“What if" series – Significant tax implications to Canadian residents working for a US employer in the US

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Episode 58: “What if Series” — Significant tax implications to Canadian residents working for a US employer in the US

Release date: June 4, 2013
Guest: Vasu Krithigaivasan
Running time: 10:00 minutes

In this episode of Tax Tracks PwC’s Vasu Krithigaivasan discusses the payroll considerations and payment of travel expenses for Canadian residents working in the US for a US employer.

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“What if Series” — Significant tax implications to Canadian residents working for a US employer in the US

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.

Sharon: Hi, it’s Sharon Mitchell; welcome to our “What if” podcast series that discusses various tax situations and issues with the Canada Revenue Agency. Today we have Vasu Krithigaivasan, a Senior Manager from the PwC Human Resource Services tax group. Vasu specializes in International Assignments and Expatriate Tax Management at PwC. He has been working in this field since 2000.

Welcome Vasu.

Vasu: Thank you Sharon.

Sharon: Now Vasu, it’s my understanding that there are a number of Canadians who are employed by U.S. companies, who work mostly in the U.S., but continue to be residents of Canada for tax purposes. Can you give us a brief description of what the Canadian reporting requirements are in this situation?

Vasu: Surprisingly, there are numerous Canadians in this exact situation. While there are a number of tax implications, in this podcast I will only address payroll matters and taxation of travel expenses paid for or reimbursed by the U.S. employer. The typical profile of such Canadians is they work in the U.S. from Monday to Thursday and work from home in Canada on Friday. Their family, if any, lives in Canada. The U.S. employer has no operations in Canada.

The Canadian Income Tax Act states than an employer who pays remuneration during a taxation year is required to deduct or withhold from the payment according to the prescribed rates, and remit that tax amount to the authorities. The employer is required to withhold income taxes from remuneration whether the employee reports for work inside or outside of Canada. Therefore, any employer who hires a Canadian resident to render services in the U.S. has an obligation to withhold and remit income taxes in Canada.

In this case, the U.S. employer is required to issue the annual T4 slip for reporting compensation earned during the year and taxes remitted to the Canada Revenue Agency (CRA).

All of these Canadian requirements are in addition to the U.S. company complying with U.S. payroll requirements.

Sharon: I see, so what you are saying in this situation, is there is both Canadian and U.S. reporting and remittance requirements by the U.S. company when dealing with a Canadian resident employee. So if this employee is subject to withholding taxes in the U.S. and Canada, does this not result in financial hardship for the employee?

Vasu: You are correct Sharon, if no action is taken to mitigate the withholding, then withholding is due both in Canada and the U.S. regardless of financial hardship. However, because of the Canada - U.S. Income Tax Convention, there should not be double tax. If no action is taken, then the individual would have to wait to file their Canadian income tax return to claim a foreign tax credit for any U.S. taxes paid during the year. This clearly represents a cash flow issue.

Sharon: This does seem a bit unfair Vasu. You mentioned being able to mitigate the Canadian withholding, how does that work? Hopefully, this will help with the hardship?

Vasu: Yes, Sharon, a taxpayer in this situation can file form T1213, which is a “Request to reduce tax deductions at source” to request a reduction in Canadian taxes withheld for the U.S. foreign tax credit they expect to claim on their Canadian income tax return. Essentially, the waiver process is a mechanism by which a taxpayer can recognize foreign tax credits early before filing their actual Canadian income tax return.

Once the waiver is approved, the employer can remit a reduced amount to CRA. This application has to be filed every year and approval from CRA must be obtained before any payment is made to the employee.

Sharon: Well, that’s certainly good news for any Canadians working in the U.S. So, we’ve talked about income tax withholding, what about social security? Is the U.S. employer required to withhold CPP and EI as well?

