Information Technology and other Canadian resident professionals who work in the United States, either as employees or as self employed contractors, either independently or through their own corporations face some unique situations.
"I have an opportunity to work in the United States – what, if anything, should I be concerned with as far as the income tax issues are concerned?" – This is a common question these days, with NAFTA in full swing and with job offers being made to Canadian professionals. The description below assumes you are considered a resident of Canada for income tax purposes. Although this may be the case, you may also be considered a resident of the United States as a result of factors in your visa status, time in the U.S., funds earned in the U.S., etc., or you may be subject to U.S. compliance filing even if you are not considered a resident.
After you have reviewed the description below, please contact us for a consultation to determine the appropriate application of these topics, and perhaps other areas, to your specific situation.
1. Canadian Operations
(a) Active Business Corporations & Small Business Deduction
A corporation, or an incorporated company is considered a separate legal entity under Canadian law, and as such must account for its income, expenses, assets and liabilities separately from that of its shareholders. As a result of this more complex and costly form of organization, there are several advantages (in a legal sense) including the ability to insulate the shareholders from legal actions, limiting the liability of shareholders to that invested in, loaned to or guaranteed on behalf of the corporation, and the ease of banking and financial transactions.
From an income tax viewpoint, a corporation operating in Canada must file a federal income tax return (form T2), a provincial income tax return, and a full set of financial statements each year, and must pay tax on its net income after deducting all expenses attributable to earning income from its source of endeavor, including salaries to its principals or shareholders.
Many active business corporations are organized in such a manner as to minimize overall taxation between the corporation and its shareholders, by optimizing the distribution of earnings to shareholders as between salaries and dividends to the principals and family members involved in the operations of the corporation, and by using year ends other than the calendar year to defer taxation of certain income, or to defer the taxation of payments to principals to future periods. In Canada, an active business corporation may also choose not to distribute all of its income, and to then use the corporation as a repository of investment funds, which will not attract further taxation at the personal level until withdrawn from the corporation.
The combined federal and provincial income tax rate payable in Ontario on the first $200,000 per year of corporate net income for a non associated Canadian Controlled Private Company (CCPC) for active business income carried on in Canada is approximately 23%, which is quite a bit less than the top personal marginal rate (of about 53%). Applicable to the 1985 and subsequent taxation years subsection 125(7), defines"active business carried on by a corporation" to mean any business carried on by the corporation other than a specified investment business or a personal services business and includes an adventure or concern in the nature of trade. Subsection 248(1) defines business as follows: "business" includes "a profession, calling, trade, manufacture or undertaking of any kind whatever and, except for the purposes of paragraph 18(2)(c), section 54.2, subsection 95(1) and paragraph 110.6(14)(f), an adventure or concern in the nature of trade but does not include an office or employment". Thus every type of business activity carried on in Canada is eligible for the small business tax deduction under subsection 125(1) except those falling within the category of a specified investment business or a personal services business. Income from investments (or property, unless incidental to the active business income) also does not qualify for the small business deduction.
Revenue Canada Interpretation Bulletin IT75-R5 defines the Meaning of "Carried On in Canada" for the purposes of the small business deduction as follows:
"10. Whether or not a particular business is carried on in whole or in part in Canada is a question of fact. ............. When a corporation's business involves the rendering of services, that business is carried on in Canada only to the extent that services are rendered in Canada, necessitating an apportionment of net business income on a reasonable basis. Income derived from property, ancillary to the activities involved in carrying on a business, that is categorized as income from an active business may also have to be apportioned on a reasonable basis having regard to the place where the related business is carried on."
If you provide personal services in the United States or elsewhere outside Canada and are paid through your own corporation - you may not claim the small business deduction, which means that all corporate income must be expensed as salary to yourself, and will attract tax at the personal tax rate.
Under these circumstances the use of a corporation may not be advantageous, unless the use of a corporation is required by the "client" company to ensure that no employment related benefits are inadvertantly conferred upon you. Many personnel and placement agencies require that a corporation be used for this purpose, and the use of a Canadian corporation cannot worsen your tax position.
