Employer Withholding Obligations under Regulation 102
Non-resident employers often send employees to Canada to provide services to Canadian clients, to assist a Canadian affiliate, or to attend conferences. Top of mind at these times are immigration issues. However, given that the employees remain on the payroll of the non-resident employer, what is often overlooked are the Canadian income tax withholding and reporting obligations of the employer with respect to the consideration it pays the employees during this time.
Pursuant to paragraph 153(1)(a) of the Income Tax Act1 ("Act") and section 102 of the Income Tax Regulations (the "Regulations"),2 the payor (referred to herein as the "employer") of the remuneration is required to withhold the prescribed amount of Canadian income taxes from the remuneration paid for employment duties performed in Canada and to remit the amount to the Canada Revenue Agency ("CRA"), even when the employee is not resident in Canada and is exempt from Canadian income tax under a tax treaty.3 Pursuant to subsection 200(1) of the Regulations, the employer is also required to issue a T4 slip to the employee and to file a T4 summary with the CRA to report the income earned in Canada (the "Regulation 102 reporting requirements").
Where withholding at source is made, an employee who is otherwise exempt from tax under a tax treaty, must file a Canadian tax return to claim a refund of the income tax remitted, resulting in a significant cash flow burden considering that the employee continues to be subject to source withholdings on the same income in the employee's country of residence.
To alleviate this burden, the CRA administratively provides two exceptions to the requirement to withhold. The first applies in the case where an employee attends a conference for less than ten (10) days and is expected to earn no more than CAN $5,000 during the year from employment services that included the conference attendance (CAN$10,000, where the employee is resident in the United States) ("de minimis threshold").4 This exception does not require that a waiver be obtained for the days spent at the conference.
The second applies when the employee obtains (or an employer and employee jointly obtain) a treaty based waiver from withholding (the "Regulation 102 waiver"). Applying for a Regulation 102 waiver5 is often cumbersome and time sensitive as, unless the consideration paid to the employee does not exceed the de minimis threshold, the application must be submitted at least 30 days prior to the start of the employment services in Canada or the initial payment for the employment services. Unless the de minimis threshold applies, the waiver does not have retroactive effect and therefore no payment can be made for the work in Canada until the waiver is obtained. The CRA somewhat relaxes these requirements where the earnings do not exceed the de minimis threshold. The waiver is effective up to 60 days prior to the date that the application was received.6
In practice, it often happens that non-resident employers do not track the time spent by their employees in Canada and neither make the required Regulation 102 withholdings nor obtain the available waivers. This is especially true in cases where the work is performed for the benefit of a related entity, and in such cases the corresponding Regulation 105 withholding7 from the fees for services charged by the non-resident employer to the related entity may also be overlooked.
Upon a subsequent audit, the employer is liable, pursuant to subsection 227(8.4) of the Act, for the amount of tax that ought to have been withheld, is subject under subsection 227(8) of the Act to a 10% penalty of such amount plus applicable interest. As the amount of tax so paid is on account of the employees' income tax obligation, the payment may be considered additional remuneration and, if not reimbursed by the employer, may give rise to an additional withholding requirement.
The New Exemption Mechanism
After significant pressure to bring relief in cases that do not pose a risk of tax leakage, paragraph 153(1)(a) of the Act is proposed to be amended to automatically exempt the employer from the Regulation 102 withholding obligations with respect to the remuneration paid to an employee for employment services performed in Canada if the following two conditions are met at the time of the payment:8
Condition 1: the employer is a "qualifying non-resident employer", 9 meaning that it either:
- is resident in a country with which Canada has a tax treaty;10 or
- is a corporation that would be resident in a country with which Canada has a tax treaty, if it were treated, for the purpose of income tax in its home country, as a corporation;
- and, obtains certification as a "qualifying non-resident employer" under subsection 153(7) of the Act; and
Condition 2: the employee in question is a "qualifying non-resident employee",11 meaning that the employee:
- is resident in a treaty country;
- is exempt from Canadian income tax under the applicable tax treaty;12 and
- works13 in Canada for less than 45 days in the calendar year that includes the time of the payment; or
- is present14 in Canada for less than 90 days in any 12‑month period that includes the time of the payment.
