Permanent establishments Canada/US

Normally a permanent establishment under a treaty follows a fairly standard description and needs some sort of office, site, mine, etc.

However, the Canada-US tax treaty adds some specific situations.  

If you are an individual, you will have a permanent establishment in the other country if

1.  services are performed by an individual who is present int he other country for an aggregate of 183 days or more during any 12 month period, and 

2. more than 50% of the gross active business revenues during that period are as a result of those services.

If you are doing business through a company or other enterprise the rules are slightly different.  You will have a permanent establishment if 

1.  services are provided in the other country for 183 days or more in any 12 month period with respect to the same or connect projects 

2. those services are provided to residents or permanents establishments in that other country.

One of the differences between these two calculations is the the calculation of 183 days - for an individual it is the number days present but for a company it is the number of days worked.  For a company, many individuals working on the same day will only count only as one day. 

My book is now on Kobo.

You can now find a copy of "Who Gets My Tax Dollars" on Kobo.

Transfer pricing legislation

For a quick overview of transfer pricing legislation in different countries try this link at the OECD for Transfer Pricing Country Profiles.

Good news for pensioners

If you reside outside Canada and receive a Canadian pension, it is subject to withholding tax when it is paid.  The withholding can be up to 25% depending on whether you are in a country that has signed a treaty with Canada.

The CRA has always allowed pensioners to reduce the withholding under certain circumstances.  Basically, a calculation is done to reduce the overall tax for the year so that the pensioner would pay tax at the same rate as residents of Canada on the income sourced to Canada including the pension.

To get a reduction in the withholding tax, you needed to apply on an annual basis.  Now the CRA is allowing you to apply once every five years.

Of course, you still must file an annual tax return to remain eligible.

CRA's new form for tax years starting January 2011 can be found here.

New Update to Model Tax Convention

The OECD approved the update to the Model Tax Convention with respect to transfer pricing and attributions to permanent establishments.

This has been underway for a large number of years and reflects much negotiation and research.

For more information, see their press release here.

Where does a trust reside?

In Canada a trust normally resides where the trustee is located.  However, if the mind and management of the trust is not with the trustee then the courts have said that a trust resides where the mind and management of the trust is located.  If the trust is considered resident in Canada it must pay taxes on its worldwide income in Canada.

In the US, a trust is a domestic US trust of one or more US persons have authority to control the decisions of the trust.  Don't forget that US persons includes US citizens, whether or not they reside in the US.   If a trust is resident in the US it must pay taxes on its worldwide income in the US.

So if a US citizen, resident in Canada is a trustee of a trust and making the decisions, the trust will be resident in both the US and in Canada under the individual country tax rules.  But the trust shouldn't have to pay full taxes in both countries, that's one of the reasons for the treaty - to eliminate double tax.  

Unfortunately, the treaty does not treat the residency of trusts automatically.  If a trust is resident in both Canada and the US for tax purposes, you must apply to the competent authorities of each country and they, not you, will make the decision on the residence of the trust.

PATA Documentation Package

When you have a company doing business in both Canada and another country you will run into an issue of transfer pricing.  

At its most basic, transfer pricing requires you to accomplish any cross-border transactions between non-arm's length persons the same way as you would if you are dealing with a person at arm's length.  So, if your normally charge $5 for a widget, you cannot charge $20 or $1 to your subsidiary across the border but should charge $5.  As each company is trying to keep the correct tax base, this has become a bigger and bigger issue in recent years.


Easier said than done when you often don't have that easy arm's-lenth comparable.

A large part of substantiating how you determined that arm's-length transaction is keeping the Transfer Pricing Documentation.  As each different country can have different requirements for keeping documentation the process can get cumbersome and expensive for the smaller business owner.  Particularly since penalties for not keeping the documentation can be high.

The Pacific Association of Tax Administrators (PATA) have tried to reduce some of that burden by creating a PATA documentation package.  That means that Australia, Canada, Japan and the United States will all accept documentation that conforms with the PATA package.

Only one set of rules - has to be a good thing.

The PATA Documentation Package through the CRA can be found here and the same thing through the IRS can be found here.

Remember that transfer pricing documentation is contemporaneous documentation  which means that it should be done "at the same time" as you are setting those prices (not two years later when you are asked how you developed them).

Control for FAPI purposes

Control in the case of a foreign affiliate has rules all of its own.

FAPI must be reported if you have a Controlled Foreign Affiliate (CFA).  To have a CFA, first you must have a Foreign Affiliate (FA).

To have an FA is a fairly easy calculation.  If you own at least 1% of the the foreign corporation and you plus related persons own at least 10% of that corporation then you have an FA.

So when does an FA become a CFA?

There are four different situations that will result in a CFA.

1.  The first is easy - if you control the corporation you have a CFA.

2.  If you combine your shares and the shares belonging to persons related to you and get control, then you have a CFA. 

3.  If you combine your shares, the shares belonging to persons related to you and all the shares of four other Canadian residents and you get control, then you have a CFA.

