Do you do business in the United States? Here is everything you need to know about tax obligations
Thinking about expanding your business into the United States? The U.S. market offers many opportunities, but it also has its own set of rules, especially regarding taxes. Many Canadian companies start this process unaware that they might have tax obligations in the U.S., even if they don’t have an official office there.
Here’s what you need to know to avoid unpleasant surprises.
What triggers U.S. federal tax for a Canadian company
Under U.S. tax law, a foreign corporation – such as a Canadian company – may be subject to U.S. federal income tax if it derives income “effectively connected with the conduct of a trade or business in the United States”. The law does not clearly define what it means to “operate a business” in the United States, but the IRS (Internal Revenue Service) has established specific criteria.
Here are a few examples of activities considered significant:
- Soliciting and/or closing sales with U.S. customers
- Keeping goods in storage in the United States
- Providing services on U.S. soil by Canadian or U.S. employees
- Use Canadian or U.S.-based subcontractors on U.S. territory
Remember: The threshold of activity required is relatively low. Even a non-permanent but regular presence can be enough to trigger tax obligations.
The effect of the Canada-U.S. tax treaty
Fortunately, the bilateral tax treaty between Canada and the U.S. provides some relief. For example, if your company does not have a permanent establishment in the U.S., you may not be taxed on your U.S. income, provided you meet certain conditions and fill out the right forms.
What is a permanent establishment?
This is a significant, fixed commercial presence in the United States, such as:
- An office or branch
- A factory, or a construction or assembly site lasting more than 12 months
- The presence of an employee, salesperson, or representative in the United States, authorized to enter into and/or negotiate the terms and conditions of contracts
- Have employees who travel to the U.S. for more than 183 days within any 12-month period for the same project
Remember: Even without a physical office, a Canadian company may be considered to have a permanent establishment.
However, even without a permanent establishment, Canadian companies must still file a U.S. tax return. In fact, even if you have no physical presence in the U.S., your company may still need to file a U.S. tax return (Form 1120-F) to claim exemption under the tax treaty.
This includes:
- Form 8833 (declaration of position based on a tax treaty)
- Employer Identification Number (EIN)
Be aware of deadlines: This declaration must be filed on or before the 15th day of the 6th month following the end of the fiscal year. Failure to do so may result in penalties of up to US$10,000.
Withholding taxes: what your American customers need to know
U.S. clients are required to determine whether you are a foreign entity and validate your U.S. tax liability. If they don’t receive the correct forms, they could withhold up to 30% of your payments.
To avoid this, you’ll need to provide them with Form W-8ECI (and have an EIN). Without this form, you’ll have to file a U.S. tax return to obtain a refund of the tax withheld at source.
U.S. states: different rules from federal ones
Even if you’re not taxable at the federal level, U.S. states may tax you according to their own rules. And the bad news is that the Canada-U.S. tax treaty doesn’t automatically apply to them.
Here are a few examples:
- A state can tax a Canadian company simply because it makes sales there, even without an office
- Some states require a declaration if you exceed a certain income threshold in their territory
- Others may impose sales or franchise taxes, or even mandatory registration fees
The “nexus” concept is a frequently used term. It refers to the minimum connection needed (such as physical presence, economic presence based on sales thresholds, or employee presence) for a state to impose taxes.
What about sales tax?
Sales tax rules in the U.S. are complex. Unlike Canada, each state (and sometimes each county or municipality) can have its own rules.
Even without an office, your company may be required to:
- Register with state tax authorities
- Collect and remit applicable sales tax
- Produce periodic declarations
Things to remember
Doing business in the United States is an excellent opportunity… but also an exercise in fiscal prudence. Even if you don’t have employees or an office there, your company could still be subject to tax, or at least have to file certain tax returns.
Here are the 5 key points to remember:
- Any regular business activity in the United States may give rise to tax obligations
- The Canada-U.S. tax treaty can protect you with the IRS… as long as you respect it and file the right tax forms
- Individual counties have their own tax rules, and not all of them recognize the tax treaty
- Penalties apply for failure to file, even if no U.S. tax is due
- Good tax advice is essential to limit risks
Targeting the U.S. market? Please contact us.
At Demers Beaulne, our team of U.S. and international tax specialists can help you:
- Determine whether your company has U.S. tax obligations
- Structure your operations to reduce your tax burden
- Prepare and produce required forms (1120-F, 8833, W-8ECI…)
- Navigate the tax requirements of the states where you do business
Don’t wait for the IRS to call. Contact us today to start (or continue) your U.S. growth on the right foot.
Article written by: Marie-Claude Péthel, CPA | Partner, U.S. and International Tax Department Leader Gerry De Luca, CPA | Partner, U.S. and International Tax