Open for business U.S. Retailers Entering Canada: Tax Considerations

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Open for
business
U.S. Retailers Entering Canada:
Tax Considerations
For more information,
contact:
Christopher Kong
416 869 8739
[email protected]
Ryan Thulien
416 869 2342
[email protected]
Eric Paton
416 869 2878
[email protected]
More than ever, U.S. retailers are considering international
expansion as an avenue for future growth. For many, Canada
is attractive because of its proximity, cultural similarities
and strong economic performance through the recent global
economic challenges. In making plans to establish operations
in Canada, retailers need to be aware of Canadian tax
requirements and planning considerations.
U.S. Retailers Entering Canada:
Tax Considerations
Income Taxes
Choice of Structure
Structuring considerations include:
Various legal structures may be used to carry
on the Canadian business. The primary
options are:
• the ability to directly claim tax deductions
and credits in the United States for the
Canadian business;
• a limited liability company formed under
Canadian corporate law;
• an unlimited liability company formed
under Canadian corporate law;
• a limited or general partnership (formed
either under Canadian law or foreign law);
or
• a Canadian branch of a foreign
corporation.
Each has advantages and disadvantages,
depending in part on the structure, objectives
and circumstances of the parent company/
group, but a Canadian company is most
commonly used. Tax-efficient structuring of
the investment in Canada may be possible,
either directly from the U.S. or through an
intermediary holding company.
• tax-efficient avenues for repatriation or
redeployment of cash;
• tax-efficient financing of the Canadian
business (with interest expense to partially
shelter business earnings); and
• the ability to use favorable tax treaty
provisions and the treaty status of nonresident entities involved in Canadian
activities or receiving certain payments
from Canada.
Tax Registration
Provincial Income Allocation
The entity that carries on the Canadian
business (whether a separate Canadian
subsidiary or a branch of a U.S. company)
will be required to register with the
Canadian federal and relevant provincial
governments to obtain tax account numbers.
For federal purposes, the “Business Number”
obtained is used for corporate income tax,
Goods and Services Tax (GST), federal
payroll taxes, withholding taxes and
customs purposes.
For provincial income tax purposes, each
corporation’s income is allocated to the
provinces in which it has a permanent
establishment (PE). The allocation formula
weighs equally the relative percentages of:
Income Tax Rates
A corporation is subject to both federal and
provincial income tax. Enacted tax rates,
including the combined federal-provincial
rates for the larger Canadian provinces,
are set out in the table below. The same
rates apply to a Canadian branch of a nonresident corporation.
• salaries and wages; and
• gross sales,
attributable to PEs in the particular
province.
Capital Taxes
Capital taxes that several provinces formerly
imposed have been phased out and for the
most part have been eliminated by the end
of 2010.
Federal-provincial corporate tax rates*
20102011201220132014
Federal only 18.0%
16.5%
15.0%
Ontario - combined 31.0%28.3%26.3%25.5%25.0%
Quebec - combined
29.9%
British Columbia combined 28.4%
28.5%26.5%
25.0%
Alberta - combined
28.0%
25.0%
26.5%
26.9%
* The combined federal-provincial tax rate for a company can be determined
by simply adding the federal and provincial rates together, because provincial
income taxes are not creditable for federal purposes and vice versa.
Financing and Deductibility of
Interest Expense
Subject to a borrowing purpose test, in
general Canadian income tax law does
not limit the deductibility of interest paid
on debt owed to an unrelated party (e.g.,
a financial institution). However, “thin
capitalization” rules generally restrict
the deductibility of interest on debt owed
to a related non-resident to the amount
payable on debt up to twice the equity base
computed for this purpose.
Transfer Pricing
Like most other jurisdictions, Canada
has transfer pricing rules that require
transactions with related non-residents to
be carried out at terms and pricing that
is consistent with those applied between
parties dealing at arm’s-length. Canada
generally follows OECD guidelines in
enforcing the arm’s-length principle.