As a result of this broad language, the employer is required to track not only the days the employee works or is present in Canada as part of the employment contract with that employer but also, as applicable, the employee's employment with another employer as well as personal time spent in Canada.
In practice, it may be difficult for the employer to establish that these conditions have been met as it may not have important factual information. For example, where an employee frequently travels or has worked for more than one employer in the year, it may be difficult to factually determine the employee's country of residence or, alternatively, whether or not the employee meets the specific remuneration or time thresholds for tax treaty exemption.
With this in mind, an amendment has been proposed to subsection 227(8) of the Act pursuant to which an employer will not be subject to the 10% failure to withhold penalty if, at the time that the payment is made, the employer had no reason to believe, after reasonable inquiry, that the employee was not a "qualifying non-resident employee". The term "reasonable inquiry" is not defined in the Act, however the CRA interprets it to mean taking prudent measures to proactively monitor and confirm that the employee is a qualifying non-resident employee.15
The Certification Process
The legislation allows the Minister of National Revenue to certify an employer if the employer has applied in prescribed form and the employer establishes to the Minister's satisfaction that it is resident in a treaty country and meets the conditions that the Minister establishes. An application for "qualifying non-resident employer" certification is made using Form RC473, which is to be filed with the CRA – Pacific International Waivers Centre of Expertise (VTSO) in Surrey, BC.
As part of the certification process, the CRA requires that the employer covenant to the following:
- to evaluate and document how the employee meets the definition
of a qualifying non-resident employee at the time(s) that it pays
the employee for employment services rendered in Canada by:
- obtaining documentation to support the employee's country of residence (it is not clear whether a document such as form NR301 would be sufficient),
- tracking and documenting all criteria relevant to applying the tax treaty under which the employee's remuneration is expected to be exempt from tax in Canada, and
- tracking and documenting, on an ongoing basis, the number of days the employee is working in Canada or is present in Canada and the employment income that corresponds to these days;
- to obtain a business number and, if required to make remittances, a payroll program account number;
- to comply with the Regulation 102 reporting requirements unless exempted, as discussed below;
- to file the applicable Canadian income tax returns for the calendar years included in the certification period;
- upon request, to make its books and records available in Canada for the CRA to inspect; and
- to inform the CRA immediately of any changes to the information presented in the application or if the employer no longer meets the conditions of a "qualifying non-resident employer".
The failure to comply with these covenants may cause the CRA to revoke the certification. If the certification is revoked, the employer may become liable to withhold and remit to the CRA and be subject to any related penalties and interest.
The certification is only valid from the day of its issuance and, if it is required in respect of a particular employee, the CRA requires that the application be made at least 30 days prior to the employee in question beginning to work in Canada. It is then valid for a maximum of two calendar years and renewable for the same term.
As the certification is independent of any particular non-resident employee, unlike the Regulation 102 waiver which is employee specific, it should be possible to apply for certification before any particular project involving Canadian on-site work is identified and the project planning of the time to be spent by employees in Canada is done. This may be particularly attractive for companies in fast-paced industries, where the lead times for determining which employee is coming to Canada can be much shorter than 30 days.
The requirement for the employer to file all applicable Canadian income tax returns for the calendar years in which it is certified should give employers pause, as it indicates an increased scrutiny by the CRA of the employer's own income tax compliance in Canada. Under the Act, an employer who is carrying on business in Canada under either the common law test or the deeming rule in section 253 of the Act must file an income tax return in Canada,16 even if the employer is not carrying business through a permanent establishment under the relevant treaty. It is always a question of fact whether the work done by the employees in Canada constitutes "carrying on business".
