Under Canadian domestic tax law, employment income is generally taxable when employment services are rendered in Canada. However, the “Dependent Personal Services” article in Canada’s income tax treaties can provide tax relief from Canadian taxation. While a few of Canada’s tax treaties contain an income threshold that exempts employment income below this threshold, the focus of this overview is on the remaining conditions that must be satisfied in order for employment income to be exempt from Canadian taxation.
Using the Canada – United States Convention with Respect to Taxes on Income and on Capital (the Canada-US tax treaty) as an example, the remaining conditions are as follows:
- The recipient must be present in the other contracting state for a period or periods not exceeding an aggregate of 183 days in any 12-month period commencing or ending in the fiscal year concerned,
- The remuneration cannot be paid by, or on behalf of, a person who is a resident of that other contracting state, and
- The remuneration cannot be borne by a permanent establishment (PE) in that other contracting state.
It is not uncommon to hear references to the “183-day test” and false presumptions that this test is the sole criteria for determining whether the exemption applies. In reality, however, once the 183-day criterion has been established, the last two conditions—1) the residence of the person paying the remuneration and 2) whether this person has a PE in the host country that is bearing the cost of the remuneration—are just as important and just as open to misinterpretation.
For example, there is a misconception surrounding the treatment of inter-corporate cross-charges or chargebacks. Some of the more common inter-corporate cross-charges include:
- Reimbursements of salary and wages for employees loaned to an affiliate to fulfil a temporary work need in another jurisdiction,
- Reimbursements of headquarter costs and centralized service fees such as those related to administration, human resources, corporate communication, strategy, finance, treasury, technology, and legal support that are charged out to the operating companies in multiple jurisdictions on the basis of a formula as per their transfer pricing agreements, and
- Service fees for specific project-related costs.
The misconception regarding the treatment of these inter-corporate cross-charges or chargebacks is that as long as an amount has been charged to and borne by a Canadian PE, the employee rendering the employment services in Canada would be taxable and the treaty exclusion would not apply. But this is not necessarily true.
The Canada Revenue Agency (CRA) has confirmed that the key determinant when applying the latter two tests is the identity of the employer—both in substance and in form (aka the “economic employer”). If it is determined that the foreign company is the employer, the inter-corporate charges paid by the Canadian PE to the foreign company would not be viewed as remuneration paid to the foreign employee for the services rendered in Canada; as such, these charges would be exempt from Canadian taxation. However, if the employer is considered to be the Canadian PE, the inter-corporate charges could be viewed as remuneration, in which case the foreign employee would be taxable in Canada as the treaty exemption would not be satisfied.
The primary issue then is to determine who is exercising the functions of an employer. Generally, jurisprudence has determined that the employer is the person who has rights to the work produced and who bears the relative responsibility and risks, including:
- Control and responsibility of the workplace,
- Authority to instruct the individual, and
- Determination of work and holiday schedules.
A secondment agreement is generally an indication that the host employer will take full employer responsibilities for the employee during the work days in the host country. Furthermore, foreign employees who are performing the services of an officer or director for a Canadian company will be deemed to be employees of the Canadian company.
There are also situations in which misguided attempts are made to forgo the inter-corporate cross-charge with the objective of avoiding Canadian personal tax. But the reality is that determining whom the remuneration is “borne by” is not dependent on whether a deduction is claimed—it is dependent on whether the inter-corporate charge is “allowable” as a deduction. Therefore, the only result of foregoing the inter-corporate charge is to put the transfer pricing offside.
A couple of examples provided by the Organisation for Economic Co-operation and Development (OECD) should illustrate these concepts:
USCO is a US company that provides engineering services. CANCO is a Canadian company that needs the temporary assistance of an engineer to complete a Canadian contract it has secured. USCO agrees to assign one of its US-resident employees to CANCO for four months under the direct supervision and control of CANCO’s senior engineers. The US employee will continue to be paid by USCO, but CANCO will reimburse USCO for the related employment expenses, including a 5% markup. The remuneration in the calendar year will be greater than $10,000.
In this example, the US employee is entering into an employment relationship with CANCO; thus, it’s unlikely that the dependent personal services exemption will apply, and likely that the US employee will be taxable in Canada for any remuneration attributable to employment services rendered in Canada.
USCO and CANCO are part of the same multinational group. USCO provides the multinational group with administration, human resources, and IT support. The costs associated with providing this support are charged out to each company in the group based on either a transfer-pricing formula or a direct charge of costs. A US-resident employee of USCO is required to travel to Canada and attend meetings at the Canadian offices of CANCO.
In this example, the employment relationship is with USCO and is part of the activities that USCO performs for CANCO. As a result, the US resident should be exempt from Canadian tax for the employment services rendered in Canada as long as the other conditions of the dependent services article are satisfied. However, if the US-resident employee of USCO was providing the services of an officer or director to CANCO, the US resident would be taxable in Canada as a deemed employee of CANCO.
Although a discussion of the payroll consequences is outside the scope of this overview, it should be noted that even where a foreign employee may be exempt from Canadian taxation by virtue of a tax treaty, compliance with Canada’s payroll regulations is mandatory and Canadian tax withholding is required, unless a withholding waiver is applied for and accepted by the CRA. Hopefully, the new streamlined process outlined in the April 2015 federal budget, which will take effect on January 1, 2016, will provide long-sought relief from the Canadian tax-withholding requirements for short-term business travellers to Canada.
Lawrence Bell is a senior manager with the human capital – global mobility and rewards practice of Ernst & Young LLP in Vancouver.
- Tax treaties generally refer to countries that are party to an agreement as “contracting states.”
- Per Technical Interpretation 2011-0403541E5, “person” refers to the party that exercises the functions of employer.
- “Permanent Establishment” is defined in Article V of the Canada – US tax treaty.
- “Borne by” here means allowable as a deduction in computing taxable income.
- Technical Interpretation 2011-0418281E5.
- ITA Section 248 – definition of “employee.”
- OECD, Commentaries on the Articles of the Model Tax Convention, 2010.
- Ibid, 8.24 example 5, p. 263.
- Ibid, 8.26 example 6, p. 263.
- On July 31, 2015, the Department of Finance released draft legislative proposals and explanatory notes relating to the tax-withholding obligations for non-resident employers with frequent business travellers to Canada. At the time of this writing, the qualified non-resident employer certification form had not yet been published by the CRA.