(b) Personal Service Corporations - Canada
Paragraph 125(7) of the Income Tax Act (Canada) defines a "personal services business": ""personal services business" carried on by a corporation in a taxation year means a business of providing services where
and paragraph 18(1)(p) limits the deductions that can be claimed by a personal service corporation to very specific items:
"18(1)(p) limitation re personal services business expenses — an outlay or expense to the extent that it was made or incurred by a corporation in a taxation year for the purpose of gaining or producing income from a personal services business, other than
(i) the salary, wages or other remuneration paid in the year to an incorporated employee of the corporation,
(ii) the cost to the corporation of any benefit or allowance provided to an incorporated employee in the year,
(iii) any amount expended by the corporation in connection with the selling of property or the negotiating of contracts by the corporation if the amount would have been deductible in computing the income of an incorporated employee for a taxation year from an office or employment if the amount had been expended by the incorporated employee under a contract of employment that required the employee to pay the amount, and
(iv) any amount paid by the corporation in the year as or on account of legal expenses incurred by it in collecting amounts owing to it on account of services rendered that would, if the income of the corporation were from a business other than a personal services business, be deductible in computing its income;"
Therefore, even if your business endeavors involve the provision of personal services in Canada, and you provide services to only one or a few companies in such a manner that you would be considered an employee if it were not for your corporation (i.e., exclusivity of your contract, control by the "customer" over your activities, an office in the "customer's" premises, business cards identifying you as an officer or employee of the "customer" or others), you will not be able to deduct any expenses except those available to employees in the same situation, and will not be eligible for the small business deduction.
If these circumstances apply to you, the corporate form of organization in Canada may not be beneficial to you.
(c) Proprietors or self-employed individuals in Canada
The last distinction, which must be made, is whether you are "self employed" or whether you are an "employee". Considerable changes have been made recently in this area, and in 1986 a tax case before the Canadian Federal Court of Appeal - Wiebe Door Services Ltd., Applicant, and Minister of National Revenue, Respondent  2 C.T.C. 200 Docket No. A-561-85 established that a wider range of contractors are considered as self employed. Generally, an individual accepting placements through an agency in Canada will be considered self employed if his terms of engagement define him as such.
A self employed individual includes income from self employment on form T2124 of the personal income tax return, must file on a calendar year basis, and may deduct any reasonable expense which is required to earn income from the source of self employment, including office in the home, salaries to assistants, vehicle expenses, and other expenses.
The self-employed individual will therefore include net income on his Canadian Individual Tax Return (T1) and will be taxed at the personal rates of tax applicable to that level of income in each year.
(d) GST - Goods & Services tax in Canada
You MUST register for the GST if you are a person, business or organization operating in Canada with worldwide revenues from taxable supplies of goods and services over $30,000 in any four consecutive calendar quarters. Only by registering are you able to recover the GST you pay on business purchases you make while bringing your taxable product or service to market. GST is charged at a rate of 7%. Businesses registered for the GST are able to claim input tax credits input tax credits (ITCs) for GST paid or payable on business purchases.
(a) Canadian corporation doing business in the U.S.
A Canadian corporation owned by a person who provides personal services in the U.S., and which is paid for the services of the individual is liable to file a U.S. 1120F U.S. Income Tax Return for a Foreign Corporation. It may, however be exempt from taxation under Article XIV of the Canada U.S. Protocol relating to Independent Personal Services.
The Canadian corporation may also have the obligation to withhold and remit income tax on behalf of the shareholder/employee providing services in the U.S. In this regard, let us look at the Internal Revenue Service Revenue Ruling 92-106:
Rev. Rul. 92-106 1992-49 I.R.B. 7, 12/07/92 -- IRC Sec. 3402 includes four situations. Situations 1 and 2 apply to U.S. citizens.
".... In Situation 3, a nonresident alien performs work within the United States as an employee of a U.S. person. In Situation 4, a nonresident alien performs work within the United States as an employee of a foreign person. The Service ruled that wages paid to the nonresident aliens in those two situations are subject to income tax withholding and FICA and FUTA taxes. The Service reasoned that the wages are effectively connected with the conduct of a trade or business in the United States. Furthermore, it said that assuming the section 864(b)(1) exception (for temporary residents) does not apply to Situation 4, the wages are subject to graduated tax rates under section 871(b) and to income tax withholding under section 3402(a)...
