January 29, 2008 By Annette Benson
With proper tax planning and structuring of U.S. activities, additional or unnecessary taxes, interest and penalties can be limited or avoided.
As Canadian greenhouse companies expand their business in the United States, they are faced with a multitude of issues and considerations with which to deal. Among the more important considerations are tax issues on both sides of the border.
Many businesses are already selling their produce into the U.S. markets. While the size of the U.S. may be an attractive way to generate more revenue, the risks must be considered.
THE U.S.-CANADIAN INCOME TAX TREATY
From the viewpoint of the U.S., a Canadian company is a foreign corporation. A foreign corporation’s business income can be taxable in the U.S. when it conducts an active trade or business through a permanent establishment (located in the U.S.). Generally, if the business regularly sells produce to U.S. customers, the corporation will be considered to have an active trade or business.
The sale of goods from a Canadian corporation to a U.S. buyer is considered to be a cross-border transaction. Here, the Canada-U.S Income Tax Treaty determines which country has the primary right to tax income from these transactions. The treaty also defines a permanent establishment, which has several intricacies that should be considered.
Typically, a place of management, an office, a branch or other fixed place of business will be viewed as a permanent establishment – a fixed place of business used solely for the storage, display or delivery of goods or merchandise is not. A permanent establishment may also be created by a dependent agent who carries on activities on behalf of the corporation if the agent habitually exercises the authority to conclude contracts in the U.S. that are binding on the corporation.
Is your company taxable in the U.S. or not?
For those companies having an active trade or business in the U.S. but no permanent establishment under the treaty, the U.S. still requires a tax return to be filed in order to claim entitlement to treaty protection (despite no taxes having to be owed).
In certain circumstances, the U.S. tax return required to be filed only requires certain portions of the return to be completed so long as appropriate treaty disclosures have been made. Each failure to disclose a treaty-based return position may result in a penalty of $10,000.
Caution should be exercised in filing treaty-based returns since the Internal Revenue Service (IRS) has the right to review such filings to ensure that companies are not claiming exemption from taxation when in fact they do have a permanent establishment that would be subject to tax. Not filing a return can be a criminal offence and, in those cases where a permanent establishment exists, a significant risk also exists because of the potential loss of deductions.
Companies conducting an active trade or business in the United States through a permanent establishment are also required to file tax returns. When a Canadian corporation has a taxable presence, the income and expenses attributable to the corporation’s permanent establishment should be reported on the U.S. tax return and subject to U.S. taxation at regular U.S. tax rates.
Consideration should also be given to state taxation requirements, as many states do not recognize the benefits of claiming an exemption from tax under the treaty. Each state has its own tax laws and these can vary widely from state to state.
Many states require a physical presence to some extent (also known as “nexus”) in order to establish the state’s ability to tax some of the revenue earned in their geography. In some states this can require as little as two days of activity in their state to create nexus (e.g., Michigan). The physical presence is now being tested in Ohio. A recent change in their law now requires no physical presence in order to impose their new commercial activity tax (“CAT”). A fee will be imposed on sales to Ohio customers starting at gross receipts of $150,000.
If this sounds a little overwhelming, don’t despair. The income tax paid in the U.S. may generally be used (if claimed in time) either as a credit against the Canadian taxes paid or as a deduction in calculating taxable income.
While this article has only scratched the surface of various issues that can arise, a qualified tax practitioner can help you. With proper tax planning and structuring of U.S. activities, additional or unnecessary taxes, interest and penalties can be limited or avoided.
Annette Benson is a senior manager with Deloitte & Touche LLP who practices in the area of U.S. corporate tax. Annette can be reached at 519-967-7786 or at email@example.com.
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