Withholding rules can be burdensome for non-resident employers and employees
Many people hear the term "business travel" and think
of the usual perils — jet lag, roaming charges,
lost luggage. Potentially more costly are the tax risks that
businesses incur when they send their employees into or out of
Canada on temporary work assignments.
Non-resident employers will incur Canadian tax-withholding obligations on salary paid to their employees that is attributable to work performed in Canada. It doesn't matter whether the employees are posted to a customer's premises for three months or working from a hotel room for three days. When an employee, even a non-resident, earns a salary for work performed in Canada, withholding is required.
This surprises (and irritates) many non-resident employers, who often assume that if they have no physical premises in Canada, they fall outside the scope of the Canadian tax regime. There is a significant administrative cost to setting up a Canadian payroll account solely for the purpose of processing the salary of these employees. But an employer that does not comply with its Canadian withholding obligations is liable to pay the tax it should have withheld from the employee, plus penalties and interest. Where the non-resident is a corporation, its directors may be jointly and severally liable.
The withholding rules can also be burdensome for non-resident employees who are already paying tax to their home country on their Canadian-source income. These employees may be exempt from Canadian tax by virtue of a tax treaty between the home country and Canada, but the withholding rule applies to the employer and operates independently of the treaty. The treaty exemption will entitle employees to a refund of the taxes withheld, but this is accessible only by filing a Canadian tax return after the year end, and the employees will be out of pocket until the refund is processed. Employers may consider extending short-term loans to employees to assist with this cash-flow problem.
Relief from the withholding obligation is sometimes available. If the non-resident employee's salary for work performed in Canada is treaty-exempt and under $5,000 Cdn. ($10,000 if the employee is a U.S. resident), the Canada Revenue Agency may waive the withholding requirement. But the waiver application must be submitted in advance; withholding is required on salary paid while the application is being processed. The only situation in which the CRA may waive withholding without an application is where an employee attends a conference in Canada for 10 days or less, and remains below $5,000 / $10,000. Those limits are arbitrary, and the CRA has acknowledged that it inconveniences many business travellers, but has not signalled any intention to change it.
An employee's activities in Canada may also cause the employer to be "carrying on business" in Canada, which the Income Tax Act defines very broadly. It includes the soliciting of orders or offering anything for sale in Canada, even if the sale transaction is completed outside Canada.
Any non-resident who is "carrying on business" in Canada must file a Canadian tax return. Even if it is not liable for Canadian tax because it has no "permanent establishment" (PE) in Canada under the applicable treaty, a return is required. Failure to file a return (even one which reports no liability for Canadian tax, known as a "nil" return) will lead to a penalty of up to $2,500 a year. Ironically, the cost of preparing and filing even a nil return can easily exceed that amount.
The PE question is also significant: Depending on the terms of the applicable tax treaty, an employee's presence in Canada may create a PE if the employee has, and habitually exercises in Canada, the authority to conclude contracts in the employer's name. In that case, the non-resident employer will be obliged to pay tax in Canada on the profits attributable to the PE. To avoid this, many non-resident businesses establish a policy reserving final approval over Canadian sales to employees working outside Canada.
Cross-border secondment arrangements should be approached carefully. A corporation may, for example, establish a subsidiary in another country and wish to assign certain employees to the subsidiary's premises temporarily. This will engage the transfer pricing rules that Canada and most other countries impose on cross-border, non-arm's length transactions to ensure that pricing between related parties is consistent with arm's length terms. If the pricing is too high or too low, the CRA or the tax authority of the other country may impose an adjustment to the pricing. Parties must refer to the OECD's transfer pricing guidelines and document the methodology they used to determine their pricing in order to avoid a penalty.
While compliance with these requirements may seem daunting, there are strategies available to minimize the expense and inconvenience to non-resident employers and their employees. The key to reducing the employer's tax exposure is advance planning with regard to the timing and duration of employee travel and the scope of their activities in Canada. As Yogi Berra may or may not have said: "If you don't know where you're going, you might wind up someplace else."
Previously published in The Lawyers Weekly.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.