COVID-19 Tax Changes and Benefits for Employers and Businesses

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Tax and Payment Deadlines

For corporations which otherwise would have had to file their tax returns after March 18 and before June 1, 2020, the filing date has been extended to June 1, 2020. Payment deadlines have also been extended to September 1, 2020, for Part 1 tax which was due after March 18 and before September 1, 2020.

Payroll remittance deadlines are remaining unchanged.

Partnership information return (T5013) deadlines have been extended to May 1, 2020. The filing date for other information returns, which would otherwise be due after March 18, 2020 and before June 2020 have been extended to June 1, 2020.

Trusts with a year-end date of December 31, 2019 have had their deadlines extended to May 1, 2020. Trusts that would have had a filing due date in April or May now have their deadlines extended to June 1, 2020.

GST/HST payments deadlines for companies and self-employed individuals, which were normally between March 27, 2020 and May 31, 2020, have now been extended until the end of June 2020. For customs duties and GST on imported goods, the new deadline will be the end of June and the deferred amounts include amounts due for March, April, and May.

Subsidies

There are two main wage subsidies that the government is offering business to help companies avoid layoffs during the COVID-19 pandemic the Temporary Wage Subsidy and the Emergency Wage Subsidy.

The Emergency Wage Subsidy could cover 75% of salaries for up to three months; organizations which do not qualify for the Emergency Wage Subsidy, they may qualify for the 10% wage subsidy through the Temporary Wage Subsidy.

For employers who are eligible for both subsidies, the amount received from the 10% subsidy for a period would reduce the amount available under the Emergency Wage Subsidy

Emergency Wage Subsidy

Eligibility

This subsidy is available for individuals, corporations, partnerships, non-profit organizations, and registered charities who have employees. Public bodies are not eligible for this subsidy (i.e. schools, hospitals).

An employer is eligible for this subsidy if it has seen a drop of 30% of its monthly revenue for March, April, or May when compared to the same month in 2019. This should be calculated using its normal accounting method, excluding income from extraordinary items, non-arm’s length sales, and amounts on account of capital.

On April 8, 2020, Prime Minister Trudeau announced that the drop of monthly revenues requirement has been changed from 30% to 15% for March 2020, since most companies only saw the effects of COVID-19 part-way through the month. He also announced the option of using January or February 2020 as a reference point, since start-ups may have low or no sales in prior years.

For not-for-profits and charities, there is the option to either include or exclude government funding for the calculation of the decrease of revenues.

How it works

An employer can claim a subsidy of 75% of the pre-crisis remuneration for an eligible employee, up to a maximum of $847 per week. The employer would be expected to make its best effort to pay the balance of the employee’s salary for this period.

This subsidy is currently available for March 15 to June 6, 2020. There is no overall limit on the total subsidy amount an employer can claim.

Employers should keep records demonstrating how their revenue amount was calculated, and that the remuneration was properly paid to employees. If incorrect or fraudulent claims are made, there will be penalties and the employer will have to repay the subsidy amount.

If an employer has already applied for the Temporary Wage Subsidy and has received benefits under that program, the amount claimed through the Emergency Wage Subsidy should be reduced correspondingly.

An employer may not claim the Emergency Wage Subsidy for an employee that has been laid off or furloughed and is claiming the Canadian Emergency Response Benefit.

How to apply

An employer who would like to apply for the Emergency Wage Subsidy should do so through the CRA My Business Account.

Further details can be found here.

Temporary Wage Subsidy

Eligibility

Eligible employers include individuals, partnerships, non-profit organizations, registered charities, and Canadian-controlled private corporations which are eligible for the small business deduction.

As well, the employer must have a business number and payroll account as of March 18, 2020, and pay salaries or other remuneration to an eligible employee.

To be an eligible employee, you must be employed in Canada.

How it works

The subsidy is equal to 10% of the remuneration paid between March 18 and June 19, 2020, up to a maximum of $1,375 per employee or $25,000 per employer.

