Non-residents are subject to Canadian income tax on taxable income earned in Canada. This means income from carrying on business in Canada, taxable capital gains from the disposition of ‘taxable Canadian property’, income from employment performed in Canada and certain other Canadian-source income such as management fees, dividends, interest, rents and royalties. This guide is concerned only with income from carrying on business in Canada.
A. Carrying on business in Canada
Non-residents are subject to Canadian income tax on income earned from carrying on business in Canada. A distinction is made between carrying on business “with” Canada and carrying on business “in” Canada. Only the latter attracts Canadian income tax and filing obligations.
Whether a non-resident carries on business “with” or “in” Canada depends on the level of activity performed in Canada by the non-resident. If, for example, this activity is limited to the delivery of goods to a customer in Canada, the non-resident will generally be considered to carry on business “with” Canada and so will not be taxable or subject to filing obligations. If, however, sales orders are procured through an agent in Canada then the non-resident may well be considered to carry on business “in” Canada and so be taxed accordingly.
Any further guidance as to where the threshold lies must be drawn by analogy from the federal sales tax context, discussed in the section entitled, When do I become subject to Canada’s federal sales tax (GST)?
Potential relief under Canada’s tax treaties is discussed under Treaty Relief.
B. Treaty relief
Canada’s tax treaties exempt non-residents from Canadian income tax on Canadian-source business income if that income is not attributable to a permanent establishment maintained by the non-resident in Canada. While the definition of “permanent establishment” differs from treaty to treaty, the basic concepts remain consistent.
1. Canada’s typical income tax treaty
The definition of a “permanent establishment” under Canada’s tax treaties is generally predicated upon any of: (i) a place; (ii) a person; or, (iii) in the case of Canada’s treaties with China and the U.S., the amount of time spent in Canada.
(a) Places
A permanent establishment as a place means a “fixed place of business”; that is, a physical location controlled by, and identifiable by prospective clients with, the non-resident taxpayer. Aside from owning or leasing space, the taxpayer may have a permanent establishment if it is permitted to use the office of a subsidiary or a client. Factors to be considered include but are not limited to whether the taxpayer has a key to the premises and access at any hour, whether it uses the premises of one client to service other clients and whether it hangs its own shingle in the lobby or hands out business cards with the address or phone number of those premises.
The Canada Revenue Agency has, in the past, determined that the premises of a subsidiary were a fixed place of business of its non-resident parent. The argument is that the subsidiary, although it is a separate legal entity, is merely the agent of the non-resident. The following may be helpful in avoiding this situation:
- agreements between the non-resident taxpayer and any Canadian subsidiary should be clear that the subsidiary is an independent third party engaged in its own business, not the non-resident taxpayer’s agent acting as part of the non-resident taxpayer’s business; and
- these agreements should make it clear that the Canadian subsidiary does not have the authority to receive orders, negotiate with clients or conclude contracts on behalf of the non-resident taxpayer, or assume any obligation on behalf of the non-resident taxpayer; they should also make clear that the Canadian subsidiary cannot hold itself out as an agent, a representative or a partner of the non-resident parent.
(b) Persons
The second concept is that of a permanent establishment as a person. A person can be a permanent establishment if it has and habitually exercises in Canada the authority to contract on behalf of the non-resident taxpayer. If circumstances permit, this situation can be avoided simply by denying any person in Canada the authority to execute contracts on the non-resident taxpayer’s behalf.
(c) Modifying Rules
The rules relating to places and persons are typically modified by supplementary rules. There are, for example, a series of exclusions pertaining to the purchase or storage of merchandise and activities of a preparatory or auxiliary character. Canada’s treaties generally also exclude from the definition of “permanent establishment” building sites, assembly and installation projects provided that such site, project or activity does not last more than twelve months—six months in the case of China or Hong Kong.
2. Canada’s tax treaty with China
The definition of a “permanent establishment” under the Canada-China Income Tax Agreement (1986) is predicated upon any of: (i) a place; (ii) a person; or (iii) time allocation.
(a) Places
A permanent establishment as a place means a “fixed place of business”; that is, a physical location controlled by, and identifiable by prospective clients with, the non-resident taxpayer. Aside from owning or leasing space, the taxpayer may have a permanent establishment if it is permitted to use the office of a subsidiary or a client. Factors to be considered include but are not limited to whether the taxpayer has a key to the premises and access at any hour, whether it uses the premises of one client to service other clients and whether it hangs its own shingle in the lobby or hands out business cards with the address or phone number of those premises.
