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Tax Issues for Cross-Border Employers:Considerations, Planning and Compliance

James A. Fraser

North York District CA Association Meeting September 24, 2013 – Donalda Club

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Non-Residents & Carrying on Business in Canada

• Over the past few years, increased interest and business activity of non-resident (NR) businesses in Canada

• NR businesses often send NR employees to Canada for:– Marketing – Sales Staff

– Operations – Managers

– Services – Technicians & Specialized Staff

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Principal Cross-Border Canadian Tax Issues for Service Providers

1. Ensuring the NR business does not have a PE in Canada under the Services PE Rules in the applicable tax treaty

• e.g., Article V(9) of the US Treaty

2. Minimizing Canadian tax compliance burden for NR employees

• i.e., source deductions, tax returns

• “Income from Employment” Rules in applicable tax treaty, e.g., Article XV(2) of the US Treaty

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Services PE Rules in the US Treaty – Article V(9)9. Subject to paragraph 3, where an enterprise of a Contracting State

provides services in the other Contracting State, if that enterprise is found not to have a permanent establishment in that other State by virtue of the preceding paragraphs of this Article, that enterprise shall be deemed to provide those services through a permanent establishment in that other State if and only if:

a) those services are performed in that other State by an individual who is present in that other State for a period or periods aggregating 183 days or more in any twelve-month period, and, during that period or periods, more than 50 percent of the gross active business revenues of the enterprise consists of income derived from the services performed in that other State by that individual; or

b) the services are provided in that other State for an aggregate of 183 days or more in any twelve-month period with respect to the same or connected project for customers who are either residents of that other State or who maintain a permanent establishment in that other State and the services are provided in respect of that permanent establishment.

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US Treaty – Article V(9) (Cont’d)

• If NR satisfies either test in Article V(9) of the US Treaty, it will be deemed to be providing services through a PE in Canada and thereby subject to Canadian tax on profits attributable thereto.

• The first test (Article V(9)(a)) requires (i) services to be performed by an individual present in Canada for an aggregate of 183 days or more in any 12-month period, and (ii) 50% of the gross active business revenues during that period are derived from that individual in Canada.

• The second test (Article V(9)(b)) requires services to be provided in Canada for an aggregate of 183 days or more in any 12-month period with respect to the same or connected projects for customers who are resident in Canada or have a PE in Canada.

– This test makes the day count for NR’s employees working in Canada for Canadian customers very important.

– The day count in Article V(9)(b) is based on an “enterprise” formula that counts each day in a 12-month period that the NR has an employee in Canada performing services (including any Canadian employees).

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US Treaty – Article V(9)(b)

• The CRA has adopted an expansive view of providing services in Canada for purposes of the day count under the US Treaty that can include the services provided by arm’s length and non-arm’s length subcontractors– "Canada Revenue Agency and Revenu Québec Round Table,"

2011 Canadian Tax Foundation Conference

– "Canada Revenue Agency Round Table," 2009 Canadian Tax Foundation Conference

– CRA Technical Interpretations: 2011-0421371E5, 2010-0391541E5, 2010-0381951E5

• Is subcontracting a solution?

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US Treaty – Article V(9)(b): Implications for Subcontracting

• The CRA distinguishes between resident and non-resident subcontractors– Takes the position that services subcontracted to a

Canadian resident non-arm’s length subsidiary for an arm’s length fee do not count towards the non-resident parent’s day count

– However, the CRA takes the opposite position when services are subcontracted to a non-arm’s length non-resident subsidiary (even at an arm’s length fee)

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Income from Employment Rules in the US Treaty – Article XV(2)

2. Notwithstanding the provisions of paragraph 1, remuneration derived by a resident of a Contracting State in respect of an employment exercised in a calendar year in the other Contracting State shall be taxable only in the first-mentioned State if:

a) such remuneration does not exceed ten thousand dollars ($10,000) in the currency of that other State; or

b) the recipient is present in the other Contracting State for a period or periods not exceeding in the aggregate 183 days in that year and the remuneration is not borne by an employer who is a resident of that other State or by a permanent establishment or a fixed base which the employer has in that other State.

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US Treaty – Article XV(2)

• Pursuant to the “Income from Employment” provisions in Article XV(2) of the US Treaty, a US employee will not be subject to Canadian tax on his/her remuneration from exercising employment in Canada if:

i. his/her remuneration does not exceed $10,000; or

ii. he/she is not present in Canada for more than 183 days in any 12-month period commencing or ending in a relevant fiscal period and such remuneration is not paid by a Canadian resident or borne by a permanent establishment in Canada.

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US Treaty – Article XV(2): Implications for Employers/Employees

• Provided a US employee falls within the exemption in Article XV(2) of the US Treaty, US employer can apply to the CRA for a waiver of the obligation to make payroll withholdings for Canadian income tax.

