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Doing Business in Canada

By: Suzanne Tuson, CPA, MST

On December 15, 2008 the new Fifth Protocol to the U.S. - Canada Income Tax Treaty came into force.

Highlights

Hybrid Entities

The protocol is designed to increase consistency between Canada and the U.S. in the tax treatment of entities. Under the new protocol, as long as the entity is treated consistently by both countries as either a flow-through entity or as a corporation, they will be granted treaty benefits. Companies that own foreign hybrid entities, or entities that are treated differently for tax purposes in each country, will be denied treaty benefits. This will impact the many U.S. companies that have structured Canadian operations using Canadian Unlimited Liability Companys "ULCs" and have elected to treat them as flow-through entities for U.S. tax purposes. Since ULCs are considered corporations for Canadian tax purposes, they would no longer be eligible for treaty benefits due to the differences in treatments. This part of the protocol becomes effective January 1, 2010.

The protocol does provide a new benefit for U.S. limited liability companies ("LLC's"). Canada will now recognize LLC's eligible for treaty benefits as long as they are treated consistently for tax purposes by both countries.

Service Providers

The new protocol has provided a new bright-line test for the determination of when a service provider can create permanent establishment (i.e. taxable presence) in Canada. The protocol defines a service entity with permanent establishment as one that either:

• Performs service in Canada for more than 183 days in a 12-month period and derives more than 50% of the gross active business revenues from those services, or
• Provides over 183 days of service over a 12-month period in Canada on a single project or connected projects for a customer that is a resident of Canada or that has permanent establishment there

This provision becomes effective tor the third taxable year ending after December 15, 2008, therefore, for calendar year taxpayers this will be effective on January 1, 2010.

Other Important Provisions

• Elimination of withholding on cross-border interest payments
• Benefits for commuters
• Binding arbitration (mandatory if elected by the taxpayer to settle cross-border tax disputes that are unresolved through competent authorities) The provisions will be come effective at various dates.

Contact us to discuss how these provisions will affect your business activities in Canada.

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