Thinking of expanding to the US? Three things you should know
TAX ALERT |
Representing more than 75 per cent of Canada’s overall trade, the United States is by far Canada’s largest trading partner. Billions of dollars in goods and services cross our shared border daily. The U.S. economy is more than 12 times the size of the Canadian economy and so tapping into the U.S. market is an obvious next step in the progression of many Canadian businesses. However when planning for this expansion, it is vital to take into consideration the U.S. tax implications of doing so. Below are three tax considerations that every Canadian business should be aware of before engaging in business in the United States. Please contact your RSM Canada representative if you would like to discuss your U.S. business expansion plans further.
1. Tax structuring
When considering an expansion to the United States, one of the first considerations should be how to structure your U.S. business. Should you operate as a branch directly through your Canadian entity? Use a U.S. subsidiary corporation? LLC? The tax benefits and consequences of each organizational structure are very different.
For example, if you operate as a branch in the United States or through a disregarded LLC, you may be subject to the branch profits tax (BPT) in addition to any other taxes. The BPT is 30 per cent of any dividend equivalent amount. If you are eligible for the benefits of the Canadian-U.S. Income Tax Treaty (Treaty), the rate can be lowered to 5 per cent (along with an exemption for the first C$500,000). By operating through a U.S. corporation, you may avoid BPT and be able to take full advantage of a wider range of tax planning opportunities, however you may have additional tax compliance requirements that you otherwise may not have had.
It is important to consider the benefits of each structure and determine what works best for you and your business. The organizational structure of the business can affect your bottom line when dealing with your annual U.S. tax compliance and maintenance costs, financing (including cross-border), repatriation considerations, and upon exit.
2. Permanent establishment
Does your company’s activities in the United States amount to a permanent establishment as defined under Article V of the Treaty? If your business qualifies for Treaty benefits, you will only have a U.S. federal tax liability if you operate in the United States through a permanent establishment. Under Article V, Paragraphs 2-5 of the Treaty, a permanent establishment includes:
- A place of management;
- A branch;
- An office;
- A factory;
- A workshop;
- A mine, an oil or gas well, a quarry, or any other place of extraction of natural resources;
- A building site or construction project if it lasts longer than 12 months;
- Use of an installation or drilling rig that is used for more than three months in any 12 month period;
- Use of a person in the United States who acts on behalf of the Canadian company and has the authority to conclude or significantly negotiate contracts in the name of the Canadian company.
Under the Fifth Protocol of the Treaty, two additional tests were introduced to determine permanent establishment. Under the first test, a Canadian company can be deemed to have a permanent establishment if services are performed by an individual who is present in the United States for 183 days or more in any 12 month period and during that 12 month period, more than 50 per cent of the gross active business revenues of the Canadian company are attributable to the services performed by that individual.
Under the second test, a Canadian company can be deemed to have a permanent establishment if they provide services in the United States for 183 days or more in any 12 month period in relation to a project or connected projects for customers who are U.S. residents or maintain a permanent establishment in the United States.
It is important to note that even if you do not maintain a permanent establishment, if you have U.S. source income, you may still have a filing obligation in the United States (even if you do not have a U.S. tax liability). Failure to file can lead to penalties of $10,000 per filing, even if no tax is due.
3. State and local tax
State and local governments are not parties to the Treaty and are therefore not bound by its provisions unless the state specifically chooses to be. Accordingly, if your business activities in the United States do not rise to the level of permanent establishment, and therefore do not generate a federal tax liability, you may still have established a state and local tax liability.
The traditional standard permitting a state to impose an income tax or sales and use tax on businesses with in-state activity (known as ‘nexus’) is a physical presence. However, even without a physical presence, nexus may be established if in-state sales thresholds or other activity thresholds, such as having property or a payroll, are surpassed. This concept, known as economic nexus, varies greatly among the states.
For example, if your only activity in New York State is making sales to customers in the state exceeding $1 million, you may be required to file and pay state corporate income tax, even if you do not have an actual physical presence in New York. In California, this sales threshold is $561,951 for 2017, although other states maintain lower sales thresholds. Additionally, some states have applied similar economic nexus sales thresholds to the sales and use tax in order to require remote businesses to collect and remit sales taxes from their in-state customers. Determining a state and local tax nexus footprint and corresponding filing requirements requires an in-depth analysis to ensure proper state and local tax compliance.