With taxation authorities, including those in Canada, increasingly looking for ways to augment their cash flows, the taxation of non-residents has become an area of focus for many jurisdictions. Non-residents doing business in Canada also face increased scrutiny as a result of significant (and ongoing) changes made to the transfer pricing landscape, starting in 2013.
Contributing to these changes is the Organization for Economic Development (OECD), which has published an action plan to address the perceived flaws in the international tax rules in order to address tax base erosion and profit shifting (BEPS). In its 2014 federal budget, Canada signalled that the OECD mandate around BEPS is an area of focus for the Department of Finance.
With the increased attention on non-residents doing business in Canada, non-resident persons/companies need to make sure they understand the current framework and the associated taxation and filing requirements.
“Carrying on business” in Canada
Generally, a non-resident that carries on business in Canada is subject to income tax on any income earned in Canada. The term “carrying on business” is not defined for Canadian tax purposes in the Income Tax Act (the Act or ITA), except in the extended meaning. As described in the extended meaning, a non-resident soliciting orders or offering anything for sale in Canada through an agent or servant—whether the contract or transaction is to be completed in or outside of Canada—qualifies as carrying on business in Canada.
Substantial jurisprudence has set out the factors to consider in determining whether a non-resident is carrying on business in Canada, and the CRA has elaborated on these factors in its administrative policy. Canadian courts have generally accepted the principle that a corporation carries on business in the place or country in which its operations take place and from which its profits arise.
The place where profit-producing contracts, such as sales contracts, are entered into is recognized as a key factor in determining where a business is carried on. However, there are a number of other factors to consider as well, including:
- The place where services are rendered;
- The place from which transactions are solicited;
- The place where a non-resident’s name and business are listed in a directory;
- The location of inventory;
- The location of a branch office; and
- The place where the non-resident’s agents or employees are located.
All relevant factors such as these should be considered in making the determination of whether a non-resident is carrying on business in Canada.
Understanding the impact of tax conventions
Where Canada has a tax convention with a non-resident’s country, and where the non-resident is considered to be carrying on business in Canada, the tax convention determines to what extent the profits arising in Canada are taxable. Under most tax conventions, only those profits that are attributable to a permanent establishment (“PE”) in Canada are taxable in Canada.
Most tax conventions into which Canada has entered are based on the OECD model, but for the purposes of this discussion, let’s focus on the Canada-US convention (“the Treaty”).
Fixed place of business
The Treaty defines a PE to include a fixed place of business through which the business is wholly or partly carried on; it includes: a place of management; a branch; an office; a factory; a workshop; and a mine, an oil or gas well, a quarry, or any other place of extraction of natural resources.
The Treaty further expands the definition of a PE to include any building, construction site, or installation project that lasts longer than 12 months; similarly, the Treaty expands the definition to include any installation, drilling rig, or ship in the exploitation of natural resources that is in use for more than three months during a 12-month period.
The Treaty includes a provision that will cause a PE in Canada if a dependent agent in Canada has and habitually exercises in Canada the authority to conclude on contracts. Under this provision, a non-resident does not have to have a fixed place of business to have a PE in Canada. Note, however, that the provision will not apply if the agent is both legally and economically independent.
The Treaty includes provisions to capture the growing services sector. A services PE is deemed to exist if a non-resident person/company provides services in Canada in certain circumstances. Even if there is no fixed place of business, a services PE could still be created if:
- Services are provided for more than 183 days by an individual in any 12-month period, and more than 50% of the gross active business revenue earned by the non-resident during that period consists of income derived from services performed in Canada; or
- Services are provided for 183 days or more and relate to the same or connected projects for customers in Canada.
Preparatory or auxiliary services
The Treaty exempts certain activities of a preparatory or auxiliary nature from constituting a PE, even if they are being carried on through a fixed place of business. These activities could include the storage or display of goods, the maintenance of inventory for the processing or collection of information, and other activities of a preparatory or auxiliary nature (such as advertising, the supply of information, and scientific research).
