Iain Morris Discusses the Tax Issues Facing Non-residents who Provide On-site Installation and Training Services in Canada

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Episode 26: Iain Morris Discusses the Tax Issues Facing Non-residents who Provide On-site Installation and Training Services in Canada

Release date: Aug 4, 2010
Guest: Iain Morris
Running time: 11:33 minutes

When companies that are not residents of Canada provide construction, installation or training services here – perhaps for a related company – both the service provider and the Canadian company can face important tax implications that should be anticipated and dealt with. Potential concerns include withholding payments, filing income tax returns, payroll taxes and sales taxes. PwC tax partner Iain Morris outlines the issues and steps that should be taken to avoid problems and expensive surprises.

Learn about the risk of audits of non-residents, how to qualify for exemptions from withholding tax and how to recognize the various tax considerations that can arise when non-residents perform services in Canada.

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Iain Morris discusses the tax issues facing non-residents who provide on-site installation and training services in Canada

You’re listening to another episode of PwC’s Tax Tracks at www.pwc.com/ca/taxtracks. This series looks at the most pressing technical and management issues affecting today’s busiest tax directors.

Gerry Lewandowski: Here with us today is Iain Morris, a partner with PwC Canada’s Tax practice based in Toronto. Iain has been with PwC for over 20 years and specializes in advising foreign multinationals investing in Canada. Iain has advised many foreign-based companies on the tax implications of carrying on business in Canada and locating facilities in Canada. Iain is with us today to discuss some of the tax issues and traps facing non-resident companies who are engaged in providing construction, installation or training services in Canada.

Thanks for joining us, Iain.

Iain: Thank you. It’s good to be here.

Gerry: So Iain, let’s start with defining the issue…what is the particular situation we are talking about here where non-residents are hired to provide certain services in Canada?

Iain: Well, the Canada Revenue Agency (the CRA) has a renewed focus on auditing non-resident entities that are carrying on business activities in Canada.

And, a situation which often arises is where a non-resident company is contracted by a related Canadian company to provide on-site installation and training services. For example, let’s say we have a Japanese auto maker setting up a wholly owned subsidiary in Canada to build an assembly line here. The Canadian subsidiary then contracts with its Japanese parent to provide installation or related training services for the assembly line.

In this scenario, various Canadian tax implications arise for both the non-resident Japanese parent as well as for the Canadian subsidiary.

Gerry: Alright, so let’s talk about the implications for the non-resident rendering services in Canada. What issues should the non-resident be mindful of?

Iain: When a payment is made by a Canadian company to a non-resident for services performed in Canada, the Canadian company is obliged to withhold and remit 15% as an advance payment on the potential Canadian tax liability, which the non-resident may have on the income earned in Canada. This is known as Reg 105 withholding tax, and note, that if the services are rendered in Quebec, an additional 9% may apply.

Non-residents carrying on these types of activities in Canada should carefully separate out any payments into three categories:

  • Those that relate to services rendered in Canada which are subject to withholding
  • Those that relate to a reimbursement of out-of-pocket expenses which are not subject to withholding and
  • Those that relate to payments for services rendered wholly outside of Canada which are also not subject to withholding

Where the non-resident is subject to withholding, it may either apply for a “treaty-based waiver,” whereby the non-resident is able to claim exemption from Canadian tax under a tax treaty or it can seek a reduction in the withholding based on its estimated Canadian tax liability.

For the Canadian payor, aside from the obligation to withhold, there are also various compliance and filing requirements.

Gerry: Does the non-resident have to file a Canadian tax return?

Iain: Generally, if the non-resident “carries on business” in Canada, it must file a Canadian tax return (notwithstanding that it may ultimately be exempt from tax under a tax treaty).  And it should be noted that there are penalties for failing to file.

Now, the threshold for a non-resident to be considered to be “carrying on business” in Canada is really quite low.  Essentially, if the non-resident performs any services in Canada or solicits orders or offers anything for sale in Canada through an agent or employee it can be considered to be carrying on business in Canada….even if the contract is ultimately completed outside the country. 

Gerry: So, Iain, how does the non-resident qualify for exemption under a treaty?

Iain: Most often, non-residents will access a tax treaty exemption if they are resident in a country that has a tax treaty with Canada and the non-resident does not carry on business through a permanent establishment or PE in Canada.

