Carrying on Business in Canada Series Part II: Regulation 102 and Regulation 105

For non-resident ("NR") enterprises entering Canada for business, few tax rules create as much confusion as Regulation 102 and Regulation 105 of the Canada's Income Tax Regulations. These two provisions determine when Canadian withholding tax must be applied to payments made to NRs for work performed in Canada.

They also operate independently of the tax treaties —which means even if the income is ultimately not taxable in Canada under the applicable treaty, withholding may still be required unless the NR has secured waiver in advance.

This article breaks down:

• What Regulation 102 and 105 actually require

• Best practices in managing Regulation 102 and 105

• Ways to mitigate/eliminate Regulation 102 and 105 withholding obligations through waiver

1. Understanding the Withholding Framework

Canadian tax law imposes withholding obligations on payors (regardless of whether the payor is a Canadian resident or not) as follows:

• Employment income for work performed in Canada is subject to withholding under Regulation 102

• Fees and commissions for services rendered in Canada paid to NRs are subject to 15% withholding under Regulation 105

These withholdings are generally prepayments of potential Canadian income tax. In most situations, the NR recipient would be required to file a Canadian tax return to calculate their final Canadian tax liabilities.

Penalties for failing to withhold would apply to the payor. Although beyond the scope of this article, the province of Quebec also have similar rules that must be considered if the business is expected to have presence in Quebec. Furthermore, typically there are other payroll tax withholding that may apply (e.g. CPP/EI). However, in many cases, there are exemptions of these payroll taxes for short-term employees. With that said, closer analysis is always recommended.

2. Regulation 102 – Withholding on Employment Income

What Triggers Regulation 102

Regulation 102 requires employers (including NR employers) to withhold tax on Canadian sourced wages paid to the NR employee.

Key concepts:

• It applies even if the employer and the employee are non-residents of Canada.

• In the situation of a US Company that send US-based employee to Canada to work for say, two weeks, the wages for that two weeks will be subject to Canadian payroll tax withholding (unless valid waiver is obtained. See below).

• Even short business visits to Canada can create withholding obligations.

Based on experience, Regulation 102 obligation typically arises in the following scenarios:

• NR business sends some of their employees to provide services to customers in Canada (e.g. installation services, consulting services, construction services, etc.)

• As part of intercompany services within a multinational group, a NR related entity sends their employees to Canada to provide services to their Canadian entity (e.g. management services, etc.)

In these scenarios, the NR employer of the non-resident employees will have Regulation 102 withholding obligations.

Final Canadian Tax Liability of the Non-Resident Employee

As mentioned above, Regulation 102 withholding is considered as a prepayment of taxes and does not represent the final Canadian tax liability of the NR employee. In order to determine the final Canadian tax liability, the NR employee would typically file a non-resident Canadian personal tax return. If the Regulation 102 withholding amount differs from the final liability, the NR employee would be required to top-up the liability / receive refund.

Tax treaty and final Canadian tax liability

One important consideration in determining the NR employee's final Canadian tax liability is whether the tax treaty between the employee's home country and Canada may reduce or exempt the Canadian-sourced wages from Canadian tax for the NR employee.

For example, under Article XV of the Canada–US tax treaty, a US resident employee would be exempt from Canadian income tax on Canadian sourced wages under one of the following two conditions:

1. Their Canadian sourced wages is less than C$10,000; or
   

2. The NR employee spend fewer than 183 days in Canada in any 12-month period AND the they are not paid by or on behalf of a Canadian resident and is not borne by a permanent establishment ("PE") in Canada.

Provided that one of the two conditions above are met, the NR employee should be able to claim full exemption of their Canadian-sourced wages on their Canadian tax return and receive a refund of the Regulation 102 taxes withheld.

Reducing or Eliminating Regulation 102 Withholding (Waiver)

The Canadian tax law recognizes that if the NR employees would be exempt from final Canadian tax liability under the tax treaty, the Regulation 102 withholding obligation imposed on the employer is not a meaningful exercise. In such situation, the NR employee may obtain Regulation 102 waiver that would reduce/eliminate the withholding obligations.

There are two types of Regulation 102 Waiver:

1. Regulation 102 Waiver (Form R102-R)

2. Non-Resident Employer Certification (RC473)

1) Regulation 102 Waiver (Form R102-R)

R102-R waiver application is filed by a non-resident employee whose Canadian-sourced wages is expected to be exempt from final Canadian tax under the applicable tax treaty. This application is filed for each NR employee that is seeking waiver of Regulation 102 withholding.

2) Non-Resident Employer Certification (RC473)

In order to streamline the waiver applications for NR employers that send numerous NR employees to Canada for short term visits, the CRA has introduced RC473 in recent years where if this "Certification" is obtained from the CRA by a 'Qualifying Non-Resident Employer' ("QNER"), generally all NR employees that are considered as 'Qualifying Non-Resident Employee' ("QNEE") would automatically be covered under this "blanket" waiver (resulting in reduced or eliminated withholding obligations for any employees that meet the QNEE conditions).

Generally speaking, a QNER is an employer that has obtained certification after filing Form RC473 and is a resident in a country with which Canada has a tax treaty with.

QNEE is generally an employee who is:

• a resident in a country with which Canada has tax treaty with;

• exempt from final Canadian tax liability under the applicable tax treaty; and

• Either:

  • Works in Canada for less than 45 days in the calendar year in which payment is made; or

  • Is present in Canada for less than 90 days in any rolling 12-months period in which the payment is made.

Even if an employee is a QNEE, if their Canadian-sourced wages exceed C$10,000 in a year, Form T4 filing may be required by the QNER.