The CRA does not calculate the subsidy automatically; it must be calculated manually. This subsidy does not need to be applied for; instead, when you calculate your payroll tax liability, reduce the remittance of federal, provincial, or territorial income tax by the amount of the subsidy.

If the payroll remittances are less than the calculated subsidy, you can reduce future amounts due, even if those payments fall outside the period to which this subsidy applies.

The employer should keep records of the total remuneration paid during the applicable period, the income tax that was deducted, and the number of eligible employees. The subsidy is taxable income and must be reported in the year the remittance reduction occurred.

 

Loans and Credit Available

Business Credit Availability Program

Export Development Canada (EDC) and the Business Development Bank of Canada (BDC) will be working with financial institutions to provide direct lending and other types of financial support to businesses during the COVID-19 crisis.

Eligibility for this program will be determined by its credit-worthiness and the viability of its business model. The funds for this program can be accessed through the entity’s financial institution, and the financial institution will contact the EDC and BDC to determine what funds are available.

Canada Emergency Business Account

This program will be rolled out in mid-April, and access to the program will be through Canadian banking institutions. Interest-free loans of up to $40,000 will be available to help cover operating expenses for companies with reduced revenue due to COVID-19.

Small businesses and not-for-profits can qualify if they paid between $50,000 and $1 million in payroll in 2019.

COVID-19 Tax Changes and Benefits for Canadian Taxpayers

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Deadlines

The due date for filing individual tax returns has been extended by just over a month, from April 30, 2020 to June 1, 2020. The deadline for payment of tax has been extended to September 1, 2020. However, the CRA suggests filing early to ensure that you receive any benefits and credits you may be entitled to in a timely fashion.

If you are self-employed, your filing deadline remains unchanged – June 15, 2020. However, your payment deadline will be extended to September 1, 2020.

The deadline for non-residents filing a form NR4 has also been extended to May 1, 2020. The payment deadlines for NR4 related payments remains unchanged.

You may still receive Notices of Assessment with the payment date listed as April 30, 2020. This is a software error that can be disregarded.

Benefits and Support

Canada Emergency Response Benefit (CERB)

This benefit is temporary income support for people who are out of work (whether as an employee or proprietor) for reasons related to COVID-19. The maximum benefit is $2,000 every four weeks, for up to 16 weeks. You can apply at Canada.ca by clicking here.

This benefit applies who workers who reside in Canada and are at least 15 years old, if you:

  • Stopped working due to COVID-19; or
  • Are eligible for Employment Insurance for unemployment or illness purposes.

You must also have had:

  • At least $5,000 of income in 2019 for the past 12 months; and
  • Expect to be without employment or self-employment income for at least 14 consecutive days in the first four weeks.

The income that counts towards the $5,000 required to be eligible includes:

  • Employment income;
  • Self-employment income;
  • Maternity and parental benefits under Employment Insurance; and
  • Parental benefits under Quebec Parental Insurance Plan.

Please note that the $2,000 benefit applies for a four week period, and if your situation of unemployment continues past four weeks, you must reapply to continue receiving the benefit. You may currently re-apply for up to four periods (16 weeks total).

It is currently estimated that you should receive your benefit within 3 business days of application, if you sign up for direct deposit. If you do not have direct deposit set up,  you should receive your benefit within 10 business days.

Employment Insurance

Individuals who are quarantined due to COVID-19 can apply for Employment Insurance sickness benefits. The one-week waiting period will be waived for new claimants who are quarantined, and they will not have to provide a medical certificate. Additionally, if you are not able to apply immediately because you are quarantined, you can apply later and have your claim backdated.

For more information regarding Employment Insurance applications, please visit the EI website here.

GST/HST Credit Payments

There will be a one-time payment of your GST/HST amount on April 9, 2020, which should be double your maximum annual benefit. If you have filed a 2018 tax return and are normally eligible for the GST/HST Credit, you should receive this automatically.

