of the non-resident corporation may provide for an exemption from Canadian tax or reduced rates of withholding tax. These withholding taxes are final Canadian taxes to the non-resident corporations. The non-resident corporations have no Canadian income tax filing requirements in respect of their Canadian source property income.
The income of a non-resident corporation from a business carried on in Canada is subject to Canadian taxation. The term business implies a certain level of activity as opposed to a passive investment. However, an income tax treaty between Canada and the resident country of the non-resident corporation may provide for an exemption from Canadian tax if the Canadian business is not carried on through a permanent establishment (“PE”) in Canada. In most of the Canadian income tax treaties, a PE is defined to include a fixed place of business, including a place of management, a branch, an office, a factory or a workshop, a mine, quarry or other place of extraction of natural resources, a building site, construction or assembly project which exists for more than 12 months. Under the Canada-US income tax treaty, a PE may also arise if services are performed or provided in Canada for an aggregate of 183 days or more in any twelve-month period.
A non-resident corporation is required to file a Canadian income tax return in respect of its business carried on in Canada. If a non-resident corporation is resident in a treaty country and its Canadian business is not carried on through a PE in Canada, the non-resident corporation should be exempt from Canadian taxation. In that case, the non-resident corporation would be required to file a treaty-based return. In all other cases, the non-resident corporation would be required to file a branch tax return to compute its taxable income from the Canadian business. The starting point in determining the branch’s taxable income is its “book” income computed in accordance with generally accounting principles or generally accepted business practices. Book income is then adjusted based on specified rules contained in the Canadian Income Tax Act. The general corporate income tax rates for 2013 range from 25% to 31%, depending on the provinces in which the non-resident carrying on the Canadian business. The filing deadline for either the treaty-based or branch tax return is six months after the fiscal year-end.
THIN CAPITALIZATION RULES
Canada has “thin capitalization” tax rules that can result in a reduction in the amount that a Canadian resident corporation can claim as a tax deduction for interest expense paid to a specified non-resident person. A non-resident is a “specified” non-resident if he owns alone, or together with other non-arms length’s parties, at least 25% of the shares of any class of the capital stock of the Canadian corporation. The interest expense is limited when the debt owing to specified non-residents exceeds a 1.5 to 1 debt-equity ratio. The disallowed interest expense will then be recharacterized as dividends, which will then be subject to the dividend non-resident withholding tax.
In September 2013, draft legislations were proposed to extend the thin capitalization rules to non-resident corporations and trusts that carry on business in Canada. For a Canadian branch of a non-resident corporation, the thin cap rule indebtedness will generally include any loan or advance that is used in the Canadian branch, to the extent it is owing to a non-resident person who does not deal at arm’s length with the non-resident corporation. Since a Canadian branch is not a separate legal person from the non-resident corporation, it does not have equity. Therefore, a 3:5 debt-to-assets ratio is used to provide a notional amount of equity against which the debts of the non-resident corporation are tested, which parallels the 1.5:1 debt-equity ratio used for Canadian-resident corporations. The debt-to-assets ratio is based on the cost of the assets used or held by the Canadian branch less the outstanding debts of the non-resident corporation that relate to its Canadian branch and that are not included in its outstanding debts to specified non-residents. The draft legislations apply to taxation years that begin after 2013 and will apply with respect to both existing and new indebtedness.
REGULATION 105 WITHHOLDING IN RESPECT OF PAYMENTS FOR SERVICES PERFORMED IN CANADA
Under section 105 of the Canadian Income Tax Regulations, payors for fees paid to non-residents for services performed in Canada (other than in the capacity as employees) are required to withhold 15% from such fee payments and remit to the Canada Revenue Agency (“CRA“) no later than 15th of the month following the month in which the payments are made. This regulation applies to both Canadian and non-resident payors. As an example, if a US general contractor hires a UK company as a subcontractor to perform services in Canada for an Australian customer, the Australian payor would be required to withhold and remit 15% of the service fee payment made to the US general contractor. The US general contractor would also be required to withhold and remit 15% of the subcontract payment made to the UK subcontractor. The 15% Regulation 105 withholding is not the final tax. The withholding is a payment on account of the non-resident’s potential Canadian income tax liabilities. The non-resident would file either a treaty-based return or a branch tax return as discussed above. If the non-resident payer can demonstrate that they are exempt from Canadian tax pursuant to the income tax treaty between Canada and its resident country, they would receive a refund of the full 15%. As such, the 15% withholding represents a cash flow issue only. If it is determined that the non-resident’s Canadian business is carried on through a PE in Canada, the 15% withholding will be applied against the non-resident’s ultimate Canadian income tax liability.
