An Employer’s Obligation to Withhold Canadian Taxes
In our September article, Mandatory Canadian Tax Withholding: Are You in Compliance?, we discussed Regulation 105, the rule requiring withholding and remittance of tax on payments made to Canadian non-residents who provide services in Canada. Rule 105 applies to payments to non-resident individual contractors, corporations, partnerships, joint ventures and LLCs. A similar rule, Regulation 102, applies to Canadian non-resident employers who pay wages to Canadian non-resident employees for work performed in Canada. Under Regulation 102, wages paid to non-resident employees who work in Canada are subject to the same withholding, remitting and reporting requirements as wages paid to Canadian resident employees.
Non-resident employers are required to withhold and remit income taxes, Canadian Pension Plan Contributions, and Employment Insurance premiums for each of their employees working in Canada, unless a waiver has been issued by the Canadian Revenue Agency (CRA). The withholding requirements under Regulation 102 apply even to employees who reside in a country with Canadian Treaty benefits that exempt his or her income from tax in Canada (i.e., U.S. resident employees). To avoid the mandatory withholding, the employee must apply for a Regulation 102 waiver or, alternatively, the employer and employee may be able to file a joint waiver application.
Waiver applications that claim treaty benefits must include an additional statement from the employer stating that it is a non-resident entity without a “permanent establishment” (PE) in Canada that is deducting the wages paid as an expense in calculation of its Canadian taxable income. An employer has a PE if it has a Canadian “fixed place of business,” but a PE can also be in a place where the company carries on business through an employee who has the general authority to contract on behalf of the employer. A PE is also established by an employee who has a stock of goods owned by the employer from which the employee fills orders, or if the employee uses substantial machinery or equipment in a particular location in Canada. The PE determination is based on the various facts and circumstances of a particular situation, but once a U.S. employer has a PE in Canada, the employer will be subject to Canadian tax return filing obligations and will be taxed in Canada on business profits attributable to that PE.
The CRA has acknowledged a practice of denying Regulation 102 waiver applications if there is even a possibility that the non-resident employer has a PE in connection with the work the employee will be doing in Canada. The CRA is not making an actual determination as to whether a non-resident employer has a PE in Canada; it is only denying the waiver application. If the waiver is denied, the Employer must then withhold and remit the requisite tax to the CRA and, in order to get the withholding back, the non-resident employee must file an individual Canadian income tax return.
If the Employer fails to comply with required withholdings and remittances, the CRA can impose significant penalties. The CRA can impose a penalty of 10% of the required amount for the failure to deduct and remit for the first offense, plus interest. The penalty increases to 20% for subsequent failures. The failure to file annual summaries can result in an additional penalty of up to CAD 7,500.
Non-resident employers who send non-resident employees to Canada to work should be aware of the withholding requirements and the potential for other administrative burdens that spring from the unintentional creation of a PE and, even sometimes, the appearance of a potential PE.
If you would like more information about Canadian non-resident withholding requirements, waiver applications, or any of Canada’s Income Tax Regulations, please contact Stuart Lyons or your BNN tax advisor at 1.800.244.7444.
Disclaimer of Liability: This publication is intended to provide general information to our clients and friends. It does not constitute accounting, tax, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.
IRS CIRCULAR 230 DISCLOSURE
Pursuant to requirements imposed by the Internal Revenue Service, any tax advice contained in this communication (including any attachments) is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code or promoting, marketing or recommending to another person any tax-related matter. Please contact us if you wish to have formal written advice on this matter.