If you have already received part of your GST/HST credit amount for the year, the remainder of your credit plus the new amount you are entitled to should be paid out in the one April payment.

You do not have to file your 2019 return to be entitled to this payment; however, your 2018 net income is the basis for this credit and it must be filed for you to be eligible.

To determine if you are entitled to a GST/HST Credit Payment, you can use the Child and Family Benefit Calculator – however the additional payments for COVID-19 support are not reflected in this calculator. You can double this amount to determine the total benefit you should receive.

Canada Child Benefit Payments (CCB)

The maximum CCB payment for the year has been increased by $300 per child. This amount will be included in your May monthly payment.

Registered Retirement Income Funds (RRIF)

Due to the volatility in the stock market and the impact that may have on retirement savings, the government has decreased the minimum RRIF withdrawal by 25% for the year.

This change will apply to those receiving payments from a defined contribution registered pension plan (RPP), as well as a pooled registered pension plan (PRPP).

Individuals who have already withdrawn more than the updated minimum amount will not be permitted to re-contribute to their RRIPs in order to meet the reduced minimum.

Benefits reviews

If your benefits are currently under review by the CRA and you are required to send in supporting documentation, you can wait to submit the documents. Benefits reviews are currently on hold and you will receive a new letter when the CRA resumes these operations.

Free Tax Clinics

Tax clinics are run each year by the Community Volunteer Income Tax Program to help individuals with modest income prepare their tax returns. Many clinics have been postponed due to the measures put in place for social distancing. For example, Toronto Public Libraries have cancelled all events, including the Tax Preparation Assistance programs, through to the end of April.

There may still be some clinics being run on a “drop-off and pick-up” or appointment basis. Unfortunately, the CVITP program is not set up to handle tax returns digitally. Once social distancing measures have been scaled back, there will be an attempt to re-schedule the tax clinics that are currently postponed.

To determine if you are eligible for free tax assistance, please visit the CRA website here. To see if there are any clinics which are still running in your area, please check here.

Drop Boxes and Walk-in Services

All CRA drop boxes have been closed, except for those located at the Jonquiere, Sudbury, and Winnipeg tax offices. The CRA is unable to ensure that your documents will be properly received and filed if they are left at any other drop boxes during this time.

There will be no walk-in services offered at the counters of any of the tax centres or CRA offices during this time.

The CRA is encouraging taxpayers to file their tax returns online using Netfile or a tax professional. Alternatively, you may mail your documents to the appropriate tax centre.

Dissolving an Ontario corporation

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To voluntarily dissolve a corporation which has been incorporated provincially in Ontario follow these steps:

Step 1

Ensure all returns which are due are filed (not the stub period up to dissolution).  Consent will not be given until this is done.  The stub period return is the only return to be marked “final return up to dissolution”.

Step 2

Determine which one of the following forms must be filed.

Form 10 – if the corporation has issued shares or commenced business, shareholder approval is required

Form 11 – if the corporation has not issued any shares, if the corporation has not commenced business

Step 3

Acquire a letter of consent to dissolve the corporation from the Ministry of Revenue.  To do this you have three options:  You must wait approx. 10 days after filing last return.

  1. Fax a request to Ministry of Revenue (1-905-433-5418)
  2. Email a request to: management@ontario.ca or
  3. Mail a request to:
Minister of Finance
Account Management and Collections Branch
PO Box 622
33 King Street West
Oshawa ON  L1H 8H5

In your request you need to include: 

  1. Corporation’s legal name
  2. Federal Business Number
  3. Contact information for taxpayer/corporation
  4. Mailing address for corporation
  5. Date business ceased operations

Step 4

After receiving the letter of consent to dissolve you have 60 days to send in the package requesting dissolution.  The final package will include the following:

  1. Form 10 or Form 11 in duplicate bearing original signatures
  2. The letter of consent from Ministry of Revenue
  3. A covering letter with a contact name, return address and phone number
  4. A $25 filing (cheque payable to Ministry of Finance)

Mail the completed package to:

Ministry of Consumer and Business Services
Companies and Personal Property
Security Branch
393 University Avenue Suit 200
Toronto, ON  M5G 2M2

Final Tax return

After articles of dissolution are received you must file the final tax up to the date of dissolution.

