Similar to the U.S. rules, Canada may tax personal services provided in Canada by U.S. persons who are not residents of Canada income tax purposes. The provisions governing this are regulations 102, 105 and section 115 of the Income Tax Act (‘ITA”).
The treaty-employment income
Article XV of the Canada/U.S. tax treaty may exempt from Canadian taxation, personal services that is employment income where the income is not more than $10K earned in the source country (ie., Canada) or more than 10K if the remuneration paid by the U.S. employer that does not have a permanent establishment in Canada and the individual is not present in Canada more than 183 days in the 12-month period ending in the calendar year. If the treaty does not apply, a Canadian tax return is filed under Section 115 of the Act to tax on a combined federal and provincial graduated tax rate on the income sourced to Canada.
The treaty-self-employment income
Article V of the treaty may exempt independent personal services (i.e., self-employment income) if the individual (i.e., the proprietor) does not carry on business in Canada through a permanent establishment (“PE”) situated therein.
Under the treaty, the taxation of independent personal services provided in Canada depends if the proprietor has a PE situated in Canada. If it were not for the “deemed PE” provision in Article V, paragraph 9, most unincorporated businesses of this nature would not generally have a PE in Canada. On a simplistic basis, if the individual is physically in Canada for more than 183 days in a 12-month period ending in the calendar year and more than 50% of the gross business revenues consist of income derived from services provided in Canada, then there is a deemed PE and therefore no treaty exemption.
Where the individual has a PE in Canada without considering this deeming service provision, the combined tax rate outlined earlier would apply. However, where the deeming provision is applicable, CRA has said that the otherwise provincial tax rate applicable to income in a tax bracket would not apply. This is because the definition of PE within the provinces would not apply. This makes sense in that the provinces like individual U.S. states generally and do not have to follow treaty provisions.
As the business income from independent personal services is not allocated to a PE, it is taxed as income not earned in a province with an additional federal surtax of 48% times the federal tax as opposed to the provincial marginal tax rate on that income.
For the self-employed individual, the savings on filing with an Ontario PE or without it depends on the tax bracket you are in. For example, using 2016 tax rates, there is a savings of about $953 with no Ontario PE on $50,000 of business income as opposed to as savings of only $35 on $100,000 of business income. The savings is greater at lower tax brackets. Note that the savings noted here take into CPP contributions that are payable the business income if no exemption is claimed under the Canada/U.S. social security agreement.
Corporations sending employees to Canada
The Article V service provider deeming PE provision could also apply to a treat a U.S. corporation (“USCO”) to have a PE in Canada by virtue of sending employees to Canada to work on a project. If this were the case, a corporate T2 return would be filed to allocate business profits derived in Canada under Article V & VII of the treaty with corporate tax payable at 26.5% as a non-resident corporation.
If the deeming provision is not applicable, say because the two-part test is not met, this does not mean that USCO is not carrying on business in Canada, and if it is carrying on business in Canada, does USCO have a PE in Canada? Here, the facts surrounding what the nature of the services are and other factors will determine if USCO is carrying on business with or without a PE in Canada.
Generally, it is wise to file a nil corporate T2 return and claim treaty exemption if USCO may be considered to be carrying on business in Canada under the Act. If a T2 return is not filed, there could be a $2,500 annual penalty for not filing the T2 return even where there is no tax payable.
CRA has commented that the mere sending employees to Canada to provide services does not in itself cause USCO to be carrying on business in Canada. Sending employees to Canada such as to the Waterloo, Ontario region is not unusual for IT / software development companies.