If a non-resident payee can show that the 15% withholding is more than their potential Canadian income tax liability, either due to treaty protection or related expenses, they may apply for a waiver to reduce or eliminate the withholdings. Such waiver application has to be filed no later than 30 days before the period of service begins, or 30 days before the first payment for the related services. The waiver, if granted, will apply prospectively to future payments only. The payor is not allowed to reduce the 15% withholding absent a waiver from the CRA.
In general, employment income is sourced to the physical location where the services are provided. Thus, subject to any treaty relief, non-resident employees who exercised their employment in Canada are subject to Canadian taxation on their Canadian sourced employment income.
The Canadian Income Tax Regulations require that employers withhold and remit Canadian source withholding from Canadian employment income. The source withholding requirements apply to both Canadian and foreign employers. Thus, non-resident employers are required to withhold and remit Canadian sourced withholding from employment remuneration paid to non-resident employees for their employment services exercised in Canada, regardless of whether the non-resident employees are exempt from Canadian taxation under the income tax treaty between Canada and the resident country of the non-resident employees. Typical federal source withholdings include income tax, Canada Pension Plan (“CPP”) contributions and Employment Insurance (“EI”) premium. Employers are also required to pay matching CPP contributions and 1.4 times of employees’ EI premium. A waiver may be obtained to reduce or eliminate the source withholding if the facts determined that the non-resident employees would be exempt from Canadian income tax or CPP contributions under the income tax treaty or Social Security Agreement respectively, or the non-resident employees’ Canadian tax liabilities would be less than the required source withholdings.
HARMONIZED SALES TAX (“HST”)/GOODS AND SERVICE TAX (“GST”) AND PROVINCIAL SALES TAXES
Non-residents who carry on business in Canada must register for the GST/HST if they make taxable (including zero-rated) goods or services in Canada in the course of carrying on a commercial activity in Canada and are not small suppliers. A business is a small supplier if the total revenues from taxable supplies (before expenses) are $30,000 or less in the last four consecutive calendar quarters. In all cases, total revenues from taxable supplies mean worldwide revenues from supplies of goods or services subject to GST/HST (including zero rated supplies) OR that would be subject to tax if supplied in Canada.
A non-resident person who is considered to be carrying on business in Canada for income tax purposes is not necessarily considered to be carrying on business in Canada for GST/HST purposes and vice versa. Whether a person is carrying on business in Canada for GST/HST purposes is a question of fact. Some of the factors that the CRA will look at in making that determination are: the place where agents or employees are located; the place where deliveries are made; the place of payment; the place where purchases are made, the place from which transactions are solicited, the location of assets or an inventory of goods; the place where business contracts are made; the location of a bank account, the place where the non-resident’s name and business are listed in a directory; the location of a branch or office; the place where the service is performed; and the place of manufacture or production. An entity generally would be carrying on a business if the activity is done on a regular or continual basis. It is not, however, necessary that the activity be undertaken for profit.
A non-resident not required to be registered for GST/HST purposes can choose to register voluntarily if it meets one of the specified conditions. By voluntarily register for GST/HST, the non-resident will be able to claim refunds of the GST/HST (i.e., input tax credits) it paid on its expenditures incurred in Canada.
In applying to register for the GST/HST, a non-resident has to provide the CRA with a security deposit if the non-resident does not have a PE in Canada. The initial amount of the security deposit is equal to 50% of the estimate net tax, whether positive or negative during the 12 month period after the business registers. For subsequent years, the amount of the security deposit is equal to 50% of actual net tax for the previous 12-month period (whether negative or positive). The maximum security deposit that the CRA currently requires is $1 million and the minimum is $5,000.
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The article is not intended to provide advice, recommendations or offers to buy or sell any product or service. The information provided in this article is compiled from our own research and is based on assumptions that we believe to be reasonable and accurate at the time the article was written, but is subject to change without notice. Readers are encouraged to contact us for further details or analysis relevant to their particular circumstances. Readers should not rely on this article without seeking professional advice on any Canadian tax matters.
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