Transcript: Tax Tracks – A PwC Tax Management Services Podcast Series -- Episode 9

Business Travellers between Canada and the US: A Fifth Protocol Treaty Update

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.

In this podcast, I will discuss tax issues for business travellers between Canada and the US. There have been some important changes to the taxation of these business travellers primarily due to the fifth Protocol of the Canada-US Treaty which generally became effective on January 1, 2009. Since then, the IRS has given guidance on these important changes with the issuance of revised Publication 597 on August 26, 2009 that provides information to US citizens and residents on the application of the Treaty changes.

The revised IRS publication focuses primarily on US citizens and residents working in Canada. However, the general principles will also apply to Canadian residents working in the US. It is also important for employers to be aware of these new rules in order to address the concerns of their employees travelling across the border on business and to understand their own tax obligations with respect to their employees.

While the revised IRS publication addresses several changes to the Protocol, I am only going to discuss the changes with respect to income from employment for individuals working across the border (which is covered by Article 15 of the Treaty).

Qualifying for the Treaty exemption:

As was the case before the Treaty changes, income or wages received by US citizens or residents for services performed in Canada may be exempt from Canadian tax if the US citizen or resident qualifies under one of two Treaty exemptions.

First Exemption:

The first Treaty exemption states that the income earned by a US citizen working in Canada is exempt from Canadian tax if the income received by the employee is less than $10,000 Canadian for the calendar year. There has been no change to this exemption.

Second Exemption:

With the second Treaty exemption, if the individual does not meet the first exemption (in other words, earns more than $10,000 Canadian for the calendar year), he or she can still be exempted from Canadian tax if both of the following tests are met.

The First Test:

The individual must be physically present in Canada for 183 days or less, in any consecutive twelve month period commencing or ending in the fiscal year. Prior to the Treaty change, the test was based on a calendar year. Now, in applying this test at a particular time, it is necessary to look at both the preceding 12-month period and the next 12-month period to determine if the 183-day test is met. This change eliminates the opportunity to effectively "double up" on Treaty exemptions by straddling assignments over two calendar years. It also broadens the scope for the taxation of employment income and can result in retroactive tax obligations for both the employee and employer.

As an example, you are an employee who has an assignment beginning August 1, 2009 and ending April 30, 2010. Under the old calendar year rule, you would not meet the 183-day test since the test would be computed for the period of the assignment covering calendar years 2009 and 2010 separately. Therefore, the Treaty exemption would be available. Under the new rolling 12-month rule, no Treaty exemption would be extended since the 183 days are exceeded over the consecutive term of the assignment.

The Second Test:

The particular income is not paid by, or on behalf of, a Canadian resident and is not borne by a permanent establishment in Canada. This second test has also been modified. The test now states that if compensation is paid by, or on behalf of, a Canadian resident person instead of the former Treaty reference to Canadian resident employer, then the exemption may no longer be available to the employee.

For an example, you are an employee of a US company and are sent to work for a Canadian subsidiary. Your compensation costs are charged to the Canadian subsidiary. Under the old rules, you may have been able to claim a Treaty exemption from Canadian tax since the Canadian subsidiary arguably was not the "employer" under common law principles. It was the US company that was your employer. Under the new rules, the Treaty exemption is no longer available to you because the Canadian subsidiary paying you does not have to be an employer, but only a Canadian resident person under the Treaty.

Application of the Treaty Exemption:

So in the end, if a Treaty exemption does not apply, the employee will be subject to tax in the US where services are performed. It is important to note that the first income tax returns affected by these Treaty changes will be for the 2009 taxation year. The deadline for filing 2009 individual US income tax returns is April 15, 2010.

On the other hand, if an individual does qualify for a Treaty exemption, he or she will not have a US federal tax obligation. However, despite the absence of a federal tax obligation, US tax law requires a US federal return to be filed in order to claim the Treaty exemption.

Note that not all US state governments recognize Treaties negotiated by the US federal government. Therefore, an individual may be exempted from US federal but not US state income tax, depending on where the employee works.

What Should You Do as an Employer?

First, employers need to be aware that payroll obligations are not exempted under the Treaty. As a result, employers need to ensure that they meet their payroll obligations in both countries or face payroll penalties and interest charges.

Secondly, employers, whose employees travel across the border to work, need to carefully determine whether this activity is creating a personal tax obligation for the employee and/or a payroll obligation on the employer.

In order to ensure employees continue to qualify for Treaty exemptions, it is important to be well prepared and obtain some necessary information from employees.

1. Employers will need to ensure their employees accurately track their business and personal travel time. As an employer, you will need to proactively monitor these travel records to identify situations where the 183-day test has or may be exceeded. Remember, you are now monitoring over a 24-month period!
2. Employers will need to reconsider any previous filing positions where Treaty exemptions were claimed based on a "no-charge back" policy. You will need to ensure your employees are aware of these changes and that they understand how they may be impacted personally.
3. You, as an employer, should ensure payroll obligations in the other country are considered, including retroactive payroll obligations for the prior year where Treaty exemptions no longer apply.

Overall, it is important for employers to be prepared for these new rules so there are no surprises to either the employees or employers with respect to taxation in another country.

To sum up:

• Both travelling employees and employers alike must take care to understand the new Treaty rules around the taxation of remuneration for cross-border employment.
• Employees need to understand that the tests to qualify for Treaty exemptions have changed and are generally more onerous. Employers need to continue to understand both their obligations to their travelling employees, as well as the payroll and other obligations that may continue to exist in both jurisdictions.

With more than 6,000 professionals in over 100 countries, the PwC network has one of the world's largest Human Resource advisory organizations. Our multidisciplinary approach allows us to advise on all aspects of people management, helping our clients to create value for their businesses through people. 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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