Category: Cross-border Tax

The Internal Revenue Service (IRS) has acknowledged that there are many US taxpayers outside of the USA who are non-compliant with their US tax filings including Reports of Foreign Bank and Financial Accounts (FBARs) and, as such, are offering special procedures for US taxpayers to become compliant.

The Streamlined Filing Compliance Procedure allows delinquent U.S. taxpayers the opportunity to come forward and avoids possible IRS enforcement action and the large penalties associated with not filing.

The streamlined filing compliance procedures are available to taxpayers certifying that their failure to report foreign financial assets and pay all tax due in respect of those assets did not result from willful conduct on their part. The streamlined procedures are designed to provide to taxpayers in such situations with:

• a streamlined procedure for filing amended or delinquent returns, and
• terms for resolving their tax and penalty procedure for filing amended or delinquent returns, and
• terms for resolving their tax and penalty obligations.

The streamlined procedures are available to both US individual taxpayers residing outside the USA and US individual taxpayers residing in the USA.  For the purposes of this article, we will focus on US taxpayer’s living outside of the USA.

For purposes of the streamlined procedures, US citizens and lawful permanent residents, i.e., green card holders, are nonresidents if, in one or more of the most recent three years for which the US tax return due date has passed, they (1) did not have an abode in the United States and (2) were physically outside the United States for at least 330 full days.

US taxpayers eligible to use the Streamlined Foreign Offshore Procedures must (1) for each of the most recent 3 years for which the U.S. tax return due date has passed, file delinquent or amended tax returns, together with all required information returns (e.g., Forms 3520, 5471, and 8938) and (2) for each of the most recent 6 years for which the FBAR due date has passed, file any delinquent FBARs (FinCEN Form 114, previously Form TD F 90-22.1). The full amount of the tax and interest due in connection with these filings must be remitted with the delinquent or amended returns.

A US taxpayer filing under the streamlined procedure must certify that:

1. they are eligible for the Streamlined Foreign Offshore Procedures;
2. all required FBARs have now been filed; and
3. failure to file tax returns, report all income, pay all tax, and submit all required information returns, including FBARs, resulted from non-willful conduct.

A taxpayer who is eligible to use these Streamlined Foreign Offshore Procedures and who complies with all of the instructions outlined by the IRS will not be subject to failure-to-file and failure-to-pay penalties, accuracy-related penalties, information return penalties, or FBAR penalties.

If returns are properly filed under these procedures and are subsequently selected for audit under existing audit selection processes, the taxpayer will not be subject to failure-to-file and failure-to-pay penalties or accuracy-related penalties with respect to amounts reported on those returns, or to information return penalties or FBAR penalties, unless the examination results in a determination that the original tax noncompliance was fraudulent and/or that the FBAR violation was willful.  As with any US tax return filed in the normal course, if the IRS determines an additional tax deficiency for a return submitted under these procedures, the IRS may assert applicable additions to tax and penalties relating to that additional deficiency.

If you need assistance in becoming compliant in the USA, we are well-seasoned in this matter and our cross border professionals can help you.

U.S. Rental income

If a Canadian resident receives rental income from real property located in the U.S., they are subject to a non-resident withholding tax of 30% of the gross rental income, which is required to be remitted to the Internal Revenue Service (IRS) by the tenant. The 30% withholding tax cannot be reduced by way of the Canada – United States income tax convention.

Non-residents of the U.S. can also make an election to be taxed as if their rental income was effectively connected with the conduct of a trade or business in the U.S. Furthermore, the taxpayer can deduct expenses engaged to earn rental income and then be taxed on the net income at graduated rates, rather than a 30% flat rate on the gross rent. To make this election and avoid the 30% withholding, a taxpayer must complete form W-8ECI and provide the form to the person who is paying the rent.

To deduct expenses in order to be taxed on your net income, a taxpayer must file a U.S. tax return as a non-resident (form 1040NR). The amount of the tax withheld will be reported on the 1040NR and will get refunded if there is excess tax withheld over the final income tax liability. The tax return must include a statement confirming that an election has been made. The election must include the address of the property, your percentage of ownership, description of improvements made, etc.

A taxpayer only has to make the election once and the election has to be made on each new property. The election will be valid for as long as a taxpayer owns a property and if their 1040NR is filed on time. To file a 1040NR, a taxpayer will need to obtain a U.S. Individual Taxpayer Identification Number (ITIN) by completing a form W-7.

A taxpayer also has to report rental income in the state where the property is located.

Selling U.S. Real Property

If a Canadian resident sells real estate located in the United States, they are subject to a 10% or 15% withholding tax of the gross selling price under FIRPTA (Foreign Investment in Real Property Tax Act). If the property is sold for an amount greater than $300,000 but less than $1,000,000 and the property is being purchased with the intention of being used as the purchaser’s residence, then the sale will only be subject to a 10% withholding as opposed to the 15% rate. The tax withheld will be offset against the U.S. tax liability on any gain realized on the sale and will be refunded if it exceeds the tax liability.

There are two exceptions to the withholding requirement which can reduce or eliminate the requirement.