Regulation 102 - Best Practices & Other considerations

• It is recommended that Regulation 102 waivers be filed at least 30 days before the NR employee visits Canada. Regardless, until the waiver is approved by the CRA, the employer must comply with the Regulation 102 obligations.

• It is recommended that the employer forecast the number of days that their NR employees would be present in Canada as accurately as possible and to track the number of days that each employee is actually present in Canada.

• In the situation where a valid waiver was not obtained, commonly the NR employer pays for the Regulation 102 tax "out of its own pocket" as opposed to deducting it from the employee's paycheck. This may be viewed as a taxable benefit to the employee which would require additional withholding.

Regulation 105 – Withholding on Fees for Services

Regulation 105 imposes a 15% withholding on gross payments made to non-residents for services performed in Canada (unless waiver is obtained). This can apply to:

• Independent contractors

• Consulting firms including architect and engineering firms

• corporations providing onsite work in Canada

• Self-employed professionals

• and more.

  
  

Similar to Regulation 102, the withholding obligation is on the payor (whether Canadian-resident or not).

If some portion of the service is rendered physically in Canada and some are rendered outside of Canada, withholding applies on the Canadian portion.

Basis for Withholding

The 15% withholding is on gross fees and with respect to the Canadian portion of the services rendered. For example, a NR consultant who earns $100,000 for a hybrid U.S./Canada project (where 40% of the work was performed physically in Canada) may see:

• $100,000 gross fees

• $40,000 subject to Regulation 105 withholding

• $6,000 withheld by the payor

It's important to note that the CRA's initial assumption is that all of the fees paid to non-resident (i.e. $100,000) relate to services rendered in Canada and thus, subject to Regulation 105 withholding. Therefore, it is always advised that on invoices issued by the NR service provider, the NR always break down the fees relating to services rendered in Canada versus outside of Canada.

Furthermore, generally reimbursement of reasonable expense should not be subject to Regulation 105 withholding. However, businesses should proceed with caution where there is a reimbursement of subcontractor expense as there have been changes to CRA's positions in recent days.

Also, similar to Regulation 102, this withholding tax is considered as a prepayment of Canadian taxes. The NR service provider should file a Canadian tax return and determine their final tax liability. For non-resident corporations, failure to file this tax return on a timely basis may result in a penalty of $2,500 (even if there is no balance owing).

There is also a risk of cascading Regulation 105 withholding obligations. For example, if the NR consultant above hires a NR subcontractor to perform services in Canada, the NR consultant will be required to comply with the Regulation 105 withholding obligations on its payment to the NR subcontractor.

Reducing or Eliminating Regulation 105 Withholding (Waiver)

Recognizing that many of the NR service providers may be exempt from final Canadian tax liability or liable for an amount that is less than 15% of the gross fees, the CRA allows for two Regulation 105 waivers:

1. Treaty-Based Waivers

2. Income and Expense ("I&E") Waivers

1) Treaty-Based Waivers

Generally, this waiver is available to non-residents that are:

• resident in a country with which Canada has tax treaty with and does not have a PE in Canada

• eligible for an exemption based on the specific provisions of a tax treaty

For these non-residents, the waiver would generally be granted if they meet one of the following tests:

1. a non-resident independent individual who earns less then CAN$5,000 for the current calendar year (including expenses reimbursed or paid on the waiver applicant's behalf);

   
   

2. a non-resident person whose presence in Canada is not "recurring" and who performs services in Canada for less than 180 days under the current contract/engagement; or

   
   

3. a non-resident person whose presence in Canada is "recurring", but whose cumulative presence is less than 240 days during "the period", and less than 180 days under the current contract/engagement.

However, there are situations in which waiver may not be granted even if conditions above are met. Furthermore, there are special rules for artists/athletes. For more detail, refer to the CRA's Guideline here: https://www.canada.ca/en/revenue-agency/services/tax/international-non-residents/information-been-moved/rendering-services-canada/guidelines-treaty-based-waivers-involving-regulation-105-withholding.html

2) I&E Waivers

I&E Waiver is available to non-residents that:

• are resident in a country that does not have a tax treaty with Canada

• would otherwise be refused under the Regulation 105 treaty-based waiver guidelines

This waiver process allows a NR person to claim their estimated expenses against their Canadian-sourced income. If the estimated tax payable is lower than the withholding normally required under Regulation 105 (i.e. 15% of the gross fees), the withholding made be reduced to a lower amount through this waiver.

Regulation 105 - Best Practices & Other considerations

• Similar to Regulation 102 waivers, it is recommended that Regulation 105 waiver be filed at least 30 days before the NR enters Canada. Again, until the waiver is approved by the CRA, the payor must comply with the Regulation 105 withholding obligations.

• If the Regulation 105 waiver is obtained but there is subsequently a change to the contract between the payor and the NR service provider, it is important to notify the CRA of such change.

Final Thoughts

• It is common that both Regulation 102 and 105 is a key Canadian tax considerations when a NR enterprise travels to Canada to perform work.

• Regulation 102 and 105 are part of broader considerations which include 'Carrying on business in Canada' and 'Permanent Establishment' (see previous article here: https://www.francisdo.com/post/carrying-on-business-in-canada-series-part-i-carrying-on-business-in-canada-and-permanent-establi).

• In order to determine whether Regulation 102 or 105 waiver may be applicable, one must first determine whether the NR is carrying on business in Canada and whether it has PE in Canada.

Contact Francis Do at Francis@francisdo.com for more details.

Disclaimer: The information provided in this article is for general informational purposes only and does not constitute professional advice. Readers should seek advice from a qualified professional regarding their specific situation before taking any action.