Regulation 105: What You Need to Know About Withholding Tax and CRA Audits

Posted on December 5th, 2024 in Domestic Tax, General Business

Executive summary

Regulation 105 of the Income Tax Regulations imposes a 15% withholding tax on payments made to non-residents for services performed in Canada. Recent updates from the Canada Revenue Agency (CRA) declare that the reimbursements for subcontractor services made after Sept. 30, 2024 are now included under these rules. This article reviews the consequences of non-compliance and offers practical steps for employers and non-resident contractors to ensure adherence to the updated regulations.

When an amount is paid by any person to a non-resident person for services performed in Canada, the payment is subject to withholding tax. Specifically, Regulation 105 of the Income Tax Regulations and paragraph 153(1)(g) under the Income Tax Act (Act) provide that payments made to non-residents for services rendered in Canada are subject to a 15% withholding tax. The policy behind this rule is to ensure that funds are available to cover any potential Canadian income tax assessments on Canadian-source income earned by non-residents.

As all other provisions within the Act, the Canada Revenue Agency (CRA) is responsible for its administration. The CRA frequently releases guidelines for practitioners to interpret the rules, and often provides technical views to clarify these rules, sometimes in response to case law developments.

Background on CRA policy and updated policy

In 2007, the Tax Court of Canada released a decision (Weyerhaeuser Company Limited v. The Queen) which confirmed that Regulation 105 applies only to payments characterized as income earned in Canada by the non-resident and does not apply to reimbursements for disbursements or travel costs, as they are not considered income. As a result of the Weyerhaeuser decision, the CRA issued a view and reaffirmed its position that excluded reimbursements from the Regulation 105 withholding requirement.

Earlier this year, CRA released a view (2022-0943241E5) which clarified that Regulation 105 will apply to payments made to reimburse a non-resident for fees related to subcontractor services performed in Canada. However, this new withholding policy will not extend to reimbursements of travel and meal expenses so long that these expenses were agreed to be reimbursed. CRA also confirmed that the updated policy will apply to reimbursements made after Sept. 30, 2024.

This marks a significant change to CRA’s longstanding policy from 2008 for withholding tax on cross-border services rendered in Canada.

Ensuring compliance

As a result of this change of position, taxpayers can take steps to ensure they are compliant. First, employers should review and amend any contracts with non-residents to explicitly state when withholding tax may apply to certain reimbursements and define who will bear the tax liability. Second, non-resident contractors should provide detailed invoices and separate travel and meal expenses as these amounts are generally not subject to Regulation 105 withholding tax. Finally, non-resident contractors can consider applying for a waiver from Regulation 105 withholding if they are not liable for Canadian tax. Until a waiver is granted, 15% withholding from payments is still required. Failure to properly withhold under the Regulations and Act could result in significant penalties.

Regulation 105 disputes

If non-compliance occurs and employers and subcontractors err in their withholding obligations, it could result in an audit by the CRA. Regulation 105 audit and compliance initiatives have escalated recently due to businesses increasingly transacting across borders. We surmise that the federal government is focusing on ensuring cross-border payments are being appropriately captured in the Canadian tax net, notably since the increase in remote work post-pandemic. As such, especially in light of the new administrative position, it is important employers and subcontractors ensure internal systems are in place to maintain compliance.

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This article was written by Sigita Bersenas, Patricia Contreras and originally appeared on 2024-12-03. Reprinted with permission from RSM Canada LLP.
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