Mandatory Canadian Tax Withholding: Are You in Compliance?
By Colleen Mathews, Tax Manager
Have you made payments to Canadian non-residents for services rendered in Canada? Are you a self-employed American doing occasional consulting or service work in Canada? If you answered yes to either of these questions, you may be subject to the Canadian Income Tax Act’s mandatory withholding requirements for non-residents.
The Canadian Government has mandated that a portion of payments to non-residents for services rendered in Canada must be withheld and remitted to the Canada Revenue Agency (CRA). Under the Canadian Income Tax Act’s Regulation 105, every person (resident and non-resident) who pays a non-resident individual, corporation, partnership, joint venture, or limited liability company (LLC) for services performed in Canada must withhold 15% of the gross payment. If the appropriate amount of tax is not withheld, the CRA could issue both the payor and non-resident payee an assessment for the 15% withholding plus interest. The payor could also be charged a penalty of CAD$2,500 per failure to withhold, plus an additional 10% of the withholding (20% if the failure is due to gross negligence).
Regulation 105 does not apply to employers making compensation payments to non-resident employees for work performed in Canada. Employers are still required to withhold Canadian taxes from their employees’ compensation, but the requirement is governed by a separate regulation, Regulation 102. We will discuss Regulation 102 in a subsequent article, along with the concept of permanent establishment in Canada.
The Income Tax Act provides a mechanism for non-resident payees to request a reduction of the amount withheld or ask for a waiver of all withholding if the non-resident can demonstrate that their actual Canadian tax liability will be less than the automatic 15% calculation. The application should be submitted either 30 days before the start of contract services in Canada or 30 days before the first payment for the services. The CRA has noted, however, that it will review applications outside of the suggested timeframe.
An application for reduction or waiver of withholding can also be based on the Canadian-United States Income Tax Treaty (the Treaty). Under the terms of the Treaty, certain income can be excluded from Canadian tax liability. In order for a non-resident to claim that income is excluded under the terms of the Treaty, she must first prove that she is a resident of the United States and establish her entitlement to treaty benefits. She must demonstrate that the type of activity being performed in Canada meets the applicable treaty provisions, including meeting either an income threshold or days-present threshold criteria. If the payee has a fixed base or permanent establishment in Canada, she cannot apply for a treaty-based waiver.
Please note that obtaining a withholding waiver does not affect the requirement to file a Canadian Income Tax return. A non-resident corporation must file a return if the corporation carried on business in Canada or disposed of a taxable Canadian property. Partnerships and LLCs generally are not required to file Canadian income tax returns; however, partners, LLC members, and other individuals who were granted a waiver or a reduction of withholding are required to file Canadian income tax returns.
If you would like more information about withholding requirements, waiver application procedures, or any of Canada’s Income Tax Regulations, please contact Stuart Lyons or your BNN tax advisor.
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.