The pandemic has reshaped the way employees work. Many have been forced to work remotely, and some have chosen to relocate. But necessity has borne some interesting insights. For example, in a 2021 global survey of its employees,1 Ernst & Young LLP found broad support for remote work, with nine out of 10 employees saying they want ongoing flexibility with respect to where and when they work.
As remote work shifts from being a stop-gap solution to a permanent option, employers will need to implement internal risk management protocols and understand the implications—in terms of domestic and international taxation, employment and labour law, immigration, and benefit plans—of allowing their employees to work remotely from foreign jurisdictions. This consideration is particularly timely, as much of the tax and administrative relief provided by governments during the pandemic has now expired.
This article explores the international and domestic payroll and corporate tax issues involved when an employer hires employees residing outside its jurisdiction. We use Canada and the US as a primary example but also touch on the considerations for employees working in a different province.
Employer payroll requirements
Foreign employers hiring Canadian-resident remote workers
Foreign employers who hire Canadian-resident employees have Canadian payroll filing and remittance obligations. They are required to withhold Canadian federal and provincial taxes, Canada Pension Plan contributions, and Employment Insurance premiums based on the employee’s worldwide compensation, and must remit these amounts to the Canada Revenue Agency (CRA). The income and deductions must be reported on individual and summary T4 slips and filed on or before the last day of February following the calendar year. If the employee lives and works in Quebec, there are additional payroll remittance and reporting requirements to Revenue Quebec. Failure to comply with these payroll obligations will expose foreign employers to penalties.
In addition, foreign employers must obtain a CRA business number and open a payroll program account by applying online, by phone, or by completing Form RC1,2 and they must register for this account before the due date for the first remittance, which is generally the 15th day of the following month.
Canadian employers hiring foreign-resident remote workers
Similarly, Canadian employers who hire foreign-resident remote workers may have foreign payroll obligations and business number registration requirements in the foreign employee’s country of residence.
For instance, Canadian employers who have employees working in the US are required to withhold US federal and state (if applicable) income taxes, FICA social security, Medicare tax, and any state unemployment or disability obligations. To remit and report the employees’ wages and taxes, Canadian employers must apply for an Employer Identification Number3—either online or by submitting Form SS-4 to the IRS. In addition, if a US employee resides in a state that assesses income tax, the Canadian employer is required to register a payroll account in that state.
International corporate tax considerations
A major concern for employers hiring foreign employees is that doing so may give the company a corporate presence in foreign jurisdictions, thereby triggering corporate tax filing obligations.
For example, foreign employers who hire Canadian employees may be viewed as “carrying on business” in Canada under the provisions of Canada’s Income Tax Act.4 Similarly, if a Canadian employer with foreign employees is determined to have created a nexus in a foreign jurisdiction—to the extent that the company receives income effectively connected to a trade or business in that jurisdiction—its income may be taxable there.
If an employer is determined to be carrying on business in a foreign jurisdiction, a taxable presence is only created if there is a permanent establishment in place. In the case of Canada and the US, for example, the Convention Between Canada and the United States of America with Respect to Taxes on Income and on Capital (Canada-US tax treaty)5 stipulates that business profits may be taxed in the foreign jurisdiction if the non-resident employer carries on business through a permanent establishment in that foreign jurisdiction. According to the treaty, “permanent establishment” (PE)6 means a fixed place of business through which the business of an enterprise is wholly or partly carried out (specific examples are provided in the treaty).
Furthermore, many of Canada’s tax treaties, including the Canada-US tax treaty,7 contain a “services PE” provision, which deems that the services provided by the foreign employer are being provided through a PE in the foreign jurisdiction if certain conditions are satisfied.
If an employer carries on business in another foreign jurisdiction through a PE located in that foreign jurisdiction, it needs to attribute its business profits to that PE. In the case of the Canada-US tax treaty, an exception is provided whereby certain activities will not result in business profits being attributed to the PE of a non-resident employee; this exemption applies if the sole activities of the PE are the “mere purchase of goods or merchandise or the mere provision of executive, managerial or administrative facilities or services for such resident.”8
Another issue Canadian employers should consider when conducting business in the US is that most US states levy corporate tax at the state level. This means that in addition to the federal tax, there will be a state tax liability at fixed or graduated rates on any US taxable income and, generally, the various US tax treaties will not apply.