Transfer pricing audits typically are carried
out in conjunction with a domestic tax audit.
If a transfer pricing adjustment is assessed,
a penalty of 10% of the adjustment can be
applied unless the company is found to have
met a relatively strict contemporaneous
documentation requirement. An Advance
Pricing Arrangement (APA) program is
available on either a unilateral or bilateral
basis. Many international retailers have
participated in this program to obtain
agreement on their royalty rates.
Repatriation of Cash
A Canadian subsidiary’s earnings can be
distributed by way of dividend (subject
to withholding tax, as noted below) or by
return of capital to the extent of available
“paid-up capital” (free of withholding tax).
For Canadian tax purposes, earnings need
not be distributed before capital. Cash may
also be repatriated by other means, such as
repaying an existing loan, making a loan or
purchasing an asset from the parent.
If a loan from Canada to a parent or other
related non-resident is outstanding more
than a year from the end of the taxation
year in which it arose, generally a dividend
is deemed to have been received. However,
tax planning can sometimes avoid a deemed
dividend on a long-term loan of Canadian
cash within the related group.
Repatriation of income from a branch
triggers a branch tax that is equivalent to
the withholding tax on dividends (including
reductions under the treaty).
Withholding tax rates on the most common
types of payments from Canada to the U.S.
are as set out below1.
Canadian
Domestic
U.S. Treaty
Dividends
25%
15% or 5%
Interestrelated
unrelated
25%
0%
Royalties
25%
0%
0%
10% or 0%
Withholding Tax on Services
Performed by Non-Residents in
Canada
A 15% federal withholding tax applies to
any payment to a non-resident in respect
of services rendered in Canada. Quebec
adds 9% where the service is rendered in
that province. If possible, inter-company
arrangements should be structured to avoid
this situation.
When the tax applies, it is fully or partly
refundable if it exceeds the actual Canadian
income tax of the non-resident (after taking
into account any treaty protection). When
non-resident individuals travel to Canada in
the course of their employment activities,
personal and payroll tax withholding and
reporting requirements apply in the absence
of a waiver, which may be obtained based on
available treaty exemptions.
Lease Agreements
Leasehold improvements or costs incurred
to acquire leasehold interests are treated
as a capital expenditure for tax purposes,
depreciable over the term of the lease plus
the first renewal term, subject to a minimum
of five years.
HINT: Where feasible, negotiate lease term
and renewal periods that reduce the number
of years required to obtain tax deductions for
capital expenditures.
Real Estate Investments
If the company will acquire a significant
amount of real estate in Canada, tax
planning opportunities may be available,
such as deferral of tax or reduction of the
effective tax rate on an amount equal to the
annual rentable value of the property.
Compliance Requirements
Key corporate tax deadlines are as follows:
1. However, certain payments made by or to hybrid
entities (entities treated as fiscally transparent in
one jurisdiction (i.e., U.S.) but not the other (i.e.,
Canada) may not be considered paid to a resident
of the U.S. for the purposes of the U.S. Treaty and
would be subject to the full Canadian domestic
withholding tax rates noted herein. In addition, U.S.
residents receiving such payments from Canada
must either be a “qualifying person” for the purposes
of the limitation on benefits (LOB) provision in the
U.S. Treaty or meet the conditions for one of the
exceptions to the LOB in order for the lower treaty
rates noted herein to apply.
• federal and, if applicable, provincial
corporation income tax returns are due
six months after the end of the taxation
year;
• tax installments are required monthly,
generally based on taxable income for the
preceding taxation year; and
• final tax payments are due two months
after the end of the taxation year.
The Canada Revenue Agency (CRA)
administers not only federal taxes but
also all provincial corporate income taxes
except those of Quebec and Alberta, which
require separate corporate income tax
returns. Audited financial statements are
not required for income tax return filing
purposes, and a Canadian subsidiary of a
U.S. company is permitted to prepare its
financial statements under U.S. GAAP.