Example – if the last return you filed was Dec 31, 2019.  You receive articles of dissolution dated Feb 1 2021.  You must file two returns, year ending Dec 31 2020 AND Jan 1 2020 to Feb 1, 2021.  Be sure and mark “final return up to dissolution” on info page.

For further information contact Jim Innes:  Jinnes@innesrobinson.ca

 

GST/HST on the Sale of Your Home Office

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Related image

A Common HST Mistake

A common and very expensive mistake made by the vendor of a used residential property is that the vendor assumes that the sale is exempt from HST.  The reason for the error is that in fact most sales of used residential property are HST exempt, however not all sales.

The most common example of HST applying is where a house or condo that is normally used for residential purposes has been converted to business or professional use.

An example is where a doctor buys a house on a busy street and gets it rezoned as his/her professional office.  If the house is someone’s home prior to the purchase, then no HST would have been paid on the purchase.  On the eventual sale the doctor would be required to charge the new buyer GST/HST.  In most cases the new buyer is only willing to pay one total price regardless if HST is part of the price, so the result is that the vendor ends up incurring the cost of the HST.  In Ontario that means a cost of 13%.

The HST is often a surprise

When selling your office/house most vendors consult their real estate agent and maybe their lawyer.  Neither of these professions are HST specialists.  Your real estate agent is very careful to insert a paragraph in your purchase and sale agreement that tells you to get your own tax advice.

Most purchasers include a clause in the purchase and sale agreement that says “GST/HST if applicable is included in the price”. That means that if HST is applicable the vendor will be the one paying it.

Vendor’s often try to get out of remitting the HST by claiming the house is a used residential property.  On closing they will represent that the property is used residential.  There are lots of problems with this approach including:

  • Your lawyers will not let you lie on a document that they are associated with.
  • There is often lots of evidence to show that the house was used in a commercial venture including such things as zoning, business listing, google map
  • CRA audits this transaction – all real estate transactions are registered. It is very easy for CRA to check the land registry office and follow up on sales.

The Purchaser is often the winner

Many time I have been able to tell the uninformed purchaser that they have just benefited from a 13% reduction in the purchase price.

Where the purchase is going to use the property as their home, they can applied for Ontario and Federal HST rebates.  Where they are using the property for commercial purposes they can either get the original transaction price reduced by 13% or they can claim the HST back on their next HST return.

Legal Ruling on Complex Disclosure Rules for US Ex-Pats

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US citizens who live outside the United States have the specter of the IRS and offshore compliance requirements over their heads, and often fear the threat of six-figure penalties and statutory fines if they are caught failing to report all their income and assets. If you have a non-US corporation, a non-US trust, invest in certain registered accounts, or have financial assets over certain thresholds, you are at increased risk.

Since 2004, the IRS has repeatedly saddled US citizens with fines in excess of $100,000 for failing to comply with foreign bank account and financial account disclosure laws. A US person who has a financial interest in non-US financial assets is required to file a Foreign Bank Account Report (currently FinCEN form 114) if the total value of their assets exceeds $10,000 at any time during the year. For willful violations of this filing requirement, the fines can be exorbitant.

U.S. v Colliot

The potential amount of these penalties has been under dispute in a court case, U.S. v Colliot. Dominique Colliot was assessed penalties for FBAR disclosure violations of $548,773 for 2007, $196,082 for 2008, and smaller penalties for 2009 and 2010. These massive penalties show the risks that US citizens face if they fail to properly disclose their foreign financial assets.