Canadian corporate filing requirements
If it is determined that a foreign employer is not carrying on business in Canada, the employer will not be liable to tax in Canada and will not be required to submit a Canadian corporate filing.
If a foreign employer is determined to be carrying on business in Canada but is not deemed to have a PE here,9 the foreign employer will not be liable to tax in Canada. However, to claim a treaty exemption and be exempt from Canadian tax, the foreign employer will need to file a T2 corporation tax return within six months10 of its taxation year-end.11
Lastly, if it is determined that the foreign employer has established a PE in Canada, the income that is attributable to this Canadian PE may be subject to Canadian income and branch tax.
US corporate filing requirements
Canadian employers with income that is effectively connected to a US trade or business are required to file a US tax return, even if they did not create a PE in the US and are, therefore, exempt from US income tax. The Canadian employer will need to file Form 1120-F, “US Income Tax Return of a Foreign Corporation,” to disclose US source income. In addition, the Canadian employer must file a treaty-based return position disclosure12 with its US tax return by April 15 following the calendar year to claim relief under the treaty from US federal taxation on income from US activities.13
If it is determined that the Canadian employer has created a US PE, the income that is attributable to this PE will be subject to US income and branch tax. Tax filings in each state will also be required where applicable.
Canadian domestic tax considerations
If a Canadian employer has a Canadian employee who works remotely in Canada and does not have to report to the employer’s establishment in person (i.e., works from a home office), the CRA’s view14 is that the employee’s “province of employment” is where the employee’s salary and wages are paid. This would normally be the location of the employer’s payroll department.
Each province and territory has its own set of tax laws and policies, including health taxes and worker compensation programs that differ from one another. Consequently, the location of an employee’s employment may result in unexpected employer costs. For example, if a BC-based employer hires an Alberta resident to work remotely, the BC Employer Health tax would be levied on the employer’s BC remuneration paid to the employee, even though the employee resides in Alberta.
The pros and cons of remote work
The pandemic has proven that remote work is not only possible but also, in some cases, advantageous. However, the advantages of remote work arrangements need to be weighed against the correlative tax challenges and potential compliance risks. An employer’s human resources, legal, and corporate tax teams should collaborate closely when offering employees a remote work alternative.
Queenie Wong, a candidate in the CPA Professional Education Program, is a tax senior with the people advisory services group of Ernst & Young LLP in Vancouver.
Lawrence Bell is a senior tax manager with the people advisory services group – global mobility and rewards practice of Ernst & Young LLP in Vancouver.
This article was originally published in the July/August 2021 issue of CPABC in Focus.
See Income Tax Act
, R.S.C., 1985, c. 1 (5th Supp.) Section 253 - Extended meaning of carrying on business.
Paragraph 1, Article VII of the Canada-US tax treaty defines the taxability of business profits.
“Permanent Establishment” is defined in Article V of the Canada-US tax treaty.
Paragraph 4, Article VII of the Canada-US tax treaty provides exceptions when business profits are not attributable to a permanent establishment.
Paragraph 6, Article V of the Canada-US tax treaty provides excluded activities performed by the corporation that will not deem the corporation to have established a permanent establishment in the contracting state.
A corporation must file no later than six months after the end of each tax year. The tax year of a corporation is its fiscal period. CRA guidance on filing deadlines
is available on the CRA website.
Form 8833, “Treaty-Based Return Position Disclosure Under Section IRC 6614 or 7701(b),” must be filed with the US corporate income tax return to claim the treaty exemption.
A corporation with a fiscal tax year ending June 30 must file by the 15th day of the third month after the end of its tax year. IRS guidance on the filing deadline
is available in the “Instructions for Form 1120-F,” on the IRS website.
CRA guidance for reporting employment income in provinces and territories is available on the CRA website.