Relying on the Exemption Mechanism
Although the conditions for exemption are clear cut, in practice it may be tricky for employers to ensure that an employee is actually a "qualifying non-resident employee" at the time of each payment. It is, for example, possible that an employee could qualify for exemption at the start of a work trip to Canada only to cease qualifying because the duration of the trip is subsequently extended beyond the time limits of the exemption.
In such cases, the CRA requires that the employer immediately advise it in writing of the fact that the employee is no longer a "qualifying non-resident employee".17 No specific timeframe is provided for giving the notice.
The consequences of the change of status will depend on whether or not the employee continues to benefit from a treaty exemption. Where this is the case, the CRA will grant, on a going forward basis, a waiver from withholding up to the maximum amount exempted under the applicable treaty and, provided that the employer took prudent measures, may waive any required tax withholdings retroactively as of the day the employee's income ceased to be exempt from withholding under the exemption mechanism. If, on the other hand, the employee is no longer treaty-exempt, the CRA will require Regulation 102 remittances to immediately be made on all payments made to the employee as of the date the employee's status changed, including for amounts already paid to the employee.
Provided that the CRA is satisfied that the notice was timely-given and that the employer took prudent measures to proactively monitor and confirm the employee's ongoing status it will not apply the failure to withhold penalty to the resulting amounts of Regulation 102 withholding.18
The exemption mechanism will, in most cases, not apply to secondment arrangements. Under a secondment arrangement, the employee is usually seconded to a Canadian-resident entity in order to avoid the non-resident employer from being subject to Canadian income tax (if it is found to carry on business in Canada and is not otherwise treaty exempt) and to transfer the Regulation 102 withholding and reporting obligations to an entity that is already familiar with this process. However, as the employer paying the employee's salary will be a resident of Canada, it will not be a "qualifying non-resident employer". Further, the employee will also not be a "qualifying non-resident employee" as, except where the remuneration paid to the employee is below the de minimis threshold under the treaty, the remuneration will not be treaty-exempt.
Under an expanded definition of "qualified non-resident employer" presented in the Notice of Ways and Means Motion to implement certain provisions of the budget tabled in Parliament on March 22, 2016 and other measures, tabled in the House of Commons on April 18, 2016, the exemption mechanism should now be available to employers who are organized as fiscally transparent entities (e.g. a U.S. limited liability company (LLC)). In prior versions of the provision, such employers could not qualify as they would not be considered resident of a country with which Canada has a tax treaty.
The CRA has expressly undertaken to not consider the applicant's Regulation 102 compliance history with respect to the first application for certification.19 However, once the non-resident has been certified, any non-compliance occurring during the certification period would jeopardize both the validity of the certification and the possibility to become re-certified in the future.
Obtaining certification as a qualified non-resident employer also does not remove liability for past non-compliance. Rather, the certification may increase the risk of such non-compliance being identified by the CRA due the fact that the employer has now self-identified as being potentially subject to Regulation 102 obligations. The covenant of the employer to make books and records available in Canada for the CRA's review, will make the identification of past non-compliance during an audit much easier. Consequently, any non-resident contemplating applying for certification should carry out an internal assessment of past non-compliance and carefully consider the option of making a voluntary disclosure of past non-compliance to avoid the applicable interest and penalties.
Even when the employer is exempt from withholding on an amount of remuneration under the new exemption mechanism, the employer remains subject to the Regulation 102 reporting obligations with respect to the income.20 However, new subsection 200(1.1) of the Regulations provides an exception if the employer, after reasonable inquiry, has no reason to believe that the employee's total taxable income earned in Canada under Part I of the Act for the calendar year during which the payment is made (including any amounts exempt from tax under a tax treaty) is more than CAD$10,000.
