Carrying on business in Canada, eh?
Any overseas companies (foreigner or non-resident) having operations or transactions in Canada would require to determine whether the activities or operations are deemed to be carrying on business in Canada. Why is this question critical? Pursuant to paragraph 2(3)(b) of the Income Tax Act (“ITA”) if a non-resident is deemed to be carrying on business in Canada it is liable to pay Canadian taxes. Determining liability for Canadian income and sales tax lies solely on whether the non-resident’s activities are considered “carrying on business” in Canada.
According to section 253 of the ITA, the factors that will be considered in determining whether a non-resident is carrying on business in Canada for tax purposes in a particular situation include:
> the place where agents or employees of the non-resident are located;
> the place of delivery;
> the place of payment;
> the place where purchases are made or assets are acquired;
> the place from which transactions are solicited;
> the location of assets or an inventory of goods;
> the place where the business contracts are made;
> the location of a bank account;
> the place where the non-resident’s name and business are listed in a directory;
> the location of a branch or office;
> the place where the service is performed; and
> the place of manufacture or production.
If the transaction and operations in Canada do not meet the above characteristics, then the non-resident will not be liable for tax in Canada[i]. Exceptions will include Part XIII withholding on Canadian source income, the disposition of taxable Canadian property or the earning of employment income in Canada.
1- Sales Tax
The federal government imposes a Goods and Services Tax (GST) of 5% on a wide range of goods and services. This also applies to many supplies of real property (for example, land, buildings and interests in such property) and intangible personal property such as trademarks, rights to use a patent, and digitized products downloaded from the internet and paid for individually. Exemptions are provided for basic foods, health care and education. All businesses providing taxable services or selling taxable goods in excess of CAD 30,000 in a single calendar quarter or in the last four consecutive calendar quarters must register for and collect the GST. All taxable purchases from a GST registrant bear the GST. GST paid on purchases made by a registrant is credited against its GST collections on its GST return if there is a net credit it will be refunded.
With the exception of the three territories (Yukon, Nunavut or Northwest Territories) and Alberta, all provinces impose a provincial sales tax on a wide variety of goods. The application of sales tax to services will vary depending on the province. General provincial sales tax rates vary from 6% to 10%. The federal government and the provinces of Newfoundland, New Brunswick, Nova Scotia, Prince Edward Island, and Ontario are parties to a sales tax harmonization agreement. Under the harmonized sales tax (HST) agreement, the participating provinces have ceased to collect provincial sales tax. In its place, the federal government collects HST under the GST rules. In some participating provinces, there are point-of-sale rebates equivalent to the provincial part of the HST on certain designated items.
British Columbia, Saskatchewan, Manitoba and Quebec are not harmonized with the Federal government and have their own Provincial Sales Tax (“PST”) regimes. The rates of federal and provincial sales tax for each province are as follows:
Tax on imports
If the Non-resident is an importer of record, most items imported into Canada are subject to the federal GST with the exception of goods classified as non-taxable imports. The tax is calculated at a rate of 5% of the duty-paid value of the goods, which must be paid at customs on time of entry at the border. For goods going straight to a warehouse, GST is collected when the goods leave the warehouse and become eligible for sale in Canada.
The Canadian Excise Tax Act & regulatory framework considers a variety of factors to determine if a non-resident is required to be a Goods and Services Tax (GST), Registrant. Place of Supply is a major factor in determining this. If the Place of Supply is determined to be in Canada, additional factors detailed above will also be used to conclude whether the non-resident is required to be a GST/HST Registrant[ii].
Quebec QST Legislation
In Quebec, Revenu Québec generally administers the GST. If the physical location of your business is in Quebec, you have to file your returns with Revenu Québec using its forms.
In the pursuit to address the concern about traditional small businesses being at a disadvantage as compared to out province when it comes to the collection of sales taxes. The Quebec provincial government has introduced an amendment to the Quebec Sales Tax Act (the “QST Act”) with effect as on September 1, 2019, for the period starting from January 1, 2019[iii]. The newly amended bill is aimed to provide an even playing field and ensure tax fairness for local businesses. Under the then-existing rules for Out of Province Suppliers selling intangibles (such as software and e-commerce sellers) who do not have a physical or otherwise significant presence in Quebec are now required to register for QST. The amended QST Act now requires out-of-province and non-resident businesses to register and collect QST on taxable supplies or services to specified Québec consumers.
The QST Act & regulatory framework considers a variety of factors to determine if a non-resident is required to be a QST Registrant.
In assessing carrying on business in Quebec for QST purposes, suppliers outside of Quebec must meet the following primary factors in order for registration to be deem mandatory;
> Are registered for the GST/HST;
> They do not have any establishments in Canada;
> Have made taxable supplies of corporeal movable property, incorporeal movable property or services in Québec to consumers; and
> Over the 12-month period preceding a particular calendar month, the specified threshold, that is, the total value of taxable supplies (other than supplies of incorporeal movable property or services made through a specified digital platform) is more than $30,000[iv].
2- Income tax
When a non-resident is deemed to be carrying on business in Canada it may be required to file and pay corporate income tax on their Canadian income. If a non-resident meets some of the above previously mentioned factors, they may be considered to be Canadian residents in relation to activities carried on through their permanent establishment in Canada.