• The first exception applies if the property is sold for less than $300,000 USD to a buyer who intends to occupy it as their principal residence. The gain on the sale is still taxable in the U.S. and a tax return (1040NR) must be filed.
• The second exception is if a Canadian resident gets a withholding certificate from the IRS on the basis that the expected U.S. tax liability will be less than 10% or 15% of the selling price. The certificate will indicate the amount of tax that should be withheld by the purchaser rather than the full 10% or 15%. Ideally, the withholding certificate should be obtained from the IRS before the sale closes. To apply for a withholding certificate a Form 8288-B must be completed and sent to the IRS. A U.S. ITIN must be included on the Form 8288-B or can be applied for by way of a Form W-7 with the Form 8288-B. The IRS will generally issue a withholding certificate within 90 days of submission.

The gain or loss on the sale of a U.S. real property by a non-resident is required to be reported on a U.S. Non-Resident Income Tax Return (1040NR). As a Canadian tax resident the disposition of a U.S. property is required to be reported in Canada. If there is a gain on the sale, the U.S. has the right to tax the gain first and the U.S. tax liability can be claimed as a foreign tax credit against any Canadian and provincial tax on the sale.

Similarly, state income tax may apply on the sale depending on where the property is located.

Please contact your DJB accountant should you wish to discuss this further.

Background

Canadian businesses continue to extend their reach into the U.S. for numerous reasons; some of which include proximity, lower corporate tax rates as a result of the 2017 US tax reform, a stable economy, and a skilled workforce. While these are all great reasons to expand operations into the U.S., companies must consider the U.S. Federal and State tax implications of carrying on a trade or business in the U.S. Note that this article does not cover U.S. state tax issues Canadian businesses may face – please contact us for further guidance on navigating such situations.

What does it mean to “carry on a trade or business in the U.S.”?

Generally, a trade or business is any activity conducted for the purpose of generating income. The threshold for this determination is fairly low in that a Canadian company could be considered to be carrying on a trade or business in the U.S. when it has considerable, regular, and continuous dealings with U.S. customers.

Effectively Connected Income and U.S. Permanent Establishments

Generally, when a Canadian company engages in a U.S. trade or business, all income associated with that trade or business is considered to be Effectively Connected Income (ECI). Note that U.S. source income may still be considered to be ECI even when there is no connection between the income and the U.S. trade or business.

Canadian companies are required to pay U.S. federal income tax on ECI (less expenses incurred to generate ECI) however, companies may seek relief from this tax burden pursuant to the U.S. – Canada income tax convention. Under the tax treaty, Canadian companies are only required to pay U.S. federal income tax if they carry on business through a U.S. permanent establishment.

Generally, a permanent establishment (PE) is defined as a fixed place of business in the U.S. through which a non-resident entity (i.e. a Canadian company) carries on business. This definition continues to evolve given the rise in e-commerce activities. Some traditional examples of a PE include:

• A fixed place of business such as a branch, an office, factory, workshop, etc.
• Agents who habitually exercise the authority to conclude binding contracts in the U.S. on behalf of the Canadian company.
• The provision of services that meet certain specified criteria.

Pursuant to the tax treaty, the following activities generally do not give rise to a U.S. PE:

• The use of facilities for storage, display or delivery of goods.
• The maintenance of a stock of goods for storage, display, and or delivery.
• The purchase of goods in the U.S.
• Advertisement, supply of information or scientific research done in the U.S. that is preparatory or secondary to the business.

U.S. Federal Income Tax Filing Requirements

Canadian companies with income effectively connected to a U.S. trade or business must file U.S. federal income tax returns. A Canadian business with U.S. ECI that is not attributable to a U.S. PE must file U.S. Federal Form 1120-F US Income Tax Return of a Foreign Corporation and Form 8833 Treaty-Based Return Position Disclosure Under Section 6114 or 7701(b) to claim relief from U.S. federal tax pursuant to the U.S.- Canada income tax treaty. Generally, this return must be filed 5 ½ months after the taxpayer’s year-end. For example, a calendar year taxpayer must file the protective return by June 15^th.  

Canadian companies with U.S. ECI attributable to a U.S. PE cannot claim the treaty exemption and must file Form 1120-F to report U.S. source income and expenses. The taxpayer may claim foreign tax credits on its Canadian income tax return for any U.S. income tax paid. Generally, this return must be filed 3 ½ months after the taxpayer’s year-end. For example, a calendar year taxpayer must file the return by April 15^th.

Penalties

If a return is filed late but no tax is payable due to the treaty exemption, interest and penalties may not apply if the return is filed by the second deadline which is 18 months from the original due date. If the return is not filed by the second deadline, the Canadian company may be taxed on its U.S. source gross business income. If a treaty exemption is claimed to eliminate the tax liability, a non-disclosure penalty of $10,000 may be levied for each item of income.

If a return is filed late and there is tax due, interest and penalties will be calculated based on the tax due and exposure can be quite significant

Summary

Canadian companies with activities in the U.S. may have federal income tax filing obligations and in some cases, a federal tax liability when business is conducted through a permanent establishment. Note that U.S. state income tax obligations may also apply based on the different laws of each state.

If you determine your business may have a U.S. income tax filing obligation or are thinking about expanding to the U.S., we can help. Our cross-border taxation advisors have the knowledge and expertise to help you evaluate and determine the implications for your business.

Foreign employers should understand that sending even one employee to work in Canada will trigger a payroll obligation. Compliance starts from the first day of the foreign employee’s physical presence in Canada. It is the employer’s responsibility to set up the foreign employee on Canadian payroll and deduct the applicable Canadian income taxes and Canadian social security taxes (Canadian Pension Plan and Employment Insurance).

This article, written by RSM Canada, explains what foreign employers need to know about payroll obligations for employee(s) who are working in Canada.