Non-Resident Companies Carrying on
Business in Canada
Under domestic law, a non-resident
carrying on business in Canada is subject
to Canadian income tax. The test is based
on the common law concept of carrying on
business, plus a statutory extension of the
concept under domestic law that deems
certain activities to be carrying on business
in Canada (for example, sales and marketing
activities carried out by an agent or servant
in Canada). The threshold is generally
low, so in many cases a non-resident must
rely on the terms of an applicable treaty to
exempt its Canadian-source income from
Canadian income tax (for example, on the
grounds that the non-resident did not have
a permanent establishment in Canada in
connection with the business).
Internet Sales to Canada
In general, a non-resident can sell to
Canadian customers via the internet without
Canadian income tax on related profits,
even if a related Canadian subsidiary
separately carries on business in Canada
though physical stores. Care must be
taken to maintain separation between the
internet sales and any such physical stores
and to avoid conducting activities (such
as shipping and handling, returns and
exchanges) in Canada in relation to the
internet sales, whether by the non-resident
or by employees of the Canadian subsidiary
or agent.
Tax Audits
Payroll Taxes
Indirect Taxes
In the context of a tax audit, retailers
commonly encounter certain issues which
include the deductibility of:
Employers in Canada must comply with
payroll withholding, remittance and
reporting requirements relating to four main
areas, in addition to personal income tax
withholding from employment income:
Two levels of sales tax apply in Canada −
federal and provincial. No stamp duties or
similar levies apply in Canada.
• Canada Pension Plan (CPP) – Mandatory
equal contributions by employer and
employee; 2010 rate of 4.95% of
pensionable earnings to a maximum
amount; 2010 maximum employer/
employee contribution of $2,163 per
employee.
The Goods and Services Tax (GST) and
Harmonized Sales Tax (HST) are valueadded taxes that are imposed on the supply
of most goods and services in Canada.
HST applies only in provinces that have
harmonized provincial sales tax with the
federal GST). GST/HST is calculated on the
value of the consideration for the supply of
taxable goods or services.
• management fees and other central costs
charged to the Canadian business (and
related deemed dividend issues);
• royalties (including those for trademarks
and tradenames, as well as for other
intangibles such as know-how, use of
formats and systems, etc.); and
• reserves (e.g., inventory, contingent
accruals, unredeemed gift cards).
On audit, many royalties are subjected
to heavy scrutiny and frequent proposed
reductions or disallowance. Mark-ups on
management services are often disallowed.
Transfer pricing adjustments typically result
in application to the competent authorities
under the treaty’s mutual agreement
procedure.
Gift Card Issues
The use of gift cards in Canada can raise
issues, particularly where the entity that
issues the cards and collects the cash
proceeds from the customer is not the entity
that ultimately makes the sale and accepts
the gift card as payment on the sale. Similar
issues can arise when a card is issued in one
country and redeemed in another. Reserves
permitted for unredeemed cards must also
be considered.
• Employment Insurance (EI) – Mandatory
employer and employee premiums based
on insurable earnings to a maximum;
2010 maximum employer premium of
$1,046 and employee premium of $747.
(These are expected to increase over
the next few years because of higher
unemployment claims.)
• Employer health and post-secondary
education premiums for certain provinces
at rates applied to total payroll varying
from 1.95% to 4.3% (e.g., Ontario
Employer Health Tax of 1.95% of payroll
over $400,000 per year).
• Provincial workers’ compensation
premiums (e.g., Ontario Workplace Safety
and Insurance Board) – Rates vary by
industry and experience rating (typically
2% to 4% for retail employees).
GST/HST and QST
The GST/ HST rates are as follows:
• Ontario: 13%
• British Columbia: 12%
• New Brunswick: 13%
• Nova Scotia: 15%
• Newfoundland and Labrador: 13%
• Rest of Canada : 5% (with separate
provincial sales tax in some cases, as
noted below)
Quebec imposes a 8.5% sales tax
(QST, calculated on the GST-included
consideration). QST is similar to GST/HST.