The Canada Revenue Agency has, in the past, determined that the premises of a subsidiary were a fixed place of business of its non-resident parent. The argument is that the subsidiary, although it is a separate legal entity, is merely the agent of the non-resident. The following may be helpful in avoiding this situation:
- agreements between the non-resident taxpayer and any Canadian subsidiary should be clear that the subsidiary is an independent third party engaged in its own business, not the non-resident taxpayer’s agent acting as part of the non-resident taxpayer’s business; and
- these agreements should make it clear that the Canadian subsidiary does not have the authority to receive orders, negotiate with clients or conclude contracts on behalf of the non-resident taxpayer, or assume any obligation on behalf of the non-resident taxpayer; they should also make clear that the Canadian subsidiary cannot hold itself out as an agent, a representative or a partner of the non-resident parent.
(b) Persons
The second concept is that of a permanent establishment as a person. A person can be a permanent establishment if it has and habitually exercises in Canada the authority to contract on behalf of the non-resident taxpayer. If circumstances permit, this situation can be avoided simply by denying any person in Canada the authority to execute contracts on the non-resident taxpayer’s behalf.
(c) Time allocation
A third concept applies if services are provided in Canada by employees or other personnel for an aggregate of 183 days or more in any 12-month period and those services are in respect of the same or a “connected” project.
“Connected” Projects
Projects that are subject to different contracts may nevertheless be “connected” for the purposes of the time-allocation concept. In general, projects are connected if they constitute a “coherent whole”, both commercially and geographically. Relevant factors include:
- whether the projects would, in the absence of tax planning considerations, have been concluded pursuant to a single contract;
- whether the nature of the work involved under different projects is the same; and
- whether the same individuals provide the services for the different projects.
3. Canada’s tax treaty with the United States
The definition of a “permanent establishment” under the Canada-United States Tax Convention (1980) is predicated upon any of: (i) a place; (ii) a person; or (iii) time allocation.
(a) Places
A permanent establishment as a place means a “fixed place of business”; that is, a physical location controlled by, and identifiable by prospective clients with, the non-resident taxpayer. Aside from owning or leasing space, the taxpayer may have a permanent establishment if it is permitted to use the office of a subsidiary or a client. Factors to be considered include but are not limited to whether the taxpayer has a key to the premises and access at any hour, whether it uses the premises of one client to service other clients and whether it hangs its own shingle in the lobby or hands out business cards with the address or phone number of those premises.
The Canada Revenue Agency has, in the past, determined that the premises of a subsidiary were a fixed place of business of its non-resident parent. The argument is that the subsidiary, although it is a separate legal entity, is merely the agent of the non-resident. The following may be helpful in avoiding this situation:
- agreements between the non-resident taxpayer and any Canadian subsidiary should be clear that the subsidiary is an independent third party engaged in its own business, not the non-resident taxpayer’s agent acting as part of the non-resident taxpayer’s business; and
- these agreements should make it clear that the Canadian subsidiary does not have the authority to receive orders, negotiate with clients or conclude contracts on behalf of the non-resident taxpayer, or assume any obligation on behalf of the non-resident taxpayer; they should also make clear that the Canadian subsidiary cannot hold itself out as an agent, a representative or a partner of the non-resident parent.
(b) Persons
The second concept is that of a permanent establishment as a person. A person can be a permanent establishment if it has and habitually exercises in Canada the authority to contract on behalf of the non-resident taxpayer. If circumstances permit, this situation can be avoided simply by denying any person in Canada the authority to execute contracts on the non-resident taxpayer’s behalf.
(c) Time allocation
A third concept applies in either of two scenarios:
- services are provided in Canada by an individual who is present in Canada for an aggregate of 183 days or more in any 12-month period and more than 50% of the non-resident’s gross active business revenues derives from those services; or
- services are provided in Canada by any number of persons, whether or not individuals, for an aggregate of 183 days or more in any 12-month period and those services are in respect of the same or a “connected” project—in this case, the customers may be either residents of Canada or merely have permanent establishments in Canada, provided in the latter case that the services are provided in respect of those permanent establishments.
The first scenario, which contemplates only a single individual, applies to any number of projects whereas the second scenario, which contemplates any number of individuals, applies only to a single or a connected project. The first scenario applies a revenue test, the second does not. Finally, non-working days are included under the first scenario but not under the second.
“Connected” Projects
Projects that are subject to different contracts may nevertheless be “connected” for the purposes of the time-allocation concept. According to the Technical Explanation of the 2007 Protocol, projects are connected if they constitute a “coherent whole”, both commercially and geographically. Relevant factors include:
- whether the projects would, in the absence of tax planning considerations, have been concluded pursuant to a single contract;
- whether the nature of the work involved under different projects is the same; and
- whether the same individuals provide the services for the different projects.