Colliot sued the U.S. government, alleging that the penalties were arbitrary and capricious, and that the IRS had incorrectly applied its own laws in calculating the penalty. The two relevant laws are 31 U.S.C. §5321(a)(5) and a related regulation, 31 C.F.R. §103.57.

§5321(a)(5) previously stated that the civil penalties in these situations could be equal to the greater of $25,000 or the balance of the unreported accounts, up to a maximum of $100,000. The related regulation, C.F.R. §103.57 agreed with the provision, using similar wording and identical numerical values.

However, in 2004, the provision in §5321 was amended by Congress and increased the maximum civil penalty which could be assessed for failing to comply with FBAR disclosure laws. The new law stated that the civil penalty for willful failure to file would be the greater of $100,000 and 50% of the balance in the unreported account.

This new provision now actually contradicted its related regulation, which continued to state that the maximum allowable penalty for a willful failure to file was $100,000. And although the IRS updated the provision for inflation and re-numbered it during a reorganization, it did not update it to align with the new §5321.

The Court therefore ruled on the side of Colliot, stating in a May 15, 2018 conclusion that the IRS cannot assess penalties in excess of the threshold set by 31 C. F. R §1010.820 (formerly 31 C.F.R §103.57). Of course, this regulation may be amended by the IRS to line up with the higher penalties in §5321, but for taxpayers who were assessed penalties between 2004 and that point, they may have a claim against the IRS to have a portion of those penalties reversed.

Despite this win for Colliot, it is important to remember that the IRS may still levy penalties of up to $100,000 per incidence of failing to properly report foreign financial assets. For US ex-pats living in Canada who have not been filing their US tax returns, this is a good opportunity to speak to a tax professional about the voluntary disclosure programs which would allow them to get up to date with their filing without the risk of incurring heavy penalties.

Tax Alert: Employment Expenses

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The CRA has made it clear that it has undertaken a new project in 2017 to carefully review employment expenses.  Many of my colleagues in the accounting profession have confirmed that they have also noticed that CRA has been more frequently asking taxpayers to support their employment expenses.

Where the employee is also an owner, we are finding that CRA is taking a tough line and denying even well-supported expenses.

CRA is basing the denial of these expenses based on the Tax Court of Canada Case, Morton Adler vs. the Queen (2010 DTC 1020), in which the burden is on the employee taxpayer to prove that there would be adverse consequences with respect to their employment if they did not use their car or home office.

In that case, the taxpayer was the spouse of the shareholder, and the court therefore took the position that there was little or no risk of the company suing the taxpayer for breach of contract if she failed to perform her duties with her car and home office. They also concluded that she would likely not suffer negative consequences of a poor performance review, and that these expenses were therefore not a requirement of employment. The expense deductions were denied.

Planning Alternatives

Wherever possible employment expenses should be paid by the employer.  For example, car expense could be accommodated by paying the employee a per kilometer amount for each supportable business kilometer driven.

Regardless of how you report the expenses, it will still be important to maintain good records.

H.R.1 The Tax Cuts and Jobs Act: Potential effects on US citizens and investors living abroad

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Individual Tax Reform

Tax rates

Tax rates for individuals and corporations are lowered across the board for individuals, but these lowered rates expire in 2025 unless there is further legislation to renew them. In conjunction with the other changes in the bill, this will result in lower taxes for some, but not all, taxpayers.

There are also new maximum tax rates for business income earned through a flow-through entity. This should replicate the lowered tax rates on corporations for individuals who conduct business through partnerships rather than corporations.

Personal exemption and standard deduction

For the years 2018 to 2025, the personal exemption is being eliminated and the standard deduction is being increased.  For non-resident individuals, this may mean a tax increase because they are not eligible to take the standard deduction.  A non-resident individual will only have specific allowable deductions to reduce their taxable income.

US 1040 filers who previously made use of the personal exemptions of their dependants, or who filed as Head of Household in order to use the larger personal exemption, may see an increase in their taxable income.

