U.S. – Canada Cross Border Tax

KYLE LODDER CPA

Lodder CPA PLLC email kyle@loddercpa.com | phone (360) 599-4340mailing address PO BOX 373, Lynden, WA 98264

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Discussion Topics Individual Tax Business Tax

◦ Federal Tax / Permanent Establishment◦ State Tax◦ Sales Tax◦ Entity Structuring

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Individual TaxU.S. citizens and residents – Worldwide taxation

Nonresidents – taxed only on U.S. income

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U.S. Tax ResidencyGreen card holders (permanent resident status)

Substantial presence testMore than 30 days present in the United States in the current year, and:183 days or more during the 3-year period that includes the current year and the 2 previous years, counting:All the days in the current year1/3 of the days in the prior year1/6 of the days from two years ago

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U.S. Residency ExceptionsCloser Connection Exception for individuals spending less than 183 days in the current year in the United States, who have a closer connection to another country. Individual must file IRS Form 8840

Canada – U.S. Treaty tie breaker rules for individuals treated as residents of both countries.When relying on the treaty, disclosure is required. Individual must file IRS Form 8833 with nonresident return.When relying on the treaty, individual is required to file additional disclosure forms that would be required of a U.S. resident (reporting foreign assets).

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Business TaxWhat does it take to trigger U.S. federal income tax?

A foreign corporation engaged in a trade or business in the United States shall be taxable on income which is effectively connected with the conduct of a trade or business within the United States

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Canada – U.S. Income Tax Treaty – Business profitsFortunately, the Canada – U.S. tax treaty provides certain relief. Under the treaty, business profits of a Canadian corporation are only taxable in the United States if they are attributable to a Permanent Establishment in the United States.

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Permanent establishment• A place of management• A branch• An office• A factory• A workshop• A mine, an oil or gas well, or quarry• An agent who has and habitually exercises an authority to

conclude contracts• For service providers, generally if individuals spend 183 days

or more in the U.S. • A warehouse does NOT constitute a permanent

establishment

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Canada–U.S. Income Tax Treaty – Business profitsIf a Canadian business has business profits in the United States, but no permanent establishment, it must file a federal income tax return to claim the benefits provided by the U.S.—Canada tax treaty. If no treaty claim is filed, federal income tax can potentially be imposed on the gross income earned in the United States without the benefit of any business deductions.

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Taxation of Canadian Branch vs. US. Subsidiary

Canadian branch taxed on earnings effectively connected to a U.S. trade or business at graduated rates. Taxed on investment income at 30% unless reduced by treaty.

U.S. corporation is subject to worldwide taxation. Generally, when a U.S. corporation is set up as a subsidiary of a Canadian corporation, the U.S. corporation’s activities are confined to the United States

With some exceptions, the federal income tax paid by a Canadian corporation doing business in the United States is very comparable to a U.S. corporation with U.S.-only activities

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Taxation of Canadian Branch vs. US. Subsidiary Canadian branch has a $500,000 exemption from branch profits tax in U.S. under treaty.

Non-tax issues may warrant the use of a U.S. subsidiary including:◦ U.S. business partner◦ U.S. banking◦ Liability protection◦ Transfer pricing◦ Immigration planning for employees

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Corporate Federal Income Tax RatesFor Taxable Income Up to $10MM

34%

39%

34%

25%

15%

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State Tax Considerations

U.S. federal corporate income tax may not be the first or most important tax issue for Canadian businesses operating in the United States

State income tax and state sales tax issues may deserve at least as much, if not more attention than federal income tax issues

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Corporate state income taxState Rate

Arizona 6.5% $50 min.

California 8.84% $800 min.

Colorado 4.63%

Idaho 7.4% $20 min.

Hawaii 4.4 – 6.4%

Montana 6.75%

Nevada 0%

Oregon 6.6 – 7.6%

Texas 0% Franchise tax on Texas earnings & capital

Washington B&O Gross revenue tax 0.5 – 3.3%

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State Tax Considerations States generally don’t follow federal tax laws or treaties 13,000+ state and local jurisdictions that impose taxes on businesses

NEXUS – minimum presence in a state subjecting company to tax in that given state

NEXUS standards differ by state and by local jurisdiction Differing NEXUS standards for income tax and sales tax

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State nexusMay be created by: Warehouse Other physical place of business Employees Independent Reps Activities of business partners Economic nexus

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Sales Tax Considerations

No federal or national sales tax Sales tax imposed by 45 states + DC Sales tax imposed by local governments GENERALLY, sales tax must be collected if a business has sales tax NEXUS, and retail sales of:◦ Tangible property◦ Downloadable software◦ Certain services

Wholesalers generally not subject to sales tax. May need to register with states in order to obtain a resellers certificate or permit. LODDER CPA

Sales Tax Considerations When a business has sales tax NEXUS, it must collect and remit sales tax to the appropriate state/local tax jurisdiction.

