Canadian transportation companies (CTC) doing business in the United States face a competitive advantage of being able to avoid U.S. federal income tax. However, many CTC ignore potential pitfalls—state tax and non-compliance—in doing business in the U.S. It is critical for CTC to properly plan their U.S. business, to understand the critical state tax differences and to adhere to the necessary U.S. federal and state tax compliance.
Under the U.S.-Canada Income Tax Treaty (the “Treaty”), profits derived by a Canadian company from the operation of motor vehicles as a common carrier or a contract carrier from the transportation of property between a point outside the United States and any other point are exempt from U.S. federal income tax. This means that CTC can operate between the U.S. and Canada and not be subject to U.S. federal tax.
The current top U.S. corporate federal income tax rate—35 percent—is significantly higher than the tax rate that CTCs are subject to in Canada, making this exemption extremely valuable to CTC. CTC are required to file an annual U.S. federal income return to affirmatively claim this Treaty exemption. The failure to file this return subjects a CTC to possible penalties, including a USD $10,000 failure to file penalty.
In its tax reform proposal, the Trump Administration is proposing to reduce the U.S. federal income tax rate to 20 percent. If this passes, CTC will have the flexibly to do more in the U.S. without incurring incremental tax. It is uncertain whether this proposal will pass, and if it does, whether the rate will be reduced as low as 20 percent.
While the typical CTC structures its U.S. operations to comply with the Treaty exemption, many CTC are subject to U.S. state tax and have complex requirements to comply with state tax reporting regimes. Many states have become increasingly aggressive to seek out non-U.S. companies doing business in the U.S., including CTC. Many CTC will often ignore or take a “wait and see” approach when it comes to state taxes. This can be detrimental as some states impose a minimum tax and 25 percent penalty for any unpaid taxes.
U.S. states are not signatories to the Treaty, and states are not required to provide the same relief from taxation as provided under the Treaty. Some states voluntarily adopt the Treaty, whereas some states do not (i.e. California and New York). In order for a state to impose a corporate income tax filing requirement, a taxpayer must have nexus (i.e. sufficient connection or contact) with a state. Generally, nexus is established when there is property, payroll and/or sales within a given state. With regard to the trucking industry nexus can also be established when a company performs backhauling activity. Additionally, some states (i.e. California) have now adopted factor presence nexus standards, such that nexus is created by the presence of a certain threshold of property, payroll or sales in a state (i.e. sales in excess of $500,000).
For a trucking company, sales levels are determined by the amount of miles that are driven through a particular state, the miles are then multiplied by that corporation's total revenue.
Another trap for unwary CTC are states that are taxing via a gross receipt tax—Ohio, Nevada, Texas, Washington—in lieu of the traditional corporate income tax. Washington imposes the Business and Occupations Tax (B&O), in which nexus is established in Washington once the taxpayer has Washington receipts in excess of $267,000. Washington does not adopt the Treaty and does not allow for deductions, therefore, the taxpayer will be taxed on their receipts and generally pay a rate of 1.5%.
One of the highest state tax rate—9.99% in Pennsylvania—is much lower than the rate CTC will pay in Canada. If a CTC that is taxable in Canada properly files in states where it has nexus, any state tax issues can be managed by proper annual compliance. As customs are sharing information, non-compliance can lead to being stopped at the border or worse refused entrance into the US. It is becoming more and more important for the transportation industry to stay abreast of changing state tax environment. As driving through a state can create nexus regardless of any other activities within the state.