• This would effectively eliminate the US employee’s obligation to file Canadian returns because there would be no Canadian income tax with respect to employment income and there would be no penalties for not filing.

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Planning Implications: An Example

• Background:– US software company (“USco”) with Canadian

customers

– Usco provides offsite & onsite services• Software license agreement

• Implementation services agreement

• Maintenance services agreement

• USco employees (US residents) performing/providing services in Canada

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Example

• Background (cont’d):– USco carrying on business in Canada

– USco and US employees entitled to benefits under the US Treaty

– Objective #1: No PE for USco in Canada

– Objective #2: Minimize Canadian compliance for US employees

– Assume relief/treaty protection under Services PE and Income from Employment Rules

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Example: Compliance & Considerations

• Reg. 105 – 15% withholding

• Canadian tax return for USco

• Canadian payroll withholding waivers– Reg. 102

– Certificates of Coverage: CPP/Social Security

• T4 Slips

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Example

Canada

US

USco

CDN Custome

r

1. 2.

1. Offsite services of US employees

2. Onsite services of US employees

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Example – Canadian Employees of USco

• Background:– USco’s Canadian business has continued to expand

• Need for staff in Canada full-time

– USco looking to hire Canadian resident employees for marketing, customer relations and software maintenance

• Plan to put them on USco’s payroll

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Canadian Employees of USco: Compliance and Considerations• Source deductions for Canadian employees: CPP, EI, tax, CRA

payroll number

• Services PE Rules – US Treaty– Presence of Canadian resident employees in Canada throughout any

12-month period will give rise to a Services PE in Canada (i.e., 183 day count)

• Income from Employment Rules – US Treaty– No relief from Canadian tax available if remuneration borne by a PE in

Canada

– Source deductions for US employees

– Canadian tax return for US employees

• Should USco incorporate a Canadian subsidiary (Canco)?

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Incorporating Canco

• Canco to provide services in Canada for Canadian customers– Can reduce or eliminate Reg. 105 withholding– Canco enters into agreements with Canadian customers

• Implications of subcontracting by USco?

• Canco to employ Canadian employees– Helps to manage USco’s day count for purposes of the Services

PE Rules (to the extent that US employees continue to come to Canada)

– Helps preserves treaty relief for US employees who travel to Canada for work

– Reduces compliance burden for USco and US employees

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Example – Canadian Employees of USco

Canada

US

USco

Canco

CDN Customer

1.

2.

1. Offsite services of US employees

2. Onsite services of Canadian employees

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Example – Employees of USco’s Indian subsidiary

• Background:– Indian resident employees of USco’s Indian

subsidiary (“Indco”) will be travelling to Canada to provide onsite services

– Indco carrying on business in Canada

– Assume relief/treaty protection under Services PE and Income from Employment Rules under the India Treaty

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India Treaty – Services PE Rules

• If Indco satisfies either test in Article 5(2)(l) of the India Treaty, it will be deemed to be providing services through a PE in Canada and thereby subject to Canadian tax on the profits attributable thereto.

• The first test (Article 5(2)(l)(i)) requires services to be furnished in Canada for an aggregate of more than 90 days in any 12-month period.

• The second test (Article 5(2)(l)(ii)) deems a PE where services are provided in Canada for a related enterprise.

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India Treaty – Income from Employment

Pursuant to the Income from Employment provisions in Article 15(2) ofthe India Treaty, an Indian employee of Indco will not be subject toCanadian tax on his/her remuneration from exercising employment inCanada if:

i. he/she is not present in Canada for more than 183 days*** in the relevant fiscal period; and

ii. such remuneration is not paid by a Canadian resident or borne by a permanent establishment in Canada.

*** However, the application of the Services PE rule in Article 5(2)(l)(i) of the India Treaty effectively reduces the Income from Employment exemption in Article 15(2) to 90 days because a Service PE in Canada for Indco would put the Indian employees offside of the second condition for the exemption.

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Indco Employees in Canada: Compliance and Considerations

• Indco provide (certain) services in Canada for Canadian customers– Indco enters into agreements with Canadian customers

• Implications of subcontracting by USco

– Reg. 105 – 15% withholding

– Canadian tax return for Indco

• Canadian payroll withholding waivers– Reg. 102

– Certificates of Coverage: CPP/Social Security

• T4 Slips

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Example: Indco Employees

Canada

US/India

USco

Indco

Canco CDN Custome

r

1.

2.

3.

1. Offsite services of US employees

2. Onsite services of Indian employees

3. Onsite services of Canadian employees

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Services PE Risk based on Day Count

• Consider secondment of US employees and/or Indian employees to Canco to deal with day count issues for USco and Indco– Helps manage day count if USco and Indco are

bumping up against respective 182 and 90 day thresholds

• However, secondment structure increases the compliance burden for NR employees because their remuneration would be borne by a Canco (i.e., a Canadian resident)

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