Buyer bears the responsibility of paying the sales tax, but it is the seller who is responsible for collection and remittance.

State/local government will require seller to pay tax on behalf of buyer if they did not collect it

U.S. buyers are generally accustomed to paying sales tax on retail purchases

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State Tax Considerations Collection/remittance of sales tax can be a large administrative burden

Consider state income tax, franchise tax, gross revenue tax, payroll tax, property tax, etc.

Many states impose a “minimum tax” “for the privilege of doing business” in that state – even if there is a loss from business operations

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State Tax Considerations State nexus is a much lower standard than permanent establishment. It is VERY common for Canadian businesses to not have a permanent establishment but to have state nexus.

In these cases, a protective return is filed for federal tax purposes.

Most states base their tax calculations from the federal tax return. A “hypothetical” federal return must be prepared, not to be filed, but to be used for state tax return preparation purposes.

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Economic nexus “Economic NEXUS” - Earning profits from a state while having no physical presence in that state.

Standards differ by jurisdiction California standard: 25% of worldwide income or $500,000 Public Law 86-272: State income tax exception if business activity is within solicitation standards. Only applies to the sale of tangible personal property. Not applicable to foreign entities.

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Entity structuring State nexus rules must be considered in entity structuring When there is a Canadian parent company and a U.S. subsidiary, the Canadian parent may inadvertently attract state nexus in addition to the U.S. sub. Example:◦ Parent has U.S. reps soliciting sales ◦ U.S. sub has reps providing services◦ Both entities may have state nexus

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Entity structuring “C” corporation “S” corporation typically not available to Canadians, although widely used in the United States.

Limited Liability Companies (LLCs) typically not used in a U.S. – Canada cross border setting as double taxation can result. A U.S. LLC is not the same as a Canadian corporation. LLCs are commonly used in the United States, but usually not the right choice for Canadians.

Various partnership forms (LP, LLP, LLLP) used for Canadian investment in U.S. real estate.

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Example - Internet sales only

Canada

U.S.

• No physical presence in the U.S.• Process orders by internet, phone, or e-mail from Canada• No salespeople or other representatives enter the U.S.• Product shipped via courier (UPS, FedEx, etc.)• All services performed in Canada• No U.S. federal income tax, may be required to file treaty-based

return, may have economic nexusLODDER CPA

Example - Service Providers

Canada

U.S.

• No permanent establishment in the U.S.• Providing services in U.S.• Generally no federal taxation, if <183 days in U.S.,

but should file protective return• State taxation, generally

Canadian Company

Example – Service Provider

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Example - Warehouse

Canada

U.S.• Physical presence in the U.S.• Salespeople may enter the U.S., but do not

have or habitually conclude contracts• No federal taxation, but should file protective

return• State income taxation, generally

Send Salespeople Without Contracting Authority

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Example – Warehouse

Canada

U.S.• Physical presence in the

U.S.• Salespeople may enter the

U.S., and have and habitually exercise contracting authority

• Federal and State taxation

Send Salespeople With Contracting Authority

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Profit repatriation Management fees

◦ Important to have consistent and complete documentation◦ Not taxed to Canadian parent if services provided in Canada

Loan repayment◦ Loans must have stated rate of interest equal or greater than

the IRS applicable federal rate (“AFR”) at the time the loan is established

◦ If no loan document, no stated interest rate, or the interest rate is less than the AFR, interest may be imputed, which could lead to a deemed dividend

◦ 0% tax rate on interest under treaty. Parent must properly complete Form W-8BEN-E prior to receiving interest payments

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Profit repatriation Dividend

◦ 5% rate under the treaty if the Canadian parent owns 10% or more of the U.S. subsidiary

◦ Parent must properly complete Form W-8BEN-E prior to receiving dividend payments

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FATCA Significantly more reporting requirements for U.S. entities paying Canadian entities

May require Canadian corporation to obtain an Employer Identification Number (EIN) to satisfy U.S. customer requirements◦ Form W-8ECI – Income effectively connected to a trade or

business in the United States◦ Form W-8BEN-E – All other U.S. sourced income. Must

determine FATCA status (“Chapter 4” status)

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QUESTIONS?

KYLE LODDER CPA

Lodder CPA PLLCemail kyle@loddercpa.com | phone (360) 599-4340mailing address PO BOX 373, Lynden, WA 98264

loddercpa.com