Under these circumstances, the non-resident will only be subject to tax in Canada if it carries on business through a PE in Canada.  Now, most treaties define a PE to include:

  • Recurring or lengthy use of a physical space in Canada (regardless of whether its owned, rented or otherwise)
  • A building site or construction project lasting more than 12 months in Canada, or
  • Even a person acting in Canada with the ability to contract on behalf of the non-resident (other than an independent agent)

It is important to note, that some treaties, including those with the U.S. and Japan, include the deeming rule for a building site, or construction or installation projects that last 12 months or more. As such, the non-resident can become taxable in Canada if the underlying project lasts 12 months or more regardless of whether the individual employees are in Canada for less than 12 months.

Gerry: Now, do payments made to non-residents for duties of employment in Canada attract payroll taxes in Canada?

Iain: Yes, if a non-resident is paid remuneration for duties of employment performed in Canada, the non-resident is subject to Canadian payroll withholding and reporting requirements. It is irrelevant whether the paying employer is resident in Canada or not. Reg 102 withholding applies unless a waiver has been obtained as discussed earlier.

Reg 105 withholding may also apply in the situation where the non-resident temporarily sends employees to Canada to work for a related Canadian entity and the Canadian entity reimburses the non-resident for the services of its employees via a management fee or other similar payment.

Only a properly structured “secondment” of these employees to the Canadian entity can get around this last obligation.

Gerry: Hypothetically speaking, if the non-resident ends up being taxable in Canada, can it not limit its tax exposure in Canada by limiting the amount of payments made for the services rendered in Canada?

Iain: Unfortunately, I wish it were that easy.

But when establishing any sort of contract for on-site installation, construction or training services in Canada, it is necessary that appropriate arm’s length terms and conditions be established in accordance with international transfer pricing principles.

However, if it becomes clear to the non-resident that they will have a PE in Canada and will be subject to tax and not able to obtain a full waiver from the Reg 105 withholding, then we recommend that an application be made to the CRA to reduce the withholding tax in accordance with the estimated gross-margin on the contract rather than the gross proceeds.

Gerry: Are there any sales tax implications for the non-resident in all of this?

Iain: Non-residents “carrying on business” in Canada are required to register for Canadian sales taxes (GST or HST) regardless of whether a PE exists under the relevant treaty. As a registrant, the non-resident will be required to charge, collect and remit the GST/HST on all taxable supplies made in Canada.

The notion of “carrying on business” for purposes of sales tax registration is based on the facts of the particular case. However, it is often advantageous for a non-resident to voluntarily register if it expects to pay GST or HST on costs incurred or goods imported into Canada.

Now, as of July 1, 2010, both the Ontario and BC provincial sales taxes will be harmonized with the federal GST and the basic rules for applying the HST, which is what it will be known as, will be substantially the same as the current GST.

It should also be noted that any items imported into Canada by non-residents may be subject to certain customs duties and taxes upon importation unless they qualify under one of Canada’s free trade agreements (such as NAFTA).

Gerry: And finally, Iain, what should non-resident companies, providing services in Canada, be doing to properly deal with all these tax considerations?

Iain: There are a number of things that non-residents should be doing.

  • Firstly, review all on-site installation and training activities in Canada to assess whether appropriate filings and payments have been made. 
  • Second, assess your PE status in Canada. There is a CRA checklist that is available and which should be completed and PwC can assist you with this. If a PE is found to exist then the non-resident should look at ways in which the Reg 105 withholding can be reduced through computation of the estimated gross margin rather than withholding on the gross proceeds.
  • Third, look at current and future contracts to assess whether a PE exists and other filing requirements have been met.
  • Next, consider any indirect tax issues.
  • And, finally, review exposure to both Reg 105 and Reg 102 withholding tax for amounts paid to non-resident sub-contractors or employees that have been or are working in Canada.

And last but not least, remember that PwC can assist you with any of these assessments, filing requirements, reviewing sales tax and customs issues, and responding to CRA audit requests and queries.

Gerry: We would like to thank Iain Morris for sharing his perspective on tax issues facing non-residents who provide on site installation and training services in Canada. For additional information on PwC Canada’s tax services please go to pwc.com/ca/tax.

Thank you for tuning into Tax Tracks at www.pwc.com/ca/taxtracks.

The information in this podcast is provided with the understanding that the authors and publishers are not herein engaged in rendering legal, accounting, tax or other professional advice or services. The audience should discuss with professional advisors how the information may apply to their specific situation.

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Through interviews with prominent PwC tax subject matter professionals, Tax Tracks is an audio podcast series that is designed to bring succinct commentary on tax technical, policy and administrative issues that provides busy tax directors information they require.