Many Canadian companies hire contractors from south of the border to perform services in Canada. The last edition of the Labour and Employment News featured an article reviewing some of the basic immigration implications that should be considered before having an employee based in the United States perform work in Canada. This article focuses on the tax implications in such a situation. Canadian employers are well advised to consider such implications in advance of engaging American contractors.
There are Canadian income tax implications even when a foreign worker is only in Canada for a relatively short period of time. It does not matter whether the worker comes to work in Canada as an employee of a company from the United States or to perform services in Canada as an independent contractor.
Income derived by a non-resident of Canada from employment in Canada will generally be subject to tax withholding upon the same deduction tables applicable to Canadian residents. Pursuant to section 153 of the Income Tax Act (Tax Act) and Regulation 102, an employer resident of the United States is required to withhold Canadian payroll deductions from salary or wages, including taxable benefits, paid to employees performing services in Canada. The expression “performing services in Canada” is interpreted broadly to include not only those employees who are in regular and continuous employment in Canada, but also those who are physically present in Canada for work. Canadian payroll deductions are required in all circumstances unless the non-resident obtains a waiver of tax withholdings and the non-resident employee is generally required to file a Canadian tax return by April 30 of the following year.
In certain circumstances, the tax treaty between Canada and the United States may provide relief from Canadian tax deductions, but the non-resident employer and employee need to jointly apply for a waiver of tax withholdings. As soon as it is known that the employee will work in Canada, the employer and employee should apply for a waiver of tax withholdings, as retroactive waiver applications are generally not allowed. Waivers will be effective at the starting date of services provided by the employee in Canada or 60 days before the date of the application.
In the case of independent contractors, section 153 of the Tax Act and Regulation 105 provide that every person, resident or non-resident of Canada, paying a fee, commission or other amount in respect of services rendered in Canada must withhold and remit to Canadian tax authorities 15% of such payment. This includes payments for independent personal services and management fees, except remuneration from an office or employment, which is generally subject to the above Regulation 102 withholding. A Regulation 105 withholding is required for any payment made by the Canadian company to a non-resident person (individual or corporation) for services rendered in Canada, unless the non-resident provides a valid withholding tax waiver issued by the Canadian tax authorities or if the payments relate to a reasonable reimbursement of expenses incurred by the non-resident.
Again, the tax treaty between Canada and the United States may provide, in certain circumstances, an exemption from the Regulation 105 withholding, but the recipient needs to apply for a waiver. A non-resident may apply for a waiver under similar conditions to the Regulation 102 waiver. Otherwise, if the amount of tax withheld exceeds the actual Canadian tax liability, such excess may be recovered by the non-resident by filing a Canadian tax return and claiming a treaty exemption.
The Canadian company may also be required to withhold additional amounts on remuneration, fees, commission or other amounts, including taxable benefits, paid to a non-resident for employment or services rendered in the province of Québec.
In some circumstances, both a Regulation 102 and a Regulation 105 waiver may be needed (for example, where a United States corporation pays a United States worker). The Canada Revenue Agency has recently been reassessing taxpayers who fail to obtain waivers in advance. Reassessments in this area can be particularly harsh because those who pay a United States entity or United States employee are obligated to pay the prescribed withholding amount (plus penalties and interest) and the overpaid tax can only be reclaimed after the non-residents who received the payment file Canadian returns and are assessed. This can be a slow and expensive process and would often be done on behalf of workers who are no longer current employees.
Before a Canadian company hires a non-resident contractor to perform services in Canada or requests an employee from the United States, the company will need to consider what withholdings are required prior to making any payments and whether or not a waiver of tax withholdings is available. The waiver application should be made by the non-resident company or contractor as soon as it is known that work will be performed in Canada. If a waiver has not been applied for and approved, the Canadian company should withhold and remit Canadian tax pursuant to Regulation 102 or 105. As soon as Regulation 102 or 105 tax withholdings are required, the non-resident should file a Canadian tax return. In any case, if the amount of tax withheld exceeds the actual Canadian tax liability, such excess may be recovered by the non-resident by filing a Canadian tax return but this may result in a much longer waiting period.