cpld: cross border tax considerations

GMM Delaware LLC

US and International Tax Services

Business across the Border Tax Considerations

Mark Mitchell, Enrolled Agent, MBA, MST

GMM Delaware LLC


ANY TAX ADVICE IN THIS PRESENTATION IS NOT INTENDED OR WRITTEN BY GMM DELAWARE LLC TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.

© GMM Delaware LLC 2010. All rights Reserved.

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How do you do business now?

Sole proprietorship

Corporation – Regular corporation

– CCPC (Canadian controlled private corporation)

Partnership

Trust

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What drives the current form of your business?

Limited liability

Complexity/simplicity

Customer expectations

Succession planning

Who you are in business with

Tax issues

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First rule of cross-border business

Don’t let tax drive your business structure!

Otherwise known as “don’t let the tax tail wag the dog”

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Forms of doing business in the United States

Sole proprietorship

Corporation

Partnership

Limited Liability Company

Trust

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Comparative maximum tax rates

Canada/BC Federal/WA Federal/CA

Sole Proprietorship 43% 35% 40%

Corporation 28% 34% 39%

Branch profits tax or dividend withholding tax

+5% +5%

Partnership No tax No tax No tax

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Second rule of cross-border business

Determine whether you are doing business IN the United States or doing business WITH the United States

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Are you doing business IN the United States?

Probably not doing business IN the United States if ONLY activity is: – Providing services to U.S. customers from Canada

– Making