Students

The House bill contained a lot of changes relating to the treatment of student income, but most of these changes did not end up in the final bill. There is a change relating to the treatment of student loans discharged on account of death or disability. In the case of a loan being discharged due to the death or permanent disability of a student, this discharge will not be included in the gross income of the individual.

Deductions capped or removed

Foreign real property taxes may not be deducted. US citizens who own homes in a foreign country may have previously been deducting their property taxes on their non-US homes and will no longer be able to do so. Property taxes paid to the US will be capped at $10,000 for the year, or $5,000 for a married individual filing separately from their spouse.

The mortgage interest deduction is now limited to the interest paid on $750,000 worth of indebtedness secured by a qualified residence. Loans which were already in place before December 15, 2017 will not be affected by the new limitation.

The medical expense deduction floor is reduced from 10% to 7.5%.

Miscellaneous itemized deductions are suspended, as is the overall limitation on itemized deductions. This includes unreimbursed employee expenses, tax preparation fees, and certain other expenses paid to produce income, to manage or maintain income producing property, or to determine or claim a refund of tax.

These changes apply for the tax years 2018 to 2025.

Deduction for Alimony

The Bill repeals the deduction for alimony payments made, as well as the provisions requiring inclusion of alimony payments in gross income.

Elimination of shared responsibility payment

HR1 eliminates the shared responsibility payment for individuals failing to maintain essential minimum coverage. This would reduce the tax bill for people who do not have minimum essential insurance coverage or meet one of the qualifying exemptions. Most foreign nationals meet an exemption due to being out of the country, so the potential removal of this tax should not affect most US persons living outside the country.

Repatriation of earnings for Controlled Foreign Corporations

A controlled foreign corporation (CFC) is a foreign corporation in which 50% of the total combined voting power or value of all classes of stock is owned by a US person on any day of the year. Previously, there has been the opportunity for deferral of taxes on income which was not effectively connected to the US, and the income would be taxed when paid out to the US shareholder as dividends.

There were provisions in place to tax Subpart F income on the shareholder’s return, which is defined in §952 as including insurance income and foreign base company income. HR1 expands the definition of Subpart F income to include all accumulated post-1986 deferred foreign income.

This could have the effect of causing any retained earnings held in a US person’s non-US company to be taxable in the current year on the owner’s personal tax return. For many US expatriates, this is an area of significant concern since they may be running their non-US businesses out of corporations in the country in which they live.

There are some provisions included in the Bill to ease the transition to the new system, and an election which may allow the taxpayer to utilize their foreign tax credits more efficiently.

Estate and gift tax

The estate and gift tax exemption will be doubled to $10 million USD (adjusted for inflation).

Corporate Tax Reform

Lowered corporate tax rates

Despite the lowered tax rates for US C-corporations, there is still no integration between the US and Canadian tax systems, and tax rates for Canadian companies operating in the US through a US C-Corporation is still not likely to be tax efficient.

Repeal AMT

The Alternative Minimum Tax system is a taxing system applied at a lower flat rate and removes many deductions which may allow certain taxpayers to pay an “unfairly” low tax rate. HR1 repealed the AMT for corporations, and increased the limitation above which AMT would be calculated.

For those who have already paid AMT and accumulated AMT tax credits, there will be a system in place to allow those credits to be used.

Moving from deferral system to territorial system

US multinationals will have a full exemption for dividends paid from foreign subsidiaries if the US parent owns at least 10% of the subsidiary. This change works in conjunction with the above-noted requirement to include accumulated earnings and profits in Subpart F income to create what is being reported as a “territorial” tax system, rather than the “deferral” system which was in place.

Pass-through tax rate instead of being taxed at individual rates

Previous US tax law treated income earned through flow-through entities, such as partnerships, LLCs, or S Corporations, as income earned by the taxpayer who owns said entity. This means that income is included on the individual’s return and taxed at the individual’s marginal tax rate.

There are new complex rules in place to calculate the taxes for flow through entities, which includes deductions for certain business income, taking salaries into account, and different marginal rates.

