Tax Treaty benefits are often relied on to alleviate double taxation, or in many cases to reduce the level of domestic withholding tax to nil, or a much more reasonable amount. However, in many cases an assumption is made that the Treaty will always be available to fall back on, which can lead to unfortunate tax consequences if care is not taken to ensure the articles of the relevant Tax Treaty apply, as intended.
With a much more robust acceptance of virtual working arising from COVID-19 social distancing measures, in addition to travel restrictions, there are several Treaty related issues arising from changes to cross-border movement. This article summarizes the following areas of concern addressed in recent guidance provided by the CRA:
- Income Tax Residency for the individual and corporation,
- Carrying on a business in Canada/permanent establishment,
- Waiver Requests – payments to non-residents for services provided in Canada
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I. Income Tax Residency
There are various common-law factual determinations that arise for factoring whether an individual has residential ties to Canada. For individuals who sojourns to Canada for a period of, or periods the total of which is, 183 days or more in a tax year will be deemed to be a resident in Canada throughout the year.
The deeming rule creates a requirement to be taxed in Canada and file the appropriate tax returns. However, the CRA has determined that where an individual has remained in Canada solely as the result of the travel restrictions, that factor alone will not cause the common-law factual determination of residency to be met. Furthermore, where the employee returns to their Country of residence as soon as possible after the travel restrictions are lifted, the CRA should not count the days in Canada where the individual was present, solely related to travel restriction, towards the 183-day limit for deemed residency.
These rules also apply to individuals residing in the US that may be employed and perform their employment duties in Canada, where remuneration is greater than $10,000 or the person is present in Canada for a period or periods not exceeding in the aggregate 183 days in any 12 month period, and the remuneration is not borne by an employer resident in Canada or a permanent establishment in Canada.
To maintain corporate residence abroad for tax purposes, it is necessary to demonstrate that not only de jure management and control exist, but also de facto control as well. In other words, management and control must exist in form and substance. There is no single test that should be met to determine the location of the mind and management of a company. The determination is a question of fact based on various factors, the most important being the determination of the persons making the strategic decisions for the company. It is essential that the powers of the local management in the foreign jurisdiction are not usurped by management in Canada (or an alternative jurisdiction).
A corporation that, prior to the implementation of the Travel Restrictions, was tax resident in a foreign jurisdiction may have one or more directors present in Canada. The Travel Restrictions might have resulted in these directors being unable to travel to the foreign jurisdiction to attend board meetings. Some of Canada’s income tax treaties will address the situation of dual residency with tie-breaker rules, often related to the resident country under whose laws the corporation was created. For treaties where effective management is the tie-breaker rule, the CRA has stated that in light of the extraordinary circumstances resulting from the Travel Restrictions, as an administrative matter, where a director of a corporation must participate in a board meeting from Canada because of the Travel Restrictions, the CRA will not consider the corporation to become resident in Canada solely for that reason.
Determinations of corporate residency involving potential dual residency with non-treaty countries will be determined on a case-by-case basis.
It should be noted that the location of board meetings alone will not determine the extent that de jure and de facto control tests are not passed. Therefore, if a board meeting is the only element the corporate structure uses to determine the location of central management and control, the CRA may challenge the non-resident corporate structure.
II. Carrying on a business in Canada/permanent establishment
Under the Canadian income tax system, where non-residents are considered to be carrying on a business in Canada, the entity is liable to pay tax on their income. Typically, Canada’s tax treaties limit the tax compliance burden to filing a nil-based treaty return, where the business profits of a resident of a foreign country are only taxed in the foreign country due to a permanent establishment situated there. The business profits would be taxed in Canada if a permanent establishment existed in Canada as well.
As an administrative matter and in light of the extraordinary circumstances resulting from the Travel Restrictions, the CRA will not consider a non-resident entity to have a permanent establishment in Canada solely because its employees perform their employment duties in Canada exclusively as a result of the Travel Restrictions being in force. Similarly, the CRA will not consider an “agency” permanent establishment to have been created for the non-resident entity solely due to a dependent agent concluding contracts in Canada on behalf of the non-resident entity while the Travel Restrictions are in force, provided that such activities are limited to that period and would not have been performed in Canada but for the Travel Restrictions.
Finally, the CRA will exclude, in determining whether an individual meets the 183-day presence test in a “services permanent establishment” provision of Canada’s tax treaties (such as Article V(9)(a) of the Canada-United States income tax treaty), any days of physical presence in Canada due solely to Travel Restrictions.
III. Waiver Requests – Payments to non-residents for services provided in Canada
Canadian income tax rules require that amounts must be deducted or withheld and remitted in respect of:
- payments for services rendered in Canada by non-residents, other than those paid in respect of an office or employment (“Regulation 105”), and
- remuneration paid to a non-resident officer or employee in respect of an office, or employment services, provided in Canada (“Regulation 102”).
In certain circumstances, an application to the CRA may be made for a waiver of the withholding requirement in respect of Regulation 105 or Regulation 102 (a “Waiver Request”). Most often, this will be the case where the recipient is exempt from Canadian income tax in respect of the payment because of an income tax treaty that Canada has with the recipient’s country of residence.
As a result of the interruptions in processing caused by COVID-19 and the travel restrictions, urgent waiver requests may be submitted electronically on a temporary basis. Additionally, where a waiver request in respect of Regulation 105 and/or Regulation 102 has been submitted to the CRA and, due to COVID-19 delays, the CRA was unable to process the request within 30 days, the CRA will not assess a person who fails to deduct, withhold or remit any amount as required by Regulations 102 and 105, in respect of an amount paid to a non-resident person covered by the particular waiver request.
The person paying the amount should be able demonstrate that they have taken reasonable steps to ascertain that the non-resident person was entitled to a reduction or elimination of Canadian withholding tax by virtue of an income tax treaty with Canada. Both the non-resident and the person paying the amount must otherwise fulfil their Canadian reporting and remitting obligations in respect of the waiver application.
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