Introduction to Tax Treaties
Canada Revenue Agency levies income taxes on two bases. The first basis is on persons who have close ties to Canada – where such persons are residents of Canada. The second basis is on income that has its source within Canada. Unlike Canada, in the US, citizenship is one of the bases in which the Internal Revenue Service may tax. Thus, it is not uncommon for two countries to levy tax on one person based on one income. For example, a US citizen that is a resident in Canada, may be subject to taxes in both jurisdictions if the person passes the Canadian resident test and the US citizenship test. Alternatively, a Canadian resident who is temporarily working in the US may be taxed on both jurisdictions because the person passes the Canadian resident test and the US income source test.
Obviously, the primary objective of tax planning by taxpayers is to minimize tax. More importantly, in the above examples, it is to minimize or eliminate double taxation of the same income in more than one jurisdiction. Double taxation is the levying of tax by more than one jurisdiction on the same income, asset, or financial transaction. Tax treaties help accomplish this goal. Canada entered into series of tax treaties with other countries to prevent double taxation. It is thus vital to review the relevant treaty if one has a foreign source of income. In this article, one specific treaty will be discussed – the Canada-US Tax Treaty.
What are Tax Treaties?
Tax treaties are bilateral agreements between two states, and they are officially known as tax conventions. There are four main purposes of a tax treaty:
- Eliminate and/or reduce double taxation;
- Facilitate the exchange of information;
- Allocate and limit taxing powers between two sovereign nations; and
- Assist with the collection of tax income.
A tax treaty may effectively override a country's domestic tax legislation in certain specified situations. However, a person seeking treaty relief must be eligible for it and generally must elect for the treaty to apply. To find out the eligibility of a tax treaty, the taxpayer must answer the following questions:
- Is the taxpayer subject to tax in both countries? If the taxpayer is taxed in one, but not the other, then the treaty will not have an application.
- Does the treaty actually cover the particular item of income or capital? A tax treaty may be silent on a particular type of income, in which case the treaty will not apply.
Introduction to Canada US Tax Treaty
The preamble of the Canada-US Tax Treaty states that the purpose of the treaty is to avoid double taxation and prevent fiscal evasion concerning taxes on income and capital. Three notable articles in the Canada-US Tax Treaty affect taxation – Article V on Permanent Establishment, Article VII on Business Profits and Article XV on Income from Employment.
Canada-US Tax Treaty introduces the idea of a permanent establishment. The treaty requires the existence of a permanent establishment before a host country may impose a tax on the activities of a non-resident. In other words, if a non-resident carries on business in the host state without a permanent establishment therein, then the taxpayer may not have to pay the host country's tax. For example, a Canadian resident who carries on business in the US without a permanent establishment in the US may not have to pay US tax. However, if the Canadian resident fails to file US tax returns due to its belief that it does not have a permanent establishment, and later is found to have a permanent establishment, then it may be denied deductions against US income.
Article V of the Canada US Tax Treaty defines a permanent establishment as a "fixed place of business through which the business of a resident of a Contracting State is wholly or partly carried on." The term includes a place of management, a branch, an office, a factory, a workshop, and a mine, an oil or gas well, a quarry or any other place of extraction of natural resources.
Under the treaty, business profits of a resident of a contracting state are taxable in the host country only if the resident of the other country carries on business in that country through a permanent establishment. For example, business profits of Canadian residents are only taxable in the US if they carry on business through a US permanent establishment. If the business is carried on through a US permanent establishment, then the business profits may be taxed by the US only to the extent that the profits are attributable to the permanent establishment.
Income from Employment
Article XV states that salary, wages and other similar remuneration derived by a resident of the contracting state in respect of employment services provided in the host state are taxable in the resident state unless the employment is exercised in the host state. For example, if a Canadian resident earned income from employment, then, generally speaking, the income is subject to only Canadian tax. However, if the employment services are provided in the US, the US may have jurisdiction to tax the income. The article provides an exemption to workers whose income does not exceed $10,000 in the host county's currency.
Toronto Tax Lawyers Can Help
Correctly interpreting the Canada-US Tax Treaty is an extremely technical process. The reason for this is because the two countries have not only different tax rules but also use different fundamental vocabulary. If you are a Canadian resident that is temporarily carrying out business or working in the US, please do not hesitate to contact one of our experienced Canadian tax lawyers for tax help.
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.