BC Business
Cross-border business | BCBusinessFor businesses looking to expand south of the border, the key to a seamless transition is to learn all the regulations regarding taxes.
For a seamless business expansion south of the border, the key is all in the numbers. As Canada’s closest neighbour and largest trading partner, the U.S. is often the most obvious choice for Canadian companies looking to expand beyond the country’s borders. Our common bonds – language, culture, free market philosophy and democratic ideals – are backed by trade and tax treaties aimed at making cross-border business as seamless as possible.?
As Canada’s closest neighbour and largest trading partner, the U.S. is often the most obvious choice for Canadian companies looking to expand beyond the country’s borders. Our common bonds – language, culture, free market philosophy and democratic ideals – are backed by trade and tax treaties aimed at making cross-border business as seamless as possible.
So southward expansion should be a fairly easy exercise for a Canadian company, right? The short answer is yes . . . and no. In spite of the many good intentions of measures such as the North American Free Trade Agreement and the Canada-U.S. Income Tax Treaty, seamless does not necessarily mean simple. In fact, when it comes to doing business in the U.S., the differences between our two systems need to be clearly understood to avoid costly and time-consuming obstacles.
For example, both countries have their own tax systems, so a Canadian company setting up in the U.S. needs to know what its tax obligations are under the U.S. system. Canadian corporations doing business down south may be required to file U.S. tax returns even if U.S. taxes are not owing. They may also be required to report other transactions related to their U.S. operations – and significant penalties may apply if these forms are not filed on time.
Even if a Canadian business is not operating in the U.S. on a permanent basis, it may need to file a U.S. return, and can then claim relief from taxation in the U.S. under the Canada-U.S. Income Tax Treaty. On the other hand, if a Canadian business has an office or other “fixed place of operations” in the U.S., the income attributable to operation is subject to U.S. tax. However, the company is entitled to claim any U.S. tax paid on its Canadian income tax returns as a foreign tax credit.
In some cases there may be uncertainty over whether the Canadian company is actually carrying on a business in the U.S. For example, merely having sales representatives soliciting business in the U.S doesn’t necessarily create a U.S. corporate tax liability, but might require a U.S. tax filing, and the individual will have to consider the personal U.S. tax implications. The best approach in this case is to file a U.S. return to avoid being hit with failure-to-file penalties and to use the filing to explain the company’s position under the tax treaties.
If a Canadian business is considering setting up a U.S. operation, the legal structure of that business will have tax implications when sending profits back to Canada. Options include a U.S. corporation, a Canadian corporation, a partnership, a limited liability company (LLC) and joint ventures. The advantages and disadvantages of each would have to be weighed against the goals and objectives of the business.
For example, using a U.S. LLC provides flexibility and tax benefits for U.S. shareholders. However, Canadian taxpayers with interests in a U.S. LLC may not be eligible for certain tax treaty benefits. Several other tax implications also need to be considered, such as branch profits tax, payroll taxes and transfer pricing in both the U.S. and Canada.
There may also be tax implications if the U.S.-based operation pays interest to the Canadian parent company, as the interest deductibility may be limited if the IRS determines that the U.S. subsidiary is under-capitalized. To address this potential challenge, most advisers recommend a three-to-one or four-to-one debt to equity ratio. It’s also important to document loan agreements and pay interest in a timely manner.
While this is just a brief snapshot of the tax implications for Canadian companies of setting up a U.S. operation, it illustrates the complexity of cross- border business and highlights just a few of the issues that Canadians need to consider before venturing southward. n
Darren Millard, CA, CPA, TEP, is a tax partner with Facet Advisors LLP, Chartered Accountants in Langley, B.C.