Carrying on Business in Canada Series: Part I – Carrying on Business in Canada and Permanent Establishments

As global business continues to expand, many foreign companies and entrepreneurs look to Canada as an attractive market. However, there are various Canadian tax rules that foreign businesses and entrepreneurs must navigate through in order to be compliant.

As such, through three parts, we will cover three core topics relating to carrying on business in Canada:

1. Carrying on Business in Canada and Permanent Establishments;

2. Regulation 102 and 105 Rules and Waivers (payroll and services withholding);

3. Operating as a branch versus subsidiary in Canada.

In this Part I article, we will discuss the Canadian income tax implications of carrying on Business in Canada and the implications of having a permanent establishment. We will also provide introduction to the Canada’s federal sales tax regime (GST/HST) and a high level overview of how the carrying on business in Canada and Permanent establishment concepts apply for GST/HST purposes.

1. INCOME TAX

As a basic rule, any non-resident (whether individual, corporation or otherwise) is subject to Canadian tax on profits related to their business activities if they are considered to be carrying on business in Canada.

Although the determination of whether a business’ activity crosses the threshold of being carried on in Canada is dependent on facts and circumstances, generally it is understood that the threshold is quite low. For example, it may be possible that the Canada Revenue Agency (“CRA”) would view a non-resident business to cross this threshold if they send some of their employees for business purposes to Canada for even one day (the payroll and other tax implications of non-resident employees present in Canada will be covered in the next Part).

Furthermore, subsection 253(1) of the Canada’s Income Tax Act explicitly states that when a non-resident solicits sales in Canada, such activity would be viewed as carrying on business in Canada.

However, it should be noted that although the threshold is low, it does not mean that every business with Canadian connection would cross this threshold. For example, a non-resident service provider merely providing services to Canadian-based clients is likely not considered to be carrying on business in Canada if they have no other connection to Canada (e.g. does not solicit sales in Canada, no presence in Canada, etc.).

Permanent Establishment

Canada has tax treaties with over 80 countries around the world including the US. These treaties generally state that a non-resident will only be taxable in Canada on their Canadian business activities if such activities are carried on through a permanent establishment (“PE”) in Canada. If the non-resident is considered to be carrying on business in Canada but without a PE, the non-resident’s business activities would not be subject to Canadian tax.

Taking the Canada – US tax treaty as an example, having the following in Canada would create Canadian PE for the non-resident business (the list is not exhaustive):

• Fixed place of business such as an office, place of management, factory, etc.;

• Building site, construction or installation project lasting more than 12 months;

• Employees of the non-resident company habitually concluding contracts in Canada; or

• Services PE (see below).

In respect of the third conditions, it is interesting to note that employees must habitually conclude contracts in Canada. Therefore, one or two contracts signed in Canada may not create PE if it is done on a non-habitual basis although it is strongly recommended that all contract conclusions occur outside of Canada. Furthermore, if contracts are negotiated in Canada to a point where it is effectively completed and the mere signing of the contract occurs outside of Canada, the CRA may deem contracts to have been concluded in Canada.

Certain auxiliary activities in Canada are deemed not to create PE in Canada. These include (but not limited to):

• Use of facilities for the purpose of storage, display or delivery of goods or merchandise belonging to the non-resident;

• Maintenance of inventory belonging to the non-resident for the purpose of storage, display, delivery or for processing by another person; and

• Advertising and other preparatory or auxiliary activities.

Services PE

Services PE is a unique PE rules in the Canada – US tax treaty intended to capture service businesses that spend considerable amount of time providing services in Canada but are not considered to have Canadian PE under the traditional definitions mentioned above (e.g. because they don’t have a physical office in Canada).

Under the Services PE rule, a non-resident business may have PE in Canada if one of the two conditions are met:

1. If the service is performed by a US individual who is present in Canada for a period of 183 days in any 12-months period and during that period, >50% of the gross active business revenues of the business is derived from Canada; OR

   
   

2. Services are provided by a non-resident (individual or company or otherwise) for 183 days or more in any 12 months period with respect to the same or connected project for Canadian clients or to a non-resident client that maintains a PE in Canada and the service is provided to the Canadian PE.

The first condition is generally intended to capture small self-employed non-resident individuals providing service in Canada whereas the second condition may apply to businesses of all sizes.

Mitigating PE risk

Some of the best practices for mitigating PE exposures are:

1. Although employees that travel to Canada can negotiate contracts in Canada, ensuring that they do not conclude or substantially conclude contracts in Canada;

2. Monitoring the # of days present in Canada for Services PE, construction PE or other PE rules that require monitoring of days.

3. If establishing a PE is inevitable, consider setting up a Canadian subsidiary (we will explore this in Part III).

Tax Compliance

If a non-resident is considered to be carrying on business in Canada, a Canadian tax return will be required. Assuming that the non-resident is a corporation:

• CRA Business Number must be obtained.