Conclusion

The new US tax bill has far reaching effects, even to those not living in the United States of America. If have concerns over how the bill will affect US citizens or those investing in the US, please do not hesitate to contact us.

Taxation of Cryptocurrency Transactions

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Transaction in cryptocurrencies like Bitcoin and Litecoin are become more common every day.  There are those who are doing business, making purchases, or doing their personal transactions using Bitcoin and other cryptocurrencies, and some people are investing in the currency for speculative purposes.

CRA has taken the position that where Bitcoin is used to complete a transaction, it should be dealt with for income tax and HST purposes like a barter transaction.  The barter transaction rules have been in place for years.  If you complete this type of transaction, CRA wants you to simply value what you paid or received as if it were a cash transaction.  You would then report it for income tax or HST purposes the same way.

For the Bitcoin investor, CRA has said that while cryptocurrencies are not “money” or “currency,” they should be treated as a commodity, like gold, for Canadian tax purposes.

Buying or selling cryptocurrencies, like transactions with commodities, will trigger either a capital gain (or loss) or business income (or loss). The normal rules of whether buying or selling a commodity constitutes income or capital will apply. If you trade frequently is likely that the gains (or losses) would be business income (or loss). Conversely, if the Bitcoin was purchased a year ago, and the taxpayer never traded it, and does one trade before year end, it is virtually certain that the gain would be on capital account.

Some factors CRA will consider in determining the tax treatment include:

  1. frequency of trades,
  2. period of ownership,
  3. knowledge of matters,
  4. relationship to the taxpayer’s business, and
  5. time spent on it.

A third Bitcoin activity is mining for Bitcoins.  Mining is where you use your computer to assist in the processing of transactions for Bitcoin, and you are paid for this service in bitcoins.  Mining undertaken for profit is taxable. Mining undertaken as a personal hobby may not taxable. If are mining as a business, some of the tax consequences generally include:

  1. income from the business is included in your income at year end based on the value of your inventory (i.e., the cryptocurrencies), and
  2. any thefts or losses are deductible from your income if they are an inherent risk to carrying on the business.

If you invest in securities of offshore entities that deal in cryptocurrencies, or if you hold such cryptocurrencies directly in an offshore account, Canadian Foreign Accrued Property Income (FAPI) rules will likely apply.

 

When to file a tax return in the US

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As a person or entity who is not a US citizen and doesn’t live or work permanently in the US, you may believe that you have no obligation to file American tax reporting forms. However, according to US tax law, if a non-US entity is engaged in a trade or business in the US, it will be taxable on its income which is effectively connected with the conducting a trade or business in the United States.

The US-Canada Tax Treaty changes the burden for paying taxes in the US for Canadian entities and persons. They are only required to pay tax when the entity has a permanent establishment in the US. In order to claim these treaty benefits, a Canadian entity would have to file a protective return.

The definition of permanent establishment varies based on state, and certain states have not adopted the US-Canada Tax Treaty into law. Any time that a Canadian person or entity conducts a trade or business in the US, it is important to look at the specific states in which they are operating to determine if state-level tax obligations exist even when no federal taxes are due.

Effectively connected income

The general rule is that if an entity is engaged in a trade or business in the US, all US source income and gains is treated as effectively connected income (ECI). This does not include investment income, but does still apply to US source income earned by the entity which is not related to the trade or business carried on in the US.

Effectively connected income can be earned in a number of different circumstances. For example, certain non-immigrant visas allow people to work in the US while they are temporarily staying there. F, J M, and Q visas are in this category. The taxable part of a US scholarship or grant received by a non-resident would be considered as income connected with a trade or business in the US.

If an entity is a membership of a partnership that is engaged in a trade or business in the US, or if an entity is performing personal services in the US, this would be considered effectively connected income. If an entity is a business or owns a business that sells products or services within the US, the entity has effectively connected income.

