Are you a Canadian service provider1 (either an individual or a corporation2) performing services for a U.S. business? If so, you could be considered a foreign person to that U.S. business, and the payments you receive may be subject to a U.S. 30 per cent federal withholding tax.3
General withholding requirements
In general, any person making a payment of U.S. source income to a foreign person must withhold the proper amount of tax. The person making the payment is considered to be the withholding agent. A withholding agent is a U.S. or foreign person that has control of any item of income of a foreign person that is subject to withholding (payments made to a foreign person for services performed in the U.S. are subject to withholding). A withholding agent may be an individual, a corporation, a partnership, a trust, an association or any other entity.
As a withholding agent, the payor is liable for any tax required to be withheld, independent of the tax liability of the foreign person to whom the payment is made. A U.S. person, whether an individual, a corporation or another entity, is, therefore, generally required to withhold 30 per cent tax on any payments made to a foreign person for services performed unless an exemption applies.
Exemptions
Services performed in Canada
Where a Canadian service provider provides services in Canada, a payor withholding agent need not withhold tax on payments to the service provider if the payor is provided with a properly completed withholding certificate.
An individual Canadian service provider should provide the payor with Form W-8BEN “Certificate of Foreign Status of Beneficial Owner for United States Withholding (Individual).” A corporate Canadian service provider should provide the payor with Form W-8BEN-E “Certificate of Foreign Status of Beneficial Owner for United States Withholding (Entities).”
The withholding certificate need not be submitted to the Internal Revenue Service (IRS), but must be obtained by the payor in case the IRS requests it. Generally, a Form W-8BEN and a Form W-8BEN-E will remain in effect for purposes of establishing foreign status for a period starting on the date the form is signed and ending on the last day of the third succeeding calendar year, unless a change in circumstances makes any information on the form incorrect.
If the Canadian service provider provides services in Canada, no further U.S. tax returns must be filed.
Services performed in the U.S.
Where a Canadian service provider provides services in the U.S., a payor withholding agent generally must withhold 30 per cent on any payments to the service provider unless one of the following exemptions applies and the payor is provided with a properly completed withholding certificate.
De minimis exemption
If the annual payments to the Canadian service provider are less than US$3,000 and the Canadian service provider spends less than 90 days in the U.S. in a calendar year, the amounts paid to the Canadian service provider are not considered a U.S. source, and withholding is thus not required.
Canada-U.S. Treaty exemption
Under the Canada-U.S. Income Tax Treaty, Canadian residents are taxable in the U.S. on their U.S. business profits only if they carry on business in the U.S. through a U.S. permanent establishment (PE), as defined in the treaty.
A PE is basically a fixed place of business through which a non-resident carries on a business (e.g. a place of management, a branch or an office). A non-resident will also be considered to have a U.S. PE if a person acting on the non-resident’s behalf in the U.S. regularly has the authority to conclude contracts in the non-resident’s name and habitually exercises such authority in the U.S.
There are two specific tests under the treaty which, if met, will deem a Canadian service provider to have a PE in the U.S. Under the first test, a Canadian service provider will have a PE in the U.S. if services are performed by an individual (or an employee of a company) who is present in the U.S. for 183 days or more in any 12-month period, and during that period more than 50 per cent of the “gross active business revenue” of the business consists of income derived from the services performed by that individual in the U.S.
Under the second test, a Canadian service provider will have a deemed PE in the U.S. if services are provided by the business in the U.S. for 183 days or more in any 12-month period with respect to the same or a connected project, for customers that either are residents of the U.S. or maintain a PE in the U.S. (and the services are performed in respect of the PE).
Effectively connected income exemption
Effectively connected income (ECI) is income that is effectively connected with a U.S. trade or business. Generally, the payor need not withhold tax on ECI if they receive a properly completed Form W-8ECI “Certificate of Foreign Person’s Claim That Income is Effectively Connected with the Conduct of a Trade or Business in the United States” from the Canadian service provider.
Withholding certificate
In order to claim any of the above exemptions, the Canadian service provider must provide the payor with a properly completed withholding certificate (discussed above) claiming relief under the treaty. The withholding certificate forms that must be completed are the same regardless of whether the services are provided in Canada or the U.S.
Employer Identification Number and U.S. tax return filing requirements
If the Canadian service provider would like to claim the treaty exemption or the ECI exemption, they must obtain either an Individual Taxpayer Identification Number (ITIN) by completing Form W-7, or an Employer Identification Number (EIN) by completing Form SS-4.
The Canadian service provider also must file an annual U.S. income tax return to claim the treaty exemption or to report income claimed to be effectively connected with a U.S. trade or business (Form 1040NR for individuals and Form 1120-F for corporations).
Conclusion
A Canadian service provider performing services for a U.S. business should be aware of the relevant withholding tax obligations. Failure to appropriately plan for withholding tax and complete the necessary reporting forms could lead to the assessment of penalties and unnecessary withholding tax.
Determining appropriate U.S. withholding taxes can be a complicated task. This article provides general information about strategies for managing withholding tax requirements. Seek professional advice regarding specific situations to ensure the rules are applied correctly. Your Baker Tilly tax advisors can help you minimize any withholding tax on payments you receive. Thanks to our affiliation with Baker Tilly in the U.S., we can help you seek advice in particular states as well. We can also put you in contact with other advisors to help make the process easier.
- Canadian service providers are also commonly referred to as non-resident aliens.
- If you are a Canadian service provider performing services in the U.S. via a Canadian partnership, please contact your professional advisor as the withholding tax rules for Canadian partnerships are more complicated.
- Withholding tax may also be levied at the state level. This article addresses U.S. withholding tax at the federal level only. Careful consideration should always be given to the withholding tax requirements of the state in which the services are performed.
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Information is current to December 12, 2019. The information contained in this release is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation.
