Fifth Protocol to the Canada-US Income Tax Convention: Tax Implications of Cross-Border Employment
On September 21, 2007 the fifth Protocol ("the Protocol") to the Canada-US Income Tax Convention ("the Treaty") was signed. The Protocol came into force on December 15, 2008. While the Protocol includes a number of relieving measures that were expected, it includes a number of unanticipated measures. The Protocol has significant implications for cross-border structures and transactions involving both individuals and multinational enterprises. The Protocol also contains new provisions that govern the taxation of employment income and business income from employers of one contracting state (The United States) who send employees to work in the other contracting state (Canada).
Article V - Permanent Establishment ("PE")
The Protocol broadened the definition of PE for an enterprise by adding two new tests. If an enterprise meets either test, a enterprise of one country will be deemed to provide services through a PE in the other country. The enterprise could then become taxable in the other country on the net profits attributable to the PE in the other country. To keep matters simple, the following discussion addresses the PE rules from the perspective of a US individual providing services in Canada. The PE rules apply equally to Canadian individuals performing services in the US.
The first new test is a two-part test. It applies to enterprises that derive most of their revenue by providing services through a few employees. The test is met if the services are performed in the Canada by an individual who is physically present there for 183 days or more in any 12-month period, and more than 50 percent of the gross active business revenues of the enterprise is derived from the services performed in Canada by that individual.
The treaty explanations clarify that the term "gross active business revenues" means the worldwide gross revenue the enterprise has charged or should charge for its active business activities. It does not include income from passive investment activities.
The second test is broader as it applies to any enterprise that provides services in the other country. This test is met if the services are performed in Canada for an aggregate of 183 days or more in any 12-month period with respect to the same or a connected project for customers who are either residents of or have a PE in Canada and the services are provided in respect of that PE.
Article XV - Income from Employment
The following discussion addresses the employment income rules from the perspective of a US individual providing employment services in Canada. The rules apply equally to Canadian individuals performing employment services in the US.
The Protocol expanded the terms governing when an employee, who is a resident of the United States and is performing employment duties in Canada, will be subject to tax on employment income earned in Canada. If an employee earns employment income in Canada and does not satisfy either the first or second test in Article XV of the Treaty, the income will be subject to tax in Canada.
The first test states that if employment income earned in Canada does not exceed CAD $10,000, then the income is not subject to tax in Canada. The treaty explanations clarify that this $10,000 safe harbour rule applies on a calendar year basis. This test was not changed under the Protocol.
The second test was revised under the Protocol. Two requirements must be met to satisfy the test. The first part states that if the US resident employee is present in Canada for a period not exceeding in the aggregate 183 days in any twelve month period commencing or ending in the fiscal year concerned, employment income earned in Canada will not be subject to tax in Canada. The key difference between this rule in the Protocol and the previous version of the Treaty is that the 183 days is no longer based on a calendar year. The twelve month period referred to can span two calendar years. Thus, the employee can potentially be subject to Canadian tax on employment income in both years. The second part states that the remuneration paid to the employee is not paid by, or on behalf of, a person who is resident in Canada and is not borne by a PE in Canada.
For US employers sending employees to perform services in Canada and vice versa, there is increased importance to manage the number of days physically spent in Canada. Careful thought should be given to travel timing in order to avoid the adverse tax consequences both corporately and personally of cross-border employment between Canada and the United States.
Jonathan Osten, CA
Senior Tax Manager
Cinnamon Jang Willoughby CAs
Metrotower II, 900 - 4720 Kingsway
Burnaby, BC V5H 4N2
Tel: 604-435-4317 Ext. 6204
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