Canadian companies, like other foreign companies, that either provide services or sell products in the United States may be subject to U.S. federal and state tax on their profits, therefore, it is in the best interest of Canadian business to remain cognizant of US tax filing requirements.
U.S. federal tax may be reduced if certain actions are taken. Even foreign companies without an office in a U.S. state could still be liable for state taxes.
Any company carrying on a U.S. trade of business must file a corporate income tax return (Form 1120-F) whether or not the company had U.S. source income or the business is protected under a tax treaty between the United States and the foreign company’s home country.
Failure to file a corporate income tax return may result in a penalty of up to $10,000 U. S. and possible taxation on gross revenue without any consideration given to the expenses incurred to earn the revenue.
What constitutes a trade or business?
The extent of U. S. activity will determine if the company is carrying on a U. S. trade or business. Regular sales shown to be effectively connected with U.S. trade or business located in the U.S. can tip the scales, provided that the sales are significant compared to the firm’s overall revenue. Physical presence and the existence of U.S. based agents will also be considered in determining if there is a U.S. trade or business.
Should your company fall under this definition, allowable deductions can offset or reduce the U.S. tax liability. The Canada – U. S. Tax Treaty itself also may offer relief.
The Canada-U.S. Income Tax Treaty
So long as the Canadian company does not have a “permanent establishment” in the U.S., the Canada-U.S. Income Tax Treaty supersedes domestic tax law and allows the company to avoid U.S. income tax.
What defines a permanent establishment, in this case, is the rub. The Treaty offers the following specific examples of a permanent establishment: a branch, an office or an employee negotiating contracts in the Canadian business’ name, and a management location. Advertising, storage, and the maintenance of goods located in the U.S. are not indicators of a permanent establishment. That said, based on the number of days company employees remain physically present in the country, the Internal Revenue Service (IRS) can still view the foreign company as operating from a permanent establishment.
A Canadian company may file Form 1120-F to protect its right to deductions and credits in cases where its requirement to file a U.S. income tax return is uncertain. With the protective return, the company may keep the option to deduct expenses should the IRS determine at some later date the company was subject to U. S. tax.
Dates to keep in mind
The U.S. return due date is the 15th day of the fourth month after the end of the company’s taxation year. Canadian companies with no business operations in the U.S. must file Form 1120-F by the 15th day, six months following the taxation year-end.
If you intend to file the protective return, do so no later than 18 months after the due date of the current year’s return.
Speak to your U.S. tax advisor to confirm timely filings and ensure compliance with U.S. tax laws.