4.  If you combine your shares, the shares belonging to persons related to you, the shares of four other Canadian residents and all the shares of people related to them and you get control, then you have a CFA.

All of the situations above are flow-through calculations (if you own the shares of the company that owns the shares, you are deemed to own those shares).  Also remember that persons and Canadian residents can be corporations.

So, you can see that "control" for FAPI purposes catches a much wider net that control under the Income Tax Act for other situations.

What is FAPI?

Canadian residents are taxed on their worldwide income, but corporations are separate entities so normally one taxpayer will not be taxed in Canada for income earned from a company in another jurisdiction . . . unless that income is FAPI.

FAPI, which stands for Foreign Accrual Property Income is when you own a foreign corporation that is earning passive income.  The section of the Income Tax Act that applies to FAPI is very complicated but in general can be thought of this way:

If you want to create a company someplace nice and warm and open up a bar selling those drinks with umbrellas, Canada has no problem with that - the income earned in that company belongs in the place with the beaches.

On the other hand, if you are opening up that company only to earn income from interest and dividends at a lower tax rate than you would have paid in Canada in a place where Canada does not have a tax treaty - you are going to end up being taxed on that income in Canada.

FAPI brings into income the foreign passive income earned in a foreign corporation.  There are mechanisms to reduce that income to allow for taxes you have paid in that other country - so if you're paying taxes at the same rate as Canada, you won't pay tax on FAPI income in Canada. 

Sometimes it is a timing issue because if you are receiving dividends from that foreign corporation, you will pay taxes when you receive the dividends.  So, if and when you do earn dividends, there is a adjustment to reduce the dividends you report to account for the FAPI income previously reported.

FAPI is only reported on income earned by "controlled foreign affiliates" but the definition of control is different for FAPI purposes than it is for regular income tax purposes.  More on that next week.

How to get overpaid tax back

If you are a non-resident of Canada and have had tax withheld that you have now discovered was too much because of a treaty, how do you get it back?

Well, that depends on the type of income the withholding was related to.

If it was employment income or business income you earned as a sole proprietor, you file a T1 individual income tax return and claim the refund.

If it was business income  earned through a corporation you file a T2 Corporate tax return (be sure to include forms T2SCH91 Information Concerning Claims for Treaty Based Exemptions and T2SCH97 Additional Information on Non-resident corporations in Canada).

If it was withholding on passive income such as interest, dividends or rent, you file a NR7-R Application for Refund of Non-Resident Part XIII Tax Withheld.

In all cases you will need to provide documentation that you are resident in the country where you are claiming treaty exemption.  In the US, use IRS form 8802.  

Many countries (such as Canada) do not have a specific form and you must write to your tax authority and request confirmation. 

Be sure to claim any refund within the refund deadline or you will no longer be eligible to receive it.

Domicile

As well as applying to residents of Canada and the UK, the Canada-UK treaty applies to a person who is domiciled in the UK and subject to tax there.

So…..what is domicile.

There is no precise or agreed definition and the argument is often taken to court.  The UK revenue and customs office defines a number of definitions of domicile:

When you are born, you have the domicile that your parents did at that time (not necessarily where you are born) this is called the domicile of origin.

A child under the age of 16 has the domicile of their parent

You can be domiciled where you have a permanent home where you are planning on returning.  Notice there is no requirement for years here.  One court case decided that although a man had lived in the UK for 40 years he always planned on returning to Canada and therefore his domicile was Canada.

If you plan to live permanently in another country you can have a domicile of choice.

If you leave your domicile of choice and do not decide to live somewhere else permanently then your domicile returns to your domicile of origin.

Despite all the different definitions, you may only have one domicile at a time.

Many of the court cases on domicile use the same rules as Canada for residence - basing the decision on the ties that a person keeps with the country he leaves.  These ties often include things like bank accounts, social groups and driver's license.

New Form for employer/employer joint waiver for non-resident employees

CRA recently announced a new form R02J Regulation 102 Treaty Based Waiver Application - Joint Employer/Employee.

You need to use this form if your employee will not be subject to final tax in Canada under a treaty (for the US normally less than $10,000 per year, for other countries $5,000).

Remember that this is an application, not yet an approval.  Until CRA approves a treaty waiver the regular withholdings for tax, EI and CPP must be withheld from your employees paycheque.

For more details on US residents working in Canada, see my E-publication "Who gets my tax dollars?" link on this page.

ETUG Workshop

Attended the Educational Technology Users Group (ETUG) Spring Workshop  this week.  Great workshops and networking opportunities.

The highlights of the workshop for me were:

 - the overall energy that was there - so many educators and instructional designers interested in technology

 - hearing Tony Bates at the keynote session tell everyone they should be looking at activity based costing to define their costs of technology in teaching (being an accountant hearing someone from outside the field talk about ABC made my heart warm)

 - being in the same workshop with Tony Bates as a participant (he was great as a keynote speaker as well but it was just so neat to be in the same workshop)

- seeing fellow MDE students making presentations on OER's (Open Educational Resources)

 - the iPad

US S Corporations

Article XXIX (Miscellaneous Rules) Paragraph 5 of the Canada-US Treaty discusses the special situation of S Corporations.  