• Corporate tax return is due six months after the year end (no extension available).

• Tax balance will be due two months after the year end.

If the non-resident can claim the tax treaty benefits and take the position that there is no Canadian PE, a Canadian corporate tax return will still be required although no tax payment would be quired. Late filing penalties of up to $2,500 per year may arise.

If the services are rendered by an individual or another entity type, different filing obligations should be considered.

2. GST/HST – INDIRECT TAX

Overview

In Canada, businesses are generally required to register and charge Goods and Services Tax (“GST”) of 5% on taxable supplies (which includes most goods and services) if their worldwide taxable supplies (including those of associates) exceed more than $30,000 in a quarter or over the past 12 months (i.e. no longer a “Small Supplier”).

Although each province may charge their own separate sales tax, the following provinces have harmonized their sales tax regime with the GST so that only a single rate of sales tax (called Harmonized Sales Tax or “HST”) is charged on taxable supplies in those provinces. The HST rate applicable to these provinces (called participating provinces) are as follows:

• Ontario – 13%

• New Brunswick – 15%

• Newfoundland and Labrador – 15%

• Prince Edward Island – 15%

• Nova Scotia – 14%

The province of Quebec administers its own separate Quebec Sales Tax (“QST”) which generally mirrors GST whereas the provinces of British Columbia, Saskatchewan and Manitoba administer their own Provincial Sales Tax (“PST”).

At a high level, the difference between GST/HST/QST and PST is that GST/HST/QST are value-added tax that applies at each level of supply chain (and businesses registered for GST/HST can generally recover such taxes) whereas PST is a sales and use tax generally imposed only on the final consumer in the PST provinces. Discussions of QST and PST are beyond the scope of this article but must be considered by any enterprise considering conducting business in those provinces.

GST/HST Registration requirement for Non-residents

Generally, a non-resident providing taxable supplies to Canadian customers (other than a Small Supplier) is required to register in one of the following two circumstances:

• It carries on business in Canada; or

• It has a PE in Canada through which it makes taxable supplies.

Carrying on business in Canada

Whether a person is considered to be carrying on business in Canada for GST/HST purposes is a question of fact requiring consideration of all the relevant facts. Although many of the considerations may be similar to the test for income tax purposes discussed earlier, it is not entirely the same and generally, the threshold for carrying on business in Canada is understood to be higher than for income tax purposes.

The CRA provides a list of factors that they would consider when determining whether a person is carrying on business in Canada in their Policy Statement P-051R2. Depending on the industry in which the non-resident operates, certain factors would be weighted greater than others.

With that said, the Policy Statement also includes the following statement:

“In general, a non-resident person must have a significant presence in Canada to be considered to be carrying on business in Canada. Generally, isolated transactions carried on in Canada as part of a business that is carried on by a non-resident person outside Canada may not result in the person being considered to be carrying on business in Canada, given that the above-noted factors will usually not be met to a sufficient degree.”

Permanent Establishment

Generally, a non-resident would be considered to have a PE in Canada for GST/HST purposes if the non-resident:

• Makes supplies through a fixed place of business in Canada; or

• Makes supplies through a fixed place of business of a dependent agent (e.g. employee) in Canada.

The meaning of fixed place of business and various examples of when a non-resident may have PE in Canada for GST/HST purposes are provided in CRA’s Policy Statement P-208R.

Security Deposits

Generally, a non-resident who registers for the GST/HST under the general framework, as well as those who register voluntarily is required to post security deposit with the CRA. This requirement does not generally apply if the registrant has a PE in Canada through which it makes supplies (unless the PE is a fixed place of business of another person).

Minimum security deposit is $5,000 and maximum is $1,000,000 and certain exceptions may apply.

Simplified Regime

Effective July 1, 2021, non-residents that would not be required to register and collect GST/HST under the regular rules discussed above may be required to register and collect GST/HST under a simplified regime. Broadly speaking, these rules expand the GST/HST registration and collection requirements to three categories of operators:

1. Digital platform operators (e.g. Netflix) that deliver taxable digital products or services to Canadian consumers;

2. Accommodation platform operators (e.g. AirBnB) that operate digital platforms through which supplies of short-term accommodations in Canada are facilitated; and

3. Distribution platform operators (e.g. Spotify, eBay) for sale of goods made through their platforms by unregistered vendors where the products are located in a fulfilment warehouse in Canada or shipped from a Canadian location. This condition may also apply to non-resident vendors that sell goods directly to Canadian consumers in certain circumstances.

The rules under the Simplified Regime is complex and should be carefully considered.

TAKEAWAY

Expanding into Canada presents exciting opportunities for your business — but also brings new Canadian tax compliance obligations. We can help you navigate the tax implications and compliance requirements so you can focus on growing your business with confidence and peace of mind.

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.