Canadian businesses operating in or selling to the United States may be subject to income taxes in the US or they may also need to pay US sales tax. Whether a Canadian startup is subject to US taxes depends on whether it has “nexus” in the US.
The concept of nexus essentially looks at whether a business has a non-trivial presence. It is determined on a state-by-state basis. There are slightly different criteria between nexus for sales tax and nexus for income taxes. In determining whether your Canadian business has nexus, consider if your business has employees (including those attending trade shows), provides installation or implementation, has inventory stored, or has a physical location or property (including intangible property) in the state.
Bear in mind that rules vary from state to state and even a temporary presence can be enough to have nexus. In Pennsylvania, for example, if a consultant is present in the state for more than seven days, the business is considered to have nexus.
It is also worth noting that if two businesses are affiliated with one another, in determining if one of them has nexus, the operations of the other can be taken into account. For example, in New York, if a business without nexus has as little as 5% cross-ownership with another business that does has nexus, it can result in the first company having nexus as a result of the affiliate nexus rules. Other connections including sharing of intellectual property such as trademarks can also result in the affiliate rules applying.
It is crucial to carefully consider the operations of a business in relation to each state in which it operates or has customers.
A Canadian business with nexus for sales tax purposes in a state will be required to register for a sales tax permit and collect and remit sales taxes like any other business operating in that state.
As with GST/HST in Canada, sales tax rates can vary significantly from one jurisdiction to another. However, in the US, there is no federal portion to the sales tax. The total sales tax that a business must collect and remit is made up of a combination of state and local government rates.
The tax amounts collected must be remitted to the state at least quarterly (although depending on size, a business may need to remit the taxes collected more often). Some local jurisdiction’s sales taxes are reported and remitted to the state (which passes them onto the local authorities), but others require that separate reporting be made.
Most services and some goods are exempt from sales taxes. Additionally, a customer can avoid paying the sales taxes if they present an exemption certificate. This can occur when the use of a product or service is deemed exempt (e.g., if the product is for resale or further manufacturing) or when the customer has been deemed exempt (e.g., a not-for-profit or government organization).
A Canadian business with nexus for US income tax purposes will be required to file a tax return for US federal and/or state income taxes. A business is taxable federally if it has a “permanent establishment.” This is a concept similar to nexus, although it generally takes more to have a permanent establishment than it takes to have nexus. As a result, you may have to pay state income taxes, but not federal income taxes.
The income tax returns will be based on the corporation’s Canadian year-end and taxes may be applied to the business’ net income, or, in some cases, to its gross revenues. When you file your Canadian tax return, you will receive a tax credit for the foreign taxes that were paid. This will decrease the amount of tax you are required to pay in Canada.