Treaty-Shmeaty, Not Quite!

Jeffrey Brown • December 20, 2018
Jeffrey Brown

Many Canadian companies, and their tax advisors, operate under the mistaken belief that the US Canada Tax Treaty protects them from ALL cross-border taxation in the US. This couldn’t be farther from the truth.

The Treaty protects a Canadian company from US federal income taxation on its US trade or business income so long as its US business activities do not arise to the level of a “permanent establishment” or “PE”. Most relevant in our experiences, a PE exists where a Canadian company concludes contracts, such as a sale, from within the United States rather than from Canada. Maintaining a warehouse in the US to store inventory does not necessarily create a PE nor does attending sales meetings, trade shows, visiting clients, etc. A “Deemed PE” can exist where a Canadian company performs services in the US or a contractor works on a construction project in the US over a specified number of days in the US.

Oft misunderstood as well is that Treaty benefits, i.e., claiming that a Canadian company does not have a PE in the US, must be affirmatively claimed by filing a US tax return and claiming treaty benefits on Form 8833 each year. By not filing a treaty return, a Canadian company can be subject to tax in the US on its gross receipts rather than net income.

We estimate that slightly more than half of the 50 states apply the Treaty. No PE, no federal tax and no state tax. Well, maybe state minimum or franchise taxes may apply. States that do not follow the Treaty may tax a Canadian company on a worldwide or branch basis. Under the former, we essentially convert T2 taxable income to US taxable income and apportion it to the taxing state based on its in state activity over its worldwide activity. Under the latter, we determine US “effectively connected income” or “ECI”, which is the same thing as if the Treaty didn’t apply to US federal taxes. We then apportion ECI to the taxing state based on in state activity over US activity.

Of course, the Treaty never has, and likely never will apply to state and local sales and use taxes. Recall that a Canadian company historically was subject to sales tax compliance if it had some physical presence in the taxing state. In June 2018, the US Supreme Court threw out the physical presence requirement requiring an instate economic presence, perhaps measured by a baseline of sales revenues in the taxing state.

You don’t go to a foot doctor when you have a headache. Make sure you treat the health of your business the same way. At Fuller Landau, our seven person US tax team handles only US tax. Our professionals have several different concentrations as well. As the firm’s lead US tax partner, I have over 25 years of state and local tax experience including 19 years with a Big Four firm. Senior Manager, Holly Haber, has expertise with US expats in Canada and some of the more relevant cross-border taxing sections of the 2017 Trump Tax Reform laws. Manager, Simone Belnavis, brings Big Four US corporate tax experience to our team.