A non-resident corporation deemed to be supplying goods by way of sale in Canada and having a permanent establishment through either a fixed place of business (e.g. an office, branch, place of management, factory, etc.) or a dependent agent may be taxed on business profits earned in Canada[v].
A “dependent agent”, is a person within Canada who normally exercises the authority to conclude contracts on behalf of the non-resident. Also, a person who is authorized to negotiate all elements and details of a contract in a way that is binding on the non-resident can be said to exercise this authority in Canada, even if the contract is signed by another person in the non-resident’s country, or if the first person has not formally been given the power of representation. The dependent agent is subject to detailed instructions and comprehensive control by the non-resident company and does not act on behalf of any company other than the non-resident company.
The corporate income tax rate depends on the type of income earned, the status of the corporation and the Canadian province or territory in which the income is earned. The general federal tax rate on corporations is 38%. A 10% rebate applies to the extent the income has been earned in a Canadian province, bringing the federal rate down to 28%. The tax rate on corporate income that is earned in a Canadian province and that does not currently benefit from a preferential tax treatment is further reduced by a general rate reduction of 13%. This makes the general rate of 15%.
The federal government imposes a branch tax on profits under Part XIV of the ITA of 25% on non-resident corporations carrying on business in Canada. The tax is payable on notional distributions of branch profits to the foreign head office. However, the reduction of this amount is based on each foreign country’s tax treaty with Canada (for example the Canada-USA Treaty under Article X (6) reduces the rate of tax and allows a cumulative exemption amount of CAD 500,000).
The appropriate provincial income tax rate is added to the federal rate (general or reduced) to get the effective combined tax rate. The rates of provincial income tax will vary per each province.
The taxable income of a corporation is determined using the accrual method of accounting. Certain professional, agricultural or fishing businesses are permitted to follow cash or modified cash method of accounting. For a corporation resident in Canada, taxable income is based on its worldwide income less allowable deductions. For a non-resident corporation, taxable income earned in Canada is essentially defined to include:
> income earned from carrying on business in Canada;
> 50% of capital gains from the disposition of certain specified Canadian assets or specified foreign assets with significant values attributable to underlying specified Canadian assets included in the definition of ‘taxable Canadian property’;
> Income from the disposition of resource property and certain other assets included in the definition of ‘taxable Canadian property’;
> Income from the disposition of certain other assets with a connection to Canada included in the definition of ‘taxable Canadian property’; and
> Recaptured Canadian tax depreciation.
The scope of the definition of ‘taxable Canadian property’ was significantly narrowed effective 4 March 2010 to exclude shares of corporations and certain other interests (such as an interest in certain partnerships and trusts). These are considered not to have derived their fair market value principally from real property situated in Canada, Canadian resource property or timber resource property, at any time within the 60 months immediately preceding the disposition. A treaty may limit Canada’s ability to tax a non-resident on the various components of taxable income earned in Canada listed above.
Tax treaty relief
Foreign income earned by a Canadian corporation is generally subject to tax in the year received or receivable. Credit is given for foreign income taxes paid, including withholding taxes. Depending upon the tax rate of the foreign country, foreign tax credits may or may not provide full relief for the foreign taxes paid. The amount of foreign tax credits is effectively limited to the amount of Canadian tax paid on the foreign income. Foreign business income taxes not utilized in a particular year may be carried forward ten years (seven years if incurred before 23 March 2004) and back three years. Excess foreign non-business income tax paid cannot be carried over but may be available as a deduction in computing income.
Dividends arising from active business income received from foreign affiliates residing in treaty countries are not subject to further tax in Canada if the business is carried on in Canada or a designated treaty country. No credit is given for foreign withholding taxes in these cases. Dividends arising from other business income received from foreign affiliates are netted against a grossed-up adjustment for the underlying foreign tax and withholding tax. Dividends arising from passive income received from controlled foreign affiliates residing in treaty countries or arising from all sources in non-treaty countries are subject to tax as ordinary income. Deductions will be given for underlying foreign tax and withholding tax, as well as Canadian tax which may have been payable at the time the income was earned.
3- Other Taxes
The federal government also imposes certain industry-specific taxes in addition to customs and excise duties. The federal large corporation’s tax, which was a minimum tax based on capital, was repealed effective 1 January 2006. There are no provincial capital taxes for general businesses. The federal government and several provinces still have capital taxes that apply to certain types of financial institutions and life insurance corporations. For corporations with a permanent establishment in Ontario, Ontario imposes a corporate minimum tax on corporations with total assets or gross revenues above certain threshold amounts in certain circumstances.
4- Legal Structuring
Once the permanent establishment has been determined, there are two options a non-resident can structure their Canadian business either as a BRANCH or INCORPORATE a Canadian subsidiary. Below we have detailed the differences between having a branch versus a subsidiary corporation in Canada.
If you require further information on whether your business is carrying on business and what are your tax obligations contact our experts:
[i] Income tax – Section 253
[ii] Excise Tax Act – Part IX, Division I, paragraph 142(2)g
[iii] Bill 150, 2018, c 18, s 78 [Bill 150].
[iv] QSTA, s 477.2 “specified threshold”
[v] Meaning of “Permanent Establishment” in Subsection 123(1) of the Excise Tax Act (the Act)