Canadian tax compliance requirements
Generally, all non-resident corporations carrying on business in Canada are required to file an annual Canadian corporate income tax return. Canadian corporate tax returns are due six months after year-end (for example, a June 30 due date for a December 31 year-end). While the Treaty (or another tax treaty) may grant a company relief from Canadian income taxes, the requirement under the Act to file a Canadian income tax return still exists if the company is carrying on business in Canada. In such cases, the company should file a Canadian corporate income tax return, claiming the treaty exemption, by the filing due date.
A non-resident of Canada who carries on business in Canada through a PE is subject to the ordinary principles contained in the Act for the calculation of taxable income and must pay corporate income tax on any taxable income attributable to the PE.
The business income of a US company’s Canadian PE should be calculated as if the PE were a separate and distinct person engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the head office and with any other person related to the company. Accordingly, the transfer pricing policies should be applied to ensure that the income of the PE correctly reflects compensation for the PE’s activities in Canada.
In addition to being subject to Canadian corporate income taxes, a non-resident corporation carrying on business in Canada through a PE (branch) will also be subject to a branch tax of 25% on any after-tax profits that have not been reinvested in qualifying property in Canada. This branch tax essentially replaces the dividend withholding tax that would be payable on dividends if the non-resident carried on business in Canada through a Canadian subsidiary.
Non-residents should also be aware of the withholding taxes they could face, and should determine if they are eligible to apply for a waiver to have withholding taxes reduced. Generally, in Canada, anyone who pays a non-resident a fee, commission, or other amount for services rendered in Canada needs to deduct and withhold 15% tax from such payments; this includes non-residents who pay other non-residents for services rendered in Canada.
Non-resident companies need to understand the Canadian corporate tax rules and review all of their activities in Canada with the rules in mind. These activities will determine if they are carrying on business in Canada, and if they have a PE in Canada to which profits can be allocated. Failure to comply with the related income tax and tax filing requirements could lead to penalties and interest.
Melanie Campbell is a manager with PricewaterhouseCoopers in Vancouver, and is part of the technology tax services group, which specializes in providing tax consulting to private and public companies.
Sherri DuMerton is a manager with PricewaterhouseCoopers in Vancouver, and is part of the technology tax services group, which specializes in providing tax consulting to private and public companies.
- Included in the OECD action points are permanent establishments and the digital economy.
- Income Tax Act 2(3) – Tax payable by non-resident persons and ITA 219(1) – Additional tax (branch tax).
- ITA (Canada), R.S.C. 1985, c.1 (5th supplement) as amended. All statutory references herein are to the Act, unless otherwise noted.
- ITA 248(1) defines a servant or employee as a person holding the employment position of an individual in the service of some other person.
- ITA 253(b).
- See “Carrying on Business in Canada,” Report of the Canadian Tax Journal, 1995 (Vol. 45, No. 5), for a synopsis of the jurisprudence vis-a-vis “carrying on business,” as well as the CRA’s administrative position.
- CRA Audit Manual, Section 15.2.7.
- Article VII(1) of the Canada – US Treaty (“the Treaty”).
- The Treaty refers to the “Convention between the Government of the United States of America and the Government of Canada with Respect to Taxes on Income and on Capital,” which was signed September 26, 1980, and amended by protocols signed June 14, 1983; March 28, 1984; March 17, 1995; July 29, 1997; and September 21, 2007.
- Article V(1) of the Treaty.
- Article V(2) of the Treaty.
- Article V(3) of the Treaty.
- Article V(4) of the Treaty.
- Article V(5) of the Treaty.
- Article V(9) of the Treaty was introduced in 2010 for an enterprise in a contracting state that provides services but does not have a PE by virtue on any other paragraph.
- Article V(9)(a) of the Treaty.
- Article V(9)(b) of the Treaty.
- Article V(6) of the Treaty.
- Branch tax is reduced to 5% under the Treaty Article VII(2).
- Article VII(2) of the Treaty.
- ITA 219(1).