Tax Articles
Changes to Canada-US Tax Treaty Intended to Encourage Trade
Dom Cocco
The Business Advocate
Given the challenges of the global marketplace today, recent amendments to the Canada-US Income Tax Convention, which are intended to encourage trade and investment and to improve tax efficiency, are likely to be warmly welcomed by Canadian businesses that conduct business across the border.
Canada ratified the fifth protocol to the Canada-US Income Tax Convention in December 2007 and the US Senate did so in September 2008. As soon as the US President signs the protocol and the two governments exchange official notifications of ratification, it will come into force. Most of the new rules will apply on the first day of the second month after notification is exchanged.
Here’s a summary of the significant changes that might impact your business.
- The withholding tax on cross-border interest payments has been eliminated. Therefore if your company borrows from an arm’s-length US lender, you will no longer have to withhold and remit the 10% Canadian tax on interest payments. For interest payable to related organizations, such as a parent company and subsidiary, the withholding tax will be reduced over three years: from 7%, to 4% and finally to 0%. These changes should help to make Canadian companies more appealing to US investors.
- Canadian companies may be more attractive to US private equity and hedge funds because treaty benefits have been extended to US limited liability companies (LLCs) – the form in which many of these funds are structured. The protocol effectively recognizes LLCs as partnerships rather than as corporations, so they won’t be subject to double taxation to the extent they have US resident unit-holders.
- Employers with employees who work in the US on a short-term basis may face more tax headaches. Canadian employees have been able to work in the US (and US employees to work in Canada) on temporary assignments and both employee and employer were usually exempt from local taxation on the basis that the employer did not have a US permanent establishment. Under the new protocol, however, Canadian employees will likely be liable for US taxation when they are in the US for more than 183 days in any 12-month period. As well, the employer will be deemed to have a permanent establishment – and will therefore be liable for US taxation – if the employee providing services in the US spends 183 days or more there in a 12-month period and more than 50% of the employer's income is created by that employee or where there is more than one employee, those employees spend more than 183 days working on the same or related contracts in any 12-month period. The same applies to US employees entering Canada.
- The protocol clarifies the taxation of employee stock options, which is intended to reduce instances of double tax on the same benefit income. Each country may now tax the portion of the option benefit based on the amount of time the employee lived and worked in each locale between granting the option and exercising it.
- Taxation of pension contribution deductions is now more equitable for employees who live in one country and work in another. The protocol specifies that employees are allowed to deduct pension contributions in the country where they work. Therefore employees no longer face the possibility of paying tax on contributions in both countries. As well, employees who move for work will be able to deduct their contributions to a plan in the original country, for up to five years.
- The protocol offers another option for dispute resolution when the tax authorities of both countries are unable to reach a timely agreement on a double tax issue. A taxpayer will be able to accelerate negotiations by requesting mandatory arbitration.
Be sure to discuss with an international tax specialist the potential impact of the agreement on your cross-border strategies.
Dom Cocco is a partner with BDO Dunwoody LLP (www.bdo.ca). One of Canada’s leading accounting firms, BDO helps entrepreneurs and family businesses succeed. You can reach Dom at (905) 525-6800 or dcocco@BDO.ca.
