Canadian businesses operating in or selling to customers in the United States may be subject to income taxes in the US and/or may need to collect and remit US state sales tax
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Whether a Canadian company is subject to US federal and/or state taxation depends on several factors. For US federal income tax purposes, the primary factor is whether the company has a permanent establishment in the US. For state income and sales tax purposes, the primary factor is whether the company has nexus within one or more states.
Permanent Establishment (PE)
If a Canadian company has a PE in the US it is subject to US federal income taxation. A PE includes a place of management, branch, office, or factory. It also includes a building site or construction/installation project if the construction or installation period exceeds twelve months. In addition, there are also services PE rules, which may deem a PE to exist based on services performed in the US by Canadian employees.
A company with a PE should be filing a US federal income tax return. If a Canadian company is operating as a branch in the US, the US federal and state income tax liability will be treated as a foreign tax paid. The company may then be eligible for a foreign tax credit on its Canadian tax return, which should decrease the company’s Canadian tax liability.
A Canadian company that does not have a PE must file an annual US federal tax return to disclose its Treaty-based position in order to avoid an annual US$10,000 penalty.
The concept of nexus looks at whether a business has a non-trivial presence in one or more states. It is determined on a state-by-state basis and the nexus criteria differs for sales tax versus income tax purposes. In determining whether the Canadian business has nexus, consider if the business has employees (including those attending trade shows), provides installation or implementation, has inventory stored, or has a physical location or property (including intangible property) in the state.
Rules vary from state to state and even a temporary presence may be enough to establish nexus.
It is also worth noting that if two businesses are affiliated with one another, in determining if one of them has nexus, the operations of the other can be taken into account. For example, in New York, if a business without nexus has as little as 5% cross-ownership with another business that does have nexus, it can result in the first company having nexus as a result of the affiliate nexus rules. Other connections including sharing of intellectual property such as trademarks can also result in the affiliate rules applying.
It is crucial to carefully consider the operations of a business in relation to each state in which it operates or has customers.
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