Doing Business in Canada: The Fifth Protocol
After a decade of negotiations and a year of administrative hold-up, the fifth protocol of the U.S.-Canada Tax Treaty is almost here. As of this writing, the administrative requirements for ratification have not been fully met but they are expected to be completed by the end of 2008.
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. Many U.S. companies have structured Canadian operations using Canadian ULCs and elected to treat them as flow-throughs 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.
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
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 after the ratification process is complete.