Therefore, a Canadian corporation or individual paying salary or wages to an individual must withhold taxes (see "Treaty Issues" below). These wages and withholdings are reported on form 1042S, which must be filed with the IRS together with form 1042 each year, whether or not any withholdings are made.
(b) U.S. personal service corporations - definition
Special rules apply in the United States for personal service corporations. These rules essentially prevent the type of corporate organization that would provide a benefit to the taxpayer, which greatly exceeds that which would be available to him as an employee. This doctrine is quite different than the principle used in Canada, and carries on to prevent the accumulation of income within a corporation, and the use of a year-end other than the calendar year to defer taxes. Personal service corporations are taxed at a flat federal rate of 35%.
A taxpayer is a personal service corporation if it meets all of the following four tests:
Generally, a personal service corporation must use a calendar year (unless some revenue pattern conditions are strictly met). In examining personal service corporations, it is important to look at Proposed Regulation § 1.269A-1:
"Personal service corporations.
(a) In general
Section 269A permits the Internal Revenue Service to reallocate income and tax benefits between personal Service corporations and their employee-owners to prevent evasion or avoidance of Federal income taxes or to reflect clearly the income of the personal service corporation or any of its employee-owners, if:
(1) Substantially all of the services of the personal service corporation are performed for or on behalf of one other entity, and
(2) The principal purpose for which the corporation was formed or availed of is the evasion or avoidance of Federal income tax. Such purpose is evidenced when use of the corporation either reduces the income of any employee-owner, or secures for any employee-owner one or more tax benefits which would not otherwise be available.
The term "tax benefits" means any expense, deduction, credit, exclusion or other allowance which would not otherwise be available. The term includes, but is not limited to: multiple surtax exemptions being claimed by the owners of a single integrated business operation conducted through multiple corporate entities, accumulation of income by the corporation, the corporate dividends received deduction under section 243, deferral of income of an employee-owner through the use of a corporation with a fiscal year or accounting method differing from that of such employee-owner, the use of multiple classes of stock to deflect income to taxpayers in lower tax brackets, group-term life insurance (section 79), certain accident and health plans (section 105 and 106), certain employee death benefits (section 101), meals and lodging furnished for the convenience of the employer (section 119), and qualified transportation expenses (section 124). ..."
Therefore, a corporate form of organization for individuals providing personal services within the U.S. is generally not beneficial to Canadian residents. U.S. citizens and residents, however, may take advantage of S Corporation status, which changes the method of income reporting.
Under these circumstances, the individual falls under the Canada U.S. Protocol - Article XIV - "Independent Personal Services", which states:
"Income derived by an individual who is a resident of a Contracting State in respect of independent personal services may be taxed in that State. Such income may also be taxed in the other Contracting State if the individual has or had a fixed base regularly available to him in that other State but only to the extent that the income is attributable to the fixed base."
Therefore all self-employment income is exempt from U.S. taxation, irrespective of amount or time spent in the United States, so long as it is paid to them personally as self-employed individuals, unless the individual has a fixed base in the United States. The Canadian individual could be deemed to have a permanent establishment in the U.S. if:
Assuming that the individual is not deemed to have a permanent establishment in the U.S. and the individual has no other dealings in the U.S., it is recommended that the following filings be made:
(d) Treaty issues - Working through a Canadian corporation in the U.S.
This filing position applies to persons who:
Under these circumstances, the individual falls under the Canada U.S. Protocol - Article XV - "Dependent Personal Services", which states:
"Subject to the provisions of Articles XVIII (Pensions and Annuities) and XIX (Government Service), salaries, wages and other similar remuneration derived by a resident of a Contracting State in respect of an employment shall be taxable only in that State unless the employment is exercised in the other Contracting State. If the employment is so exercised, such remuneration as is derived there from may be taxed in that other State."
