For those clients who operate in the United States and think they are not required to file any income tax returns because they do not have a permanent establishment or federal treaty protection, they need to reconsider.
Any Canadian company engaged in a trade or business in the United States is subject to U.S. corporate income tax on income which is effectively connected with the trade or business within the U.S. However, the Canada-U.S. Treaty provides exemptions from U.S. corporate tax for those companies that do not maintain a "permanent establishment" in the United States. The term "permanent establishment" specifically includes the place of management, an office or branch or a workshop.
Even though the Canada-U.S. Tax Treaty exempts the income from taxation, the U.S. still requires certain filings. Canadian companies that conduct business in the U.S. must file form T1120-F (U.S. Income Tax Return of a Foreign Corporation) and form 8833 (Treaty-Based Return Position Disclosure). The form 8833 must be filed to disclose the fact that the company is relying on a treaty position to exempt it from U.S. federal income tax. Failure to file a treaty-based disclosure can result in a fine of US$10,000 for each failure. This is a significant cost in not filing a treaty-based disclosure.
Even if there is no federal income tax, careful consideration should be given as to whether or not there may be State income taxes. None of the States are governed by the Canada-U.S. Treaty. Therefore, the States will have their own rules as to whether or not a company is taxable in that state.
The key message here is: it is better to file the treaty-based disclosure than to risk having the penalty and other possible sanctions applied by the U.S. government.
TAX TIP OF THE WEEK is provided as a free service to clients and friends of the Tax Specialist Group member firms. The Tax Specialist Group is a national affiliation of firms who specialize in providing tax consulting services to other professionals, businesses and high net worth individuals on Canadian and international tax matters and tax disputes.