The reporting exemption is quite limited in scope and should be relied on with care. As the CAD$10,000 threshold includes all Canadian sources of income even if they are exempt from tax under a tax treaty and even if they do not relate to the employer, the threshold could often be inadvertently exceeded. This is especially true, since the threshold is established in Canadian currency and so the Canadian dollar equivalent of remuneration paid in a foreign currency that is strong as compared to the Canadian dollar may be quite high. The employer is required to make a reasonable inquiry with respect to sources of income that it may not be aware of and therefore, except in the most clear cut cases, it may be more prudent for an employer to file T4s and a T4 Summary than to rely on the reporting exemption.
In order for the employer to issue a T4 slip, it is also necessary for the employee to obtain a taxpayer identification number (ITN) with the CRA.
The new Regulation 102 withholding and reporting exemptions are a welcome improvement on the cumbersome waiver procedures under the CRA's administrative policies. However, due to their limited scope (both in terms of days in Canada and de minimis income thresholds) and requirements for the employer to gather extensive data on the employee that goes beyond the particular employment duties, employers wishing to avail themselves of this measure will need to implement significant data tracking mechanisms in order to benefit from these measures.
Non-resident employers who are considering certification should also carefully review any Regulation 105 non-compliance by their clients with respect to the services the non-resident performed in Canada. Although the liability for the failure to comply generally lies with the payor,21 the non-resident may wish to advise important clients of the increased audit risk and to work with them on a voluntary disclosure to deal with the compliance issues.
In the 2016 Budget the Federal Government announced its intention to proceed with these proposed measures but also its openness to consider the consultations and deliberations since their announcement. Employers considering certification may wish to wait to see whether modifications will be brought to the measures to reduce the compliance burden of maintaining certification as it is not clear whether such changes, if any, would be applied retroactively to employers that have already agreed to the CRA's requirements when they obtained the certification.
1 RSC 1985, c 1 (5th Supp).
2 C.R.C., c. 945.
3 Unless an exception applies, the employer is also required to withhold and pay Canada Pension Plan (CPP) contributions and employment insurance (EI) premiums. An exception from CPP contributions may be available if the employee has a certificate of coverage under a reciprocal social security agreement between Canada and the employee's home country, the employer does not have an establishment in Canada, or where the employee is resident in the United States, if the employee will be present in Canada less than 183 days. An exception from EI premiums is available if the EI laws of the employee's home country require premiums to be paid on the same income.
4 See CRA, "Non-resident employees residing in a treaty country attending conferences in Canada" available at: www.cra-arc.gc.ca.
5 The general Regulation 102 waiver application is made by the employee using form R-102-R.
6 The application for a Regulation 102 waiver where the de minimis threshold applies is made jointly by the employer and employee using form R-102-J.
7 This withholding is required under paragraph 153(1)(g) of the Act and section 105 of the Regulations.
8 See subparagraph 153(1)(a)(ii) of the Act.
9 Defined at subsection 153(6) of the Act.
10 In the case of a partnership, the condition is that at least 90% of the income or loss of the partnership for the fiscal period that includes the payment time, is allocated to partners that are resident in a treaty country.
11 See note 9, supra.
12 See for example Article XV of the Canada-United-States Tax Convention.
13 According to the Technical Notes to the definition of "qualifying non-resident employee" at subsection 153(6) of the Act, "days worked in Canada" include only days during which the employee is physically present in Canada and paid by the employer for the time spent here; weekends, days off and holidays are generally excluded.
14 According to the Technical Notes to the definition of "qualifying non-resident employee" at subsection 153(6) of the Act "days present in Canada" include all days during which the employee is present in Canada, even if the employee is only present for a portion of the day.
15 See CRA, "Non-resident employer certification" available at: www.cra-arc.gc.ca.
16 For example, in the case of corporations see clause 150(1)(a)(i)(B) of the Act.
17 See note 15, supra.
19 CRA "Withholding for non-resident employers" available at: www.cra-arc.gc.ca.
20 A consequential amendment to subsection 200(1) of the Regulations clarifies this point.
21 See paragraph 227(8.4) of the Act.
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.