New U.S. tax reform rules encompass more than simply lower tax rates for businesses and individuals. Further to these changes are new filing requirements for partnerships and the Wayfair case decision, which impact Canadian businesses making sales of products to U.S. customers.
To determine whether your business may be affected by the changes, ask yourself the following questions:
• Does your business have U.S. customers?
• Does your business hold an interest in a U.S. entity?
• Does your business own U.S. assets?
• Has your business sold an interest in a U.S. partnership?
• Does your business have sales in excess of $500,000 in a U.S. state?
• Has your business reorganized their business structure?
• Is your business a partner in a partnership filing a U.S. income tax return?
If you answered yes to any of these questions, it is time to speak with a U.S. Tax Advisor that can identify the impact this new legislation has on you and offer advice on how best to serve them.
Here are some of the Top Issues faced by Canadian business selling into the U.S.:
1. Federal income tax and tax treaty
Doing business in another jurisdiction will be subject to tax in that jurisdiction. For the sake of convenience and mutual tax collection, Canada and the U.S. have a treaty in place that reduces the tax liabilities of the other country’s residents.
For example, the withholding tax rate on U.S. interest income is reduced from 30% to 0%. Also, if you are a Canadian doing business in the U.S. without a fixed place of operation, you are not liable for U.S. federal income tax.
However, just living in Canada or incorporating a company in Canada does not automatically qualify you for benefits under the Canada-U.S. tax treaty. Your business will still need to file tax returns and forms to take advantage of these benefits. Additionally, certain entities, such as U.S. limited liability companies (“LLC”) are specifically denied benefits under the treaty.
Sometimes it is not even the tax that is the issue as penalties apply for failing to disclose intercompany cross-border transactions, treaty positions, and other items. The penalties are currently $25,000 per failure, which is not an insignificant amount. While it is possible to appeal the penalties, avoiding them altogether is a whole lot easier.
2. State Income tax
In additional to federal income tax, each state in the U.S. may impose income taxes as well. Even if your business is free of U.S. federal tax under the treaty, some states like California will still impose income taxes based on your level of activity (“nexus”) in the state.
Some states have a bright line test of $500,000 in sales, $50,000 in payroll, or $50,000 in property in the state. So, it is quite possible to never have stepped foot in a state and still be liable for taxes there by selling a certain amount to residents in that state or holding inventory there, including in third party warehouses such as an Amazon fulfilment centers.
Software services, such as SAAS, provide additional concerns as states have started imposing income tax on electronic services to state residents even if the services are provided elsewhere. Some states have even stated that having a website accessible by their state creates nexus. That is not very practical, of course, and arguably the state would have no way to impose that. However, it gives a sense of how low the threshold is.
An assessment of the potential exposure should be done by an experienced U.S. Tax Advisor to effectively manage the tax or the risk of assessment
3. State Sales tax / Wayfair case decision
Out of state retailers benefited from the exemption from withholding state sales tax. However, the recent Wayfair case and changed that. Most state since have now imposed state sales tax collection and remittance on out of state sellers if the sales into their state consist of over 200 transactions or $100,000 in sales. The actual thresholds may vary by state.
If you answered yes to any of the questions above or are concerned regarding your potential U.S. tax exposure, a U.S. Tax Advisor, such as our team at MNP, can help you to manage or mitigate the tax exposure with an effective corporate structure and satisfaction of the correct tax returns.
Dennis Werkman, CPA, CGA, is a Partner in MNP’s Tax Services group in Vancouver. Focused on international tax, Dennis assists private and public corporations in a variety of industries, including real estate, mining and technology, with both inbound and domestic U.S. corporate tax and outbound Canadian corporation tax services. With over 12 years of experience, Dennis is the GCS lead for MNP’s Global Compliance Services, connecting the firm’s clients and affiliated firms with the resources they need for compliance in and out of Canada.