There are U.S. tax implications and considerations that may impact your business when you expand into the United States. These considerations are particular to each venture’s circumstances when conducting business in the U.S. market.
Under the Canada-U.S. tax treaty, a Canadian corporation is taxable in the U.S. on its U.S. profits if the company carries on business through a U.S. PE for U.S. federal income tax purposes. When an employee has and habitually exercises the authority to conclude contracts in U.S., the Canadian corporation would be considered to have a U.S. PE. Profits attributable to the U.S. PE would be subject to U.S. federal income tax.
What if the employees are contractors? It is important to assess the key roles and responsibilities to determine if a contractor truly operates as an independent contractor. If they could be viewed as dependent agents/employees, U.S. PE could be triggered.
Other U.S. tax implications
For Canadian corporations that sell into the U.S., besides U.S. federal income taxes, they should also consider state income tax, sales and use tax and other taxes.
For sales and use tax, after the Supreme Court ruled in the case of South Dakota v. Wayfair on June 21, 2018, more than 40 states enacted economic nexus rules for assessing sales tax in lieu of the physical nexus rules.
Companies should be aware of the economic nexus standards when starting to sell into the States in order to assess tax exposure and determine the necessary tax filings.
When a Canadian corporation sends employees to the U.S. to perform employment duties, doing so may trigger U.S. payroll reporting obligations at the corporate level and U.S. individual tax compliance at the employee level for both U.S. federal and state tax purposes. The Canadian corporation is required to withhold and remit payroll source deductions to the U.S. federal and state/local (if applicable) tax authorities on the employees’ compensation derived from their presence in the U.S. and issue the Form W-2 (the U.S. equivalent of Canada’s T4) to the employees at year-end. For employees whose income is exempt from U.S. income taxation by virtue of the Canada-U.S. tax treaty, alternative procedures are available to apply for a waiver of payroll source deductions. The employees are required to file U.S. federal and state/local (if applicable) individual income tax returns annually for every year they perform the employment duties in the U.S., even if their income could be treaty exempt from U.S. income taxation.
Canadian corporations should start tracking the number of days their employees are in the U.S. in order to assess and comply with U.S. payroll reporting obligations. U.S. individual tax filing obligations should also be considered for the employees themselves.
Key take-away: In general, when a Canadian corporation expands into the U.S., whether the corporation starts selling into the U.S. or anticipates opening an office in the U.S., the corporation should consider the potential U.S. corporate federal income tax, state income tax, state and local sales and use tax, payroll tax and other tax implications.
The Canada-U.S. treaty provides a list of activities that could trigger a U.S. PE. If a company’s activities in the U.S. do not give rise to a U.S. PE, that company should still consider filing a U.S. treaty protective return if it has sales from the U.S. This does not mean you have to pay federal income tax, but you can be protected from penalties or the risk of losing U.S. expense deductions if the IRS disagrees with the treaty filing position.
Many states have implemented economic nexus rules, and some states require state income tax filings based on a certain sales threshold. Even if there is no physical presence, you should monitor your sales in each state and assess state income nexus. The state income tax nexus rules are different from sales tax nexus rules and should be separately assessed.
Key take-away: A company should assess its activities and determine if it has a U.S. PE and whether it can file a federal treaty protective return. The company should also assess state income tax, sales and use tax, and other tax exposure. Understanding the tax risk helps to manage the tax exposure and determine the best structure for expansion into the U.S.
When a Canadian company’s U.S. activities give rise to a U.S. PE, the company may want to consider forming a U.S. corporation to conduct the U.S. business.
While each business is different, there are a few business-friendly states in which to incorporate a U.S. company. Delaware, Wyoming and Nevada are popular due to relatively low fees, no or limited state-level tax, and their corporate laws. You should consult your lawyer and accountant when choosing the state of incorporation.
When setting up a U.S. corporation, you should review the activities conducted by the Canadian company and U.S. company to optimize a structure that minimizes Canadian and U.S. tax exposure, aligns the cash flow with the business plan and repatriates profit back to Canada in a tax-efficient way. You should also develop an effective transfer pricing strategy.
A Canadian company will have additional Canadian tax filings relating to the U.S. company, which is a foreign affiliate. If the cross-border intercompany transactions exceed $1M, the Canadian company will also need to file a Form T106.
You should also consider the costs of setting up a U.S. corporation, including, but not limited to, incorporation expenses, annual tax expenses, costs to comply with tax and legal requirements, and bookkeeping and accounting costs.
Key take-away: The decision to set up a U.S. corporation should be based on business growth. You should assess tax and legal exposure and consider costs related to incorporation. Before expanding into the U.S., or when your U.S. activities change, you should review the tax exposure and determine whether and when to form a U.S. corporation.