Canadian resident shareholders of US S Corporations do not have the option of the new flow-through rules the same as US resident shareholders of those same corporations.  However, they do have the option of applying to the Competent Authority of Canada to have their income to be taxed similar to the US rules to eliminate the timing rules.  Basically what the rules will do is as follows.

- the S Corporation will be a considered controlled foreign affiliate

- all income will be foreign accrual property income (FAPI)

- the separate deduction from income for foreign property taxes paid will not be permitted (they will calculated under the FAPI rules instead of separately)

- dividends will be excluded from income and adjusted to the cost base of the shares

In many cases, it is a good idea to take this option.  But, you need to look at this option carefully before jumping in with both feet.  

There can be some unintended consequences such as the designation that "all income" will be FAPI.  Normally in Canada you pay taxes on ½ of the capital gain but if you select this option, 100% of the gain will be taxed.  (I'll write more about FAPI in another post).

Taking advantage of the special treaty rules for an S Corporation can be beneficial but be sure to look at the whole situation before making a final decision.  You may want to think about long term decisions and apply for the special designation only for those years where you are fairly sure of your type of income.

Treaties stop you from paying tax twice on the same income

One of the purposes of treaties is to ensure that you do not end up in a situation where you are taxed in both countries.  They do this by the countries negotiating which one gets to keep your tax dollars.

Two important things to remember:

One, most treaties do not relieve withholding tax (that tax you have to pay before you file a tax return to calculate the actual amount owing).  But most countries have a mechanism to reduce that amount of withholding if you are not going to owe tax in that country.

Two, if you have paid tax that under the treaty you should not have paid you cannot claim a foreign tax credit for that amount.  You need to go back to the first country and request a refund of overpayment.

Tax on Wages Canada vs US

Canada and the US are very close on taxes on wages according the the OECD in their latest publication on Taxing Wages.  The calculations for taxes on wages includes both income taxes and social security.

A single person making average wage pays 30.8% of their wages in Canada, whereas in the US that same person would pay 29.4% of their wages out which isn't too great of a difference.

A one-earner family with 2 children earning the average wage pays 13.7% in taxes in the US and 18.3% in Canada.

On the other hand, if you earn lots (167% of average), the tax bite in the US is 34.6% and only 32.9% in Canada.

So I guess the lesson here is that you it's okay to be a resident of Canada if your wages are high enough:J

New Proposed HST Place of Supply Rules

I am not a fan of GST.  Not because I don't like tax - but because it is not logical.  How and when you charge GST does not always make sense - you have to confirm everything to be sure.

Well, now BC and Ontario are moving to the HST on July 1, 2010 (which will likely happen regardless of Mr. VanderZalm's efforts).

So the Minister of Finance has come out with some tentative rules on place of supply for HST to make things "easier" for GST registrants.

Remember that these rules are tentative - MOF is awaiting comments. . . but here's what at stake so far for consulting services.

If the supplier of the services has obtained a recipient's address in Canada, the supply will be considered to be at that address.

If there is no address in Canada, it will be where the services are primarily (more than 50%) performed.  If performed equally in two or more provinces it will be considered to be in the one with the higher rate of HST.

If the services are location specific (i.e. at a convention centre) - then they will be considered to be supplied at that location.

Of course, computer-related services are slightly different.  Those are considered to be supplied where the person who acquires the service is ordinarily located.

The main thing that was removed in all of the proposed new rules is the negotiation aspect.  That is good news  - if these rules go forward, it is the services themselves that matter not where the contract was signed.


And, of course, all of the above might be overridden if the services are supplied with tangible or intangible personal property - this is why the GST/HST drives me crazy.

My first e-publication!!

Yahoo!

My book "Who gets my tax dollars?" has just been published as an e-publicaiton on Smashwords.com for 5.99.  See my book page to the left or jump straight to my book page.

Entertainers and Sportsmen - OECD changes

They used to be called Athletes and Artistes (and still are in several treaties). The OECD now refers to them as entertainers and sportsmen. The OECD recently released a discussion draft to propose some changes to their commentary.

The change that most twigged my interest is the fact that a one-time amateur sports winner of a race could now be considered in this category. So, if the running race has a cash prize - it could be subject to tax withholding.

LLCs and Canada/US Treaty

In an interesting decision the TCC decided that "properly interpreted and applied in context in a manner to achieve its intended object and purpose, the US Treaty’s favourable tax rate reductions apply for years prior to the Fifth Protocol Amendments to the Canadian‑sourced income of a US LLC if all of that income is fully and comprehensively taxed by the US to the members of the LLC resident in the US on the same basis as had the income been earned directly by those members".

The treaty was changed because both governments fully believed that it didn't apply to LLCs - now, the courts apparently aren't as sure.