Vasu: Great question Sharon. Under the Canadian Employment Insurance (or EI) rules for employment outside Canada, EI contributions are only required if employment is not considered insurable employment in the U.S. The U.S. unemployment insurance is governed by both Federal and State rules and contributions are only required to be made by employers. Therefore, if the employment was not considered “insurable” for U.S. purposes, in this specific circumstance, Canadian employment insurance would need to be withheld from the employee and remitted.

Where Canadians are employed outside Canada , CPP contributions will only be required if the employee ordinarily reports for work at an establishment that his employer has in Canada or is a resident of Canada and is paid at or from an establishment that his employer has in Canada. In our situation, the employee reports for work in the U.S. and is paid by the U.S. employer. Therefore, the employer will not be required to deduct or contribute to CPP.

Sharon: Vasu, you mentioned earlier that a T4 slip needs to be issued for the remuneration earned in the U.S. Who is responsible for issuing that T4 slip?

Vasu: In this case, the U.S. employer is required to issue the T4 slip. In order to comply with the Canadian payroll requirements, the U.S. employer can set up a shadow payroll in Canada to facilitate income reporting and tax remittances (where applicable).

Sharon: Now what is a shadow payroll?

Vasu: In a shadow payroll situation, no cash is actually delivered to the employee in Canada, as he/she will be paid out of the U.S. payroll.

To set up the shadow payroll, the U.S. employer will need to apply for a business number with the CRA. They will use this business number to remit any applicable taxes and to prepare and remit the T4s.

It is important to note that there may be some cost involved for administering the shadow payroll. This is one of the reasons why some non-resident employers shy away from complying with the Canadian payroll requirements.

Sharon: I see, now what happens if the employer fails to deduct taxes, or remits taxes late?

Vasu: The Canada Revenue Agency can assess penalties and interest on late remittances and failure to withhold. Interest will also be charged from the day the remittance is due till payment is received by CRA. These types of penalties can end up being significant.

Sharon: Well, this certainly sounds like companies need to ensure they are aware of the residency positions of their cross-border employees in order to avoid being non-compliant. I imagine that there are some compensation reporting issues as well. You had indicated that these might include taxable benefits like travel expenses. Can you give me a few examples of such expenses?

Vasu: Yes sure Sharon — airfare back and forth to the U.S., accommodation while in the U.S., per diems, and cost of rental cars are some of the more common taxable benefits.

The main issue here is that the cost of travel to work is generally considered a personal expense. Therefore, if the employer pays for or reimburses an employee for such expenses, then, under the Canadian rules, such reimbursements are considered taxable to the employee and must be reported on the employee’s T4 slip and taxes remitted thereon. It is difficult to argue that the individual is working at a “Special Worksite” for Canadian income tax purposes which would allow exclusion as a taxable benefit, as these employment travel arrangements are permanent and not temporary.

However, there may be an argument to exclude such reimbursements from taxable compensation when the employee travels directly to various client sites in the U.S. In this case, one will need to review the facts and circumstances of each situation before concluding such reimbursements are taxable or not.

Sharon: How will this impact the employee?

Vasu: Inclusion of these items in compensation means that tax must be remitted to both Canada and the U.S. As you can imagine, the impact could be very significant to the employee if the employer does not cover the additional tax on these taxable benefits.

Sharon: It sounds like individuals in this situation need to review how compliant they and their employers are around these reporting and remitting requirements in both Canada and the U.S. before the CRA comes knocking on their door.

Vasu: Couldn’t agree more.

Sharon: Thanks for joining us today, Vasu. If people listening to this podcast have any questions pertaining to these types of employment arrangements, Vasu’s contact details are listed on our PwC podcast website 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.

Copyright 2013 PricewaterhouseCoopers LLP. All rights reserved. PricewaterhouseCoopers refers to PricewaterhouseCoopers LLP, an Ontario limited liability partnership, or, as the context requires, the PricewaterhouseCoopers global network or other member firms of the network, each of which is a separate and independent legal entity. For full copyright details, please visit our website at pwc.com/ca.

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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.