Generally, U.S. taxpayers who are carrying on business in Canada are required to calculate profits attributable to Canada and pay the related Canadian income tax. However, the U.S.-Canada income tax treaty provides some relief, as it sets forth a higher standard that must be met before becoming subject to the Canadian income tax.
The treaty provides that U.S. taxpayers must have a “permanent establishment” (PE) in Canada in order to be liable for Canadian income taxes. There are a number of activities that can create a PE. A classic example would be an office building or other fixed place of business. However, other activities can create a deemed PE, including a sales person with the ability to approve orders or an employee providing services for an aggregate of 183 days or more in any 12-month period. These activity-related PE provisions apply not only to employees but also to independent contractors such as consultants and service providers.
Keep in mind that even if the treaty provides you with income tax relief for your Canadian business activities, it still may be necessary to file a Canadian income tax return to claim this treaty position — formally letting the Canadian Revenue Agency know that your business activities do not rise to the level that would create income tax liability.
So what happens if your activities do create a PE in Canada? You will be subject to Canadian income tax on attributable profits. However, income taxes paid to Canada are eligible for a foreign tax credit (dollar-for-dollar reduction) against U.S. tax, subject to certain limits. Proper planning can ensure this credit is maximized, thereby reducing worldwide taxes.
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Notwithstanding that these materials do not constitute legal, accounting or other professional advice, as may be required by United States Treasury Regulations and IRS Circular 230, you should be advised that these materials are not intended or written to be used, and cannot be used by you or any other person, for the purpose of avoiding penalties that may be imposed under federal tax laws. No written statement contained in these materials may be used by any person to support the promotion or marketing of or to recommend any federal tax transaction(s) or matter(s) addressed in these materials, and any taxpayer should seek advice based on the taxpayer’s particular circumstances from an independent tax advisor with respect to any such federal tax transaction matter.