The Construction or Installation Projects Exception To The Permanent Establishment Article of the Canada-U.S. Tax Treaty
Generally maintaining a fixed place of business in Canada is one thing that creates an income taxable connection to Canada. However, there is an exception contained in Article V of the Canada –U.S. Tax Treaty. In Paragraph 3, the exception to the general rule provides potential opportunity for construction companies and software installation companies, for example, which can manage to limit their projects to a shorter term physical presence in Canada. This exception is specifically worded that “A building site or construction or installation project constitutes a permanent establishment if, but only if it lasts more than 12 months.”
Suppose a client has an opportunity for a project in Canada but is unsure of its long-term plans for operations in Canada and it does not want to jump right in and form a corporation or long-term branch in Canada which are clearly income taxable. This exception can work for a wide variety of companies for example U.S.: construction companies, engineering companies, architectural firms, which require minimal site visits, software companies which require on-site installation work, pipeline installers in petroleum and gas, film industry trailer companies, wind power turbine installers, some interior designers, shopping mall kiosk installers and even trade show booth set up firms which are hoping to do business across the border.
In order to take advantage of this cost savings opportunity, we recommend that the client should plan the project and write contracts in advance of doing things on the ground or creating any significant physical presence including subcontractors in Canada if at all possible. If negotiations of contracts can take place over the phone or in the U. S. client’s home country, this is a favorable fact pattern. Original design plans and samples should remain in the home country while initial design plans are hammered out. In order to take advantage of this exception clients need to keep the project under 12 months from start to finish, including all physical presence of employees, dependent agents and sub-contractors. A lease of a fixed place of business is sometimes sufficient to create a permanent establishment.
Regulation 105 and Waiver
Regulation 105 of the Income Tax Act requires every person (whether resident or not in Canada) who pays a non-resident person (individual , corporation, partnership, joint venture, hybrid entity like an LLC) a fee or payment for services rendered in Canada to deduct and withhold 15% of the gross proceeds and remit it to the Canada Revenue Agency (CRA). There is a procedure with the CRA which enables a client to seek advance clearance for its short term presence in Canada without creating the need for the normal required 15% of gross proceeds non-resident withholding tax to be deducted at source (by the payor) from any payments to the client. The contract should explicitly say “short term construction or installation project” to help with possibly obtaining a Regulation 105 waiver. Dates for the installation should specify a short term presence well under 12 months total. The facts need to comply with what actually happens as the physical presence should be expected to be checked and enforced by both border agents and the CRA. Honesty is the best policy and waivers granted for facts inconsistent with actual facts can be invalidated.
Construction or installation delays are not the CRA’s problem but they certainly can be the U.S. client’s problem. Any delays which causes greater than 12 months presence on other side of the border leads the presence to be income taxable in Canada and this would likely add significant cost, administrative and compliance burden, cash flow and timing issues to occur. Make employees and any subcontractors keep border crossing logs, airline tickets or receipts and proof that they have left the other Canada according to plan.
We recommend that U.S. clients hoping to utilize this exception should apply for a Regulation 105 Waiver well in advance of starting the project – at least 30 days in advance to allow for processing. The client should make attempts actually to receive the Regulation 105 waiver before any physical presence in the other country or at least before any payments are made to them otherwise 15% of gross proceeds withholding tax should be expected to be withheld by the payor. If the waiver is going to be denied it is often better for the client to know about this upfront so they can make informed decisions about whether to and how to proceed with the Canadian project or to adjust the pricing. Clients may actually decide that a local Canadian resident corporation is more conducive to developing business than operating from a distance through a foreign company.
AG TAX LLP Can Help
If you have any other tax-related queries, and/or need assistance with tax planning/filing please contact AG Tax. Our tax professionals are highly-experienced with U.S. and Canadian tax laws and can provide you the right guidance to handle your tax situation.
Aylett Grant Tax LLP is a full service accounting firm with a dedicated team of experts, who are highly-qualified and experienced in handling situations related to U.S., Canada and other international tax laws.
We can assist with:
- Canadian Personal and corporate tax returns
- Cross Border Taxation and Business Planning
- Personal and Corporate Taxation
- Disclosure of Foreign Assets and other information filings
- Retirement planning
- Estate Planning, Inheritance tax advice
To obtain a quote or to arrange for a consultation to discuss your tax related queries, please contact us at:
- 416-238-5920 (Greater Toronto Area, ON)
- 604-538-8735 (Greater Vancouver Area, BC)
- 780-702-2732 (Greater Edmonton Area, AB)
Disclaimer: The information in this publication is accurate as of the time of its publication. AG Tax assumes no responsibility for changes to tax legislation subsequent to the publication of this document. The information provided is for general information purposes only and should not be acted upon without seeking professional advice. If you would like to engage our services, please contact our staff and obtain authorization to send our firm confidential information. A client relationship is not created by the transmission of information. A client relationship is only formed with our firm when a scope and engagement letter signed by the firm and the potential client detailing the terms of engagement is present.
