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US tax considerations for Canadian businesses:

Reducing your total tax burden


With the Canadian dollar performing under par, many Canadian businesses are considering opportunities for growth south of the border. From the development of a larger U.S. client base to opening a U.S. branch, there are many paths that can lead to success. Yet there are also many considerations that affect such business decisions, not the least of which are U.S. tax implications.

The Corporate tax rate in the United States is about 40%, with some variance from state to state. This is considerably higher than the rates in other industrialized nations, and a sharp increase from the rate—about 26%—that most Canadian companies pay.

Strategies for Cross-Border Business Activities

When establishing U.S. operations, businesses should choose a structure that will minimize their combined Canadian and U.S. tax burden. This means addressing not only immediate concerns surrounding U.S.-based business activities, but acting with an eye toward future profits, repatriation of income, and possibly the future sale of the business. As part of this discussion, any planning implemented should be integrated with your Canadian structure.

Under the current U.S. tax code, non-U.S. resident businesses are only taxed on their U.S.-source income that is effectively connected with a U.S. trade or business. However, determining which business revenues count as U.S.-sourced is more complex than many anticipate. Core variables used to determine U.S.-sourced income include:

  • Whether the business activities in the U.S. are “regular, continuous, and substantial”
  • Whether the business maintains a permanent establishment in the U. S., and
  • The location in which the business activities are conducted.

If a Canadian company does business in the United States but is not deemed to have a permanent establishment, their business profits may be exempt from U.S. taxes under the Canada/U.S. Tax Treaty. For example, a Canadian business selling goods to American customers online or through a third party such as Amazon would likely be exempt. However, such firms would nonetheless be recommended to file a protective U.S. tax return to claim treaty benefits and avoid any potential misunderstandings from the IRS. Businesses also need to remain cognizant of state taxes and regulations, which can vary widely and may not follow federal tax treaties.

Structuring a Business to Reduce U.S. Tax Obligations

For Canadian companies that desire or require a location in the U.S., there are a number of options for corporate structures that can be used. At a high level, some common options include:

Businesses looking to sell merchandise to U.S. customers that wish to deal with a U.S. legal entity often use a distributorship model. Under this structure, the Canadian company incorporates a separate U.S. company to act as their distributor in the U.S., and enters into a formal distribution agreement with the newly created entity. This structure keeps most of the commercial risk with the Canadian business, ensures that most of the profits will be taxed in Canada, and avoids having the Canadian entity deal with U.S. state and local tax considerations.

Canadian corporations that want a more permanent presence in the United States, but do not wish to establish a U.S. legal entity, can conduct business though a U.S. branch operation. However, under this structure, income is subject to immediate tax in Canada with no ability to defer taxation of excess profits, some profits may be subject to a 5% withholding tax, and more complex state tax filings will be required. Additional complications, including increased liability and exposure, keep the foreign branch model from being the best choice for many businesses.

If a Canadian company wishes to establish more substantial operations in the U.S., creation of a U.S. corporate entity may be the appropriate vehicle. While taxable income of the U.S. company would be subject to U.S. federal and state taxes, U.S. business income is not taxable in Canada until it is repatriated, providing additional flexibility. This structure may also afford more tax planning opportunities and is generally less complex from an accounting and tax administration perspective compared to a U.S. Branch. In addition, it fences in the U.S. liability risk and reduces risk to the Canadian assets.

Canadian companies should note that U.S. business partners, legal counsel, and U.S. CPAs often recommend a U.S. limited liability company (LLC) as the optimum U.S. entity due to its liability protection and flexibility. However, such recommendations do not take into consideration the Canadian tax implications of a U.S. LLC, which can result in unnecessary complications and the loss of certain tax treaty benefits.

Other Factors to Consider

When choosing the optimal strategy for a business's operations in the United States, taxes should not be the only factor. Company size and sophistication are critical concerns, as is the company's ability to properly administer and maintain the chosen corporate structure. Any potential advantages can be lost if the resulting structure is unmanageable.

As with any business decisions, long-term thinking should also play a part. The ideal approach to U.S. operations may look very different if the business owner is planning to maintain and grow the business versus one that plans to sell within a few years. Long-term business goals surrounding growth, expansion, and industry change can all have an impact, as will plans for the repatriation of profits to Canada. Balancing these concerns is a key part in the creation of a sustainable U.S. expansion plan that is integrated with your existing Canadian structure.

Avoiding Potential Complications

While Canadian business owners have heard of companies that have avoided filing and paying U.S. taxes, sometimes for years, these stories are becoming more rare. With the proliferation of electronic data, the information on any company's foreign dealings is now readily available; it is just a matter of the IRS connecting the dots.

The fear of a hefty tax burden that keeps many business owners from proper filing is generally unfounded. For most Canadian corporations who have only “dipped their toe” into the U.S. market, U.S. taxes are minimal, and often considerably less than business owners expect. That said, not complying with U.S. reporting requirements can leave the Company exposed to certain U.S. penalty regimes that may result in hefty fines.

Related Article
State and Local Tax Considerations for Canadian Businesses

The information in this publication is current as of June 3, 2016.

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.

While discussions about lowering U.S. tax rates to improve competitiveness are ongoing—and have been a topic of debate for the upcoming presidential election—efforts for reform have had little effect to date. With this in mind, it must be assumed that any Canadian company looking to expand the reach of their business to the U.S. will have to deal with the current American tax code.

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