This has been defined to mean that employment income is exempt from U.S. taxation unless it is over $10,000 per year. If it is over $10,000 per year, it is exempt only if:
The Canadian corporation will not be deemed to have a permanent establishment in the U.S. by virtue of the employment of the individual, but could have a permanent establishment if:
Assuming that the corporation is not deemed to have a permanent establishment in the U.S., the corporation is exempt under Treaty Article XIV (Independent Personal Services) and if the individual has no other dealings in the U.S., it is recommended that the following filings be made:
3. International Tax Issues
(a) Foreign Tax Credits
For Canadian residents, a tax credit is available for any tax paid on U.S. source income. As a result, the maximum effective rate of tax which is payable is the Canadian rate of tax. It is only through double taxation of corporate dividends that the tax rate would increase.
Therefore, it is not relevant where the taxes are paid, so long as they are paid to the appropriate authority. Most foreign tax credits and other benefits provided by treaties are only available if the returns are filed accurately and on a timely basis.
(b) Social Security Tax and Canada Pension Plan Canada and the U.S. have entered into an agreement concerning Social Security taxes, which prevents double taxation of income in both states. Therefore, if you are a resident of Canada, you may file for a certificate of coverage under the Canada Pension Plan (Form CPT56), which will prevent the deduction of social security taxes in the U.S. Accordingly, you must continue to pay into the Canada Pension Plan or Employment Insurance, as appropriate for this coverage exemption to remain in effect.
(c) Leaving Canada - definition of residence for Canadian tax purposes.
If you have read this far, you may be reaching the conclusion that if you remain a resident of Canada you will be taxed at a very high personal income tax rate, and may be contemplating leaving Canada for tax purposes.
Prior to making that decision, you should ensure that you have a place to go. That is to say, certain visa classifications require that the individual be a resident of Canada in order for the visa to remain in effect. These visa classifications are considered nonimmigrant visas, and may become void if there is an attempt at establishing permanent residence in the U.S. You should seek appropriate legal counsel prior to making any change of residence decisions.
Canada's tax system is based on residence, and the cessation of residence in Canada will eliminate all liability for Canadian tax. In making this decision, however, you must consider the immigration implications of living in the United States, and you should also consider the following factors used in the definition of "residence" for Canadian tax purposes.
According to Revenue Canada Views, released in 1993,
"The meaning or interpretation of the term "resident" or "residence" is not defined in the Income Tax Act. For Canadian income tax purposes the matter of residence, excluding certain deeming provisions under the Income Tax Act (e.g. individuals who sojourn in Canada for 183 days or more in a calendar year are deemed to be resident in Canada throughout the entire year), is a question of fact. The Canadian court system has held that an individual is resident in the place where he, in the settled routine of his life, regularly, normally or customarily lives. That quality is chiefly a matter of the degree to which a person in mind and fact settles into or maintains or centralizes his ordinary mode of living. While the following list does not purport to be exhaustive, material factors include:
1. Permanence & Purpose of the Stay Abroad
2. Residential Ties Within Canada
- must be a degree of permanence to absence from Canada
- return to Canada foreseen at time of departure
- guaranteed employment upon return to Canada
- status with Employment and Immigration Canada
- dwelling place (or places)
- spouse and dependents
- friends and family
- personal property (furniture, automobile, clothing, etc.)
- economic ties (employment, union membership, business, investments
- financial services (bank accounts, credit cards, safety deposit box)
- social ties (membership in professional, social, recreational, or religious organizations)
- provincial and private medical coverage
- social security coverage
- driver's licenses - telephone listings
- subscriptions to newspapers and other periodicals
- Canadian burial plots
3. Residential Ties Outside Canada
- everyone must be resident somewhere
- it is possible to be a dual resident
4. Regularity & Length of Visits to Canada - status generally not affected by occasional return visits to Canada
- return visits on a regular basis may indicate a continuing resident"
Learn more about leaving Canada
4. What is Best for Me?
Every situation is slightly different, and although you have reviewed a significant amount of information, there may be other factors, which may be of significance in your particular situation. Contact us to discuss your unique situation.