Real Property Taxes
PST
Three provinces (Saskatchewan, Manitoba,
and Prince Edward Island) impose provincial
sales tax (PST). Rates range from 5% to
10%. Intangible property is not subject to
PST. Provincial retail sales taxes are similar
to U.S. state sales and use taxes. Unlike GST,
PST is not recoverable.
Generally, PST is payable on the sale of most
tangible personal property that is physically
located in a province that imposes a PST.
However, PST is not charged on the transfer
of items such as inventory for purposes of
resale, certain machinery and equipment,
real property and fixtures.
4. Rules relating to price adjustments:
•
•
•
•
discounts
coupons
gift cards
gift certificates
5. Policies and mechanisms for dealing
with indirect taxes on employee travel
and other business expenses:
6. Cross-border sales:
• sales to non-residents of a
particular province
• exports
• on-line sales
A retailer in Canada should consider the
following requirements and issues in
relation to indirect taxes:
7.Drop-shipments
1. Registration requirements for entities
that carry on business in Canada.
9.Returns/refunds
2. Determining the appropriate sales
tax coding (GST/HST and PST) to be
applied to products and expense items.
For example, tax may not apply based
on the status of the purchaser and
point-of-sale rebates. Documentation
must be retained to support
exemptions. For certain HST provinces,
input credit restrictions apply to certain
expenses.
3. Bookkeeping and tax filing
requirements:
• invoice requirements
• requirements for retention of
books and records
• periodic tax returns (usually
monthly)
8. Delivery/freight charges
10. Early/late payments
11.Deposits
12. Bad debts
13. Credit cards
14. Escheat laws
• Certain provinces impose a land transfer
tax on the transfer of real property (land
and buildings) – rates vary by province.
• Property Tax – imposed at the municipal
level
Environmental Levies
• Blue Box program (recycling in Ontario)
• E-waste/hazardous waste
• Tire stewardship
Taxes on Insurance
• Federal Excise Tax
• Provincial Sales Tax (PST)
• Premium Tax
Customs
The duty cost of direct shipment of inventory purchases to Canada should be
compared to that of replenishment through U.S. distribution centers. U.S.
retailers may be able to take advantage of Canadian duty relief programs or
U.S. foreign trade zone programs to reduce or recover duty on cross-border
transactions. Other issues to consider include the following:
Customs valuation
Importer of record
• Meeting the “purchaser in Canada”
requirement
• Consider whether the U.S. company
should act as a non-resident importer
• The effect on customs value of shipping
offshore goods through an intermediary
country
Administrative matters
• Canadian approach to related-party
transactions
• Obtain an importer/export account for
the federal Business Number
• Canadian treatment of royalties and
license fees
• Arrange for security to cover duty and
taxes
• Non-dutiable U.S. design assists, which
become dutiable on Canadian imports
• Set up compliant record-keeping
processes
Tariff classification and duty rates
• U.S. and Canadian tariff classification
numbers and descriptions are similar but
not identical
• U.S. and Canadian duty rates differ
(highest Canadian rates are on apparel
and footwear)
Tariff treatment (free trade areas)
• Canada has multiple free trade
agreements and extends preferential
tariff treatment to developing and nonreciprocal tariff countries
• The effect on tariff treatment of
shipping of offshore goods through an
intermediary and the need for processes
to secure exporters’ certifications of origin
• Appoint a customs broker
• Consider whether to apply for Partners
in Protection (PIP) (roughly equivalent
to C-TPAT) or (at later date) Customs SelfAssessment (CSA)
• Possible advance rulings (e.g., value for
duty)
Anti- dumping/ countervailing duty
• Identify any products subject to Canadian
anti-dumping or countervailing duties.
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