Selling real property or real property interests within the US is considered engaging in a trade or business in the US. Income from the rental of real estate is subject to an election to allow it to be considered ECI.

Permanent establishment

Not all entities carrying on business in the US are required to pay taxes on their effectively connected income. Canadian entities earning business profits in the US have treaty protection against paying US taxes on business profits earned in the US if they did not earn those profits through a “permanent establishment.”

Article V of the Canada-US Tax Treaty defines “permanent establishment” as “a fixed place of business through which the business of a resident of [Canada] is wholly or partly carried on. The Treaty definition is fairly broad and includes a place of management, a branch, an office, a factory, a workshop, and a place of extraction of natural resources.

If a state follows the Canada-US Tax Treaty, failing to have a permanent establishment means that the entity should not have to pay income tax in that state (although franchise and licensing taxes may still apply). If the state does not follow the Canada-US Tax Treaty, state law will have to be considered to determine if the entity has nexus in that state and should therefore file a tax return and pay taxes.

Even if the entity does not have a permanent establishment, it does not automatically receive treaty protection. In order to claim treaty benefits, an entity would have to file a US return (1120-F); this return should include a treaty statement declaring that it is a Canadian entity wishing to claim the benefits of the US-Canada Tax Treaty and stating that they have no permanent establishment in the US and therefore are exempt from taxation on business profits. This is called filing a “Protective return.”

If this return is not filed, the US retains the right to issue a request to file and may claim that the treaty benefits were forfeited for failure to file. Filing this return also protects the right of the company to take deductions and credits against gross income in the event that the IRS does not agree with the entity’s determination that it does not have a permanent establishment in the US.

It is therefore very important to consult with professionals about an entity’s US tax liability, even if it only has limited activity in the US.

 

Subsection 216(1) Late-filing Policy

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A non-resident of Canada who owns real property in Canada has an obligation to report any rental income earned to the CRA. Many property owners believe that once they are no longer living in Canada, that they not required to report any of their income to the CRA. Or they may believe, that since there is no net profit on this property (i.e. expenses of owning the property are higher than the income earned from renting it), that there is no tax obligation. However, if they are earning income from real estate in Canada, that income is considered Canadian-sourced, and this income should be reported.

Non-residents earning rental income from Canadian real property are required to remit 25% of the gross income from the property to the CRA. The person who is paying the rent is the one who has the obligation to withhold this 25%, but many renters are unaware of this requirement and pay the full rent to the owner.

If the owner is also unaware of this obligation, there can be huge penalties involved. The non-resident owner will be expected to pay the outstanding 25% tax on gross income – plus interest and penalties. If there is a narrow profit margin on the rental income, this tax can often be more than the amount the owner netted on the rental.

In order to pay tax on the net income using graduated tax rates, the owner can submit an NR6 form, requesting to file a tax return to report income and expenses. However, to make this request, the non-resident must first be up-to-date on their past taxes. And the idea of paying 25% of gross income plus interest and penalties is very daunting.

The section 216(1) late filing policy at the CRA is to apply a one-time retroactive application of the NR6 election. The CRA may charge arrears interest on the full amount that should have been deducted, but if it determines that a non-resident’s circumstances warrant the one-time relief, it has an administrative policy to act as though each year’s tax return was filed on time. This means that the non-resident will only have to pay interest on the late monthly 25% remittances up to April of the following year. The CRA will then apply interest to the tax owing on the net income as reported for that year moving forward.

This policy has the potential to reduce a huge burden for non-residents who did not know or understand their Canadian tax obligations. In a recent case, over $40,000 of back taxes, interest, and penalties was reduced to approximately $2,000. This policy may allow non-residents to come forward, file their back taxes, and be onside with their taxes in the future. This is especially important for non-residents who are hoping to move back to Canada, or who would like to dispose of their Canadian real property.

If you are a non-resident who has not been properly reporting your Canadian real property income, please contact us for further information on submitting your back taxes under this policy.