Canadian businesses and others making payments to non-resident service providers have a long-standing obligation to withhold 15% of the payment for services rendered in Canada. This withholding tax (known as the Regulation 105 withholding tax) is a pre-payment of the non-resident entity’s Canadian income tax obligation.
Provided that the income tax return is filed within the statutory time frame, the amount withheld is either applied to Canadian taxes that are owed when the non-resident files a Canadian income tax return for taxable Canadian activities, or it is refunded if the non-resident can claim an exemption from Canadian tax due to an income tax treaty.
Quebec imposes an additional 9% withholding tax on similar payments if the services are rendered in the province of Quebec.
Historically, the Canada Revenue Agency (CRA) has allowed the payment subject to withholding tax to exclude the portion that is a reimbursement of expenses, provided the expenses and the Canadian service fees are itemized separately on the invoicing documents.
Earlier this year, however, the CRA modified its position with respect to withholding tax requirements for expenses that are subcontractor fees for services rendered in Canada. This new position applies to reimbursements of subcontractor fees paid after September 30, 2024.
How does this impact businesses and contractors? A practical example
To understand the change in position on Regulation 105 withholdings on subcontractor fees, let’s consider the following scenario provided by the CRA:
- A U.S. resident corporation (USCo) enters into an agreement (Agreement) to provide services to a Canadian resident customer (CanCustomer), some of which must be physically performed in Canada and some of which may be performed outside of Canada.
- USCo enters into an agreement (Subcontract) with its Canadian resident subsidiary (CanSub) for CanSub to provide services that require a physical presence in Canada.
- Under the Agreement, CanCustomer agrees to reimburse USCo for all direct and indirect travel costs and meals.
- After CanSub provides services, it sends an invoice (Invoice #1) to USCo which separately itemizes its fees for services rendered in Canada from any travel and meal costs incurred.
- USCo pays CanSub’s invoice. USCo then sends an invoice (Invoice #2) to CanCustomer, which separately identifies its fee for services performed outside Canada, the travel and meal costs, and the fee that CanSub invoiced for the services performed in Canada.
In this scenario, the CRA’s previous position would generally not require Regulation 105 withholdings on amounts paid by CanCustomer to USCo as a reimbursement of USCo’s subcontracting expenses.
The CRA is now making a distinction between the amounts reimbursed to USCo by CanCustomer for:
- services rendered in Canada by CanSub; and
- travel and meal costs incurred by CanSub to provide such services.
The CRA acknowledged that this is a change in its position.
Relief from withholding tax
The CRA allows non-residents to apply for relief from withholding tax in advance of receiving payments for services rendered in Canada by applying for a waiver. This waiver will generally be allowed when the non-resident can show that they do not have a permanent establishment in Canada and that their activities in Canada are exempt under an income tax treaty. When presented to the Canadian payor, the waiver allows the payor to make the payment free of withholding tax.
Both the 2024 federal budget and draft legislation released in August 2024 have proposed that such waivers can be applied to cover payments made within a specified period of time, instead of on a transaction-by-transaction basis.
Key takeaways
As the CRA’s new guidance requires Regulation 105 withholding on amounts paid to non-residents for the reimbursement of subcontractor fees for services rendered in Canada, it effectively reduces the amount the non-resident corporation will receive by the 15% withholding tax on these payments. It is important to consider the following next steps:
- Customers should carefully review agreements and invoices with non-resident contractors who use subcontractors to provide services in Canada, to determine if their Regulation 105 withholding tax obligations have changed. This will help customers comply with their withholding tax obligations in light of the CRA’s new position and to minimize the risk of non-compliance penalties.
- Customers and non-resident contractors should ensure that travel and meal cost reimbursements are clearly separated from the fees for services rendered in Canada on any invoices, to help minimize the amount that would be subject to withholding tax.
The information in this publication is current as of September 18, 2024.
This publication has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The publication cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it.