Finishing Livestock in the U.S. Can Cause U.S. Tax Consequences
Bruce Ball , Partner, BDO Dunwoody LLP
Alberta Farmer
July, 2008
A new trend has developed for those farmers who sell livestock to U.S. customers – rather than shipping mature livestock to the U.S., many Canadian farmers are now choosing to finish their livestock on U.S. feedlots due to economic advantages, which can include cost savings, access to facilities, marketing advantages and the current low level of the U.S. dollar.
Despite the economic benefits, you should keep in mind that the use of U.S. feedlots could also create a requirement to file U.S. tax returns and even pay U.S. taxes.
Why are U.S. taxes a concern?
U.S. tax issues for Canadian exporters can arise depending on how they solicit business in the U.S. Shipping goods for sale from Canada to the U.S. will generally not, in itself, cause a requirement to pay tax to federal or state governments in the U.S.. For U.S. federal income tax purposes, one must generally have a permanent establishment (“PE”) in the U.S. before they become liable for U.S. tax. In the case of state taxes, tax can become payable where an exporter has “nexus” with the state. We’ll describe what both these terms mean in greater detail.
What you do need to keep in mind, however, is that sending livestock to the U.S. for finishing and slaughter is substantially different than simply exporting livestock to the U.S. or even temporarily housing the livestock there as inventory prior to a sale.
U.S. Federal Income Tax
For U.S. federal income tax purposes, the main issue is whether a Canadian has a PE in the U.S. You’ll have a PE in the U.S. if you have a fixed place of business through which your business is wholly or partly carried on. This includes an office or factory, but it is not restricted to what we would ordinarily view as a business establishment. There are exceptions too – one includes maintaining inventory in the U.S. for resale.
The reference to whether you are partly carrying on your business in the U.S. is the biggest issue. That is, are you just storing your inventory at a U.S. feedlot, or is it more than that? Where a good is processed further in the U.S., then there is a much greater chance that you have moved some of your business operations to the U.S. The test will come down to a comparison of the good that entered to the U.S when compared with what was sold there. For example, if the weight of your livestock increases substantially while in the U.S., then there is a greater chance you are carrying on business there.
Note that even if you can argue you are simply storing inventory in the U.S., this doesn’t mean that you don’t have to file a tax return with the Internal Revenue Service. The fact Canadians do not have to pay U.S. tax in this situation is due to relief in the tax treaty we have with the U.S. and this relief is only available when it is disclosed as part of a U.S. personal or corporate income tax return.
State Taxation
Another and perhaps larger concern is U.S. state tax. Even if you can argue that you are simply holding the livestock in the U.S. as inventory for resale, you may still have state issues. This is because states, in general, tax business owners based on a concept known as nexus, meaning the nature and frequency of contacts an out-of-state vendor has with a state. If there are enough connections, then nexus has been established and state tax may apply. Unfortunately, the concept of nexus is not especially well defined and is difficult to describe, but it is commonly agreed that it is much easier to be caught by a state nexus test when compared with the tests around whether a PE exists. If nexus does exist, states are generally not bound by the tax treaty between Canada and the U.S. So both storing livestock inventory in a state and finishing the livestock in a state can cause nexus.
If you have nexus with a particular state, there are a variety of potential taxes that can apply:
- State income tax – for both unincorporated and incorporated farmers.
- State franchise taxes for incorporated farmers.
- State sales and use taxes.
In terms of sales and use taxes, there is a good chance that you won’t have a tax liability (as the sale of livestock by you won’t generally be to an end user), but you may still have filing requirements.
Canadian Tax Implications
There may be good news on the Canadian side. If you do have to pay U.S. federal or state income tax, that tax can be claimed as a foreign tax credit in Canada. The problem though for many will be that these credits can only be applied to reduce Canadian tax, which will mean that you will not receive immediate benefit if you don’t have a Canadian income tax liability before the foreign tax credit. If you can’t claim a credit, you may be able to carryover the tax paid to claim as a credit in a future year. As most farmers calculate income for Canadian tax purposes on a cash basis, this can make claiming a foreign tax credit more difficult.
Other U.S. taxes, such as state franchise taxes for corporations, can be claimed as a deduction in Canada as a business expense in the year in which they are incurred.
Sending livestock to the U.S. for finishing can provide economic advantages. However, there can also be hidden costs. One of those costs is dealing with U.S. tax rules, both in terms of possibly paying tax and the cost of complying with U.S. tax legislation.
