Canadian businesses operating in or selling to customers in the United States may be subject to income taxes in the U.S. and/or may need to collect and remit U.S. state sales tax.
Whether a Canadian company is subject to U.S. federal and/or state taxation depends on several factors. For U.S. federal income tax purposes, the controlling document is the Canada-U.S. Income Tax Convention (Treaty) and a determination of whether the company has a permanent establishment in the U.S. For state income and sales tax purposes, the primary factor is whether the company has nexus within one or more states.
Permanent Establishment (PE)
If a Canadian company has a PE in the U.S. it is subject to U.S. federal income taxation. A PE includes a place of management, branch, office, or factory. It also includes a building site or construction/installation project if the construction or installation period exceeds twelve months. In addition, there are also services PE rules, which may deem a PE to exist based on services performed in the U.S. by Canadian employees.
Companies that have a PE should be filing U.S. federal income tax returns. If a Canadian company is operating as a branch in the U.S., the
U.S. federal and state income tax liability will be treated as a foreign tax paid. The startup may then be eligible for a foreign tax credit on its Canadian tax return, which should decrease the company’s Canadian tax liability.
A company that does not have a PE must file an annual US federal tax return to disclose its Treaty-based position in order to avoid an annual U.S. $10,000 penalty.
The concept of nexus essentially looks at whether a business has a non-trivial presence in one or more states. It is determined on a state- by-state basis and there are slightly different criteria between nexus for sales tax and nexus for income taxes. In determining whether the Canadian business has nexus, consider if the business has employees (including those attending trade shows), provides installation or implementation, has inventory stored, or has a physical location or property (including intangible property) in the state.
Rules vary from state to state and even a temporary presence may be enough to establish nexus. In Pennsylvania, for example, if a consultant is present in the state for more than seven days the business is considered to have nexus. In addition, a growing trend in certain states is the adoption of economic nexus rules, whereby nexus is deemed to exist in a state where the business has a threshold amount of revenue- notwithstanding that the business does not have a physical presence in the state.
It is also worth noting that if two businesses are affiliated with one another, in determining if one of them has nexus, the operations of the other can be taken into account. For example, in New York, if a business without nexus has as little as 5% cross-ownership with another business that does have nexus, it can result in the first company having nexus as a result of the affiliate nexus rules. Other connections including sharing of intellectual property such as trademarks can also result in the affiliate rules applying.
It is crucial to carefully consider the operations of a business in relation to each state in which it operates or has customers.
State Sales Tax
A Canadian business with nexus for sales tax purposes in a state will be required to register for a sales tax permit to collect and remit sales taxes like any other business operating in that state.
As with GST/HST in Canada, sales tax rates can vary significantly from one jurisdiction to another. However, in the U.S., there is no federal sales tax. The total sales tax that a business must collect and remit is comprised of state and local sales taxes.
The tax amounts collected must be remitted to the state periodically; typically, as a company’s sales increase so does the frequency of its remittances. Some local jurisdiction’s sales taxes are reported and remitted to the state which passes them onto the local authorities, but others require that separate reporting be done.
Most services and some goods are exempt from sales taxes; however these rules vary on a state-by-state basis. Additionally, a customer can avoid paying the sales taxes if they present a valid exemption certificate. This can occur when the use of a product or service is deemed exempt (e.g. if the product is for resale or further manufacturing) or when the customer has been deemed exempt (e.g., a not-for-profit or government organization).
For more information contact our Director of U.S. Tax, Alan Tippett, CPA (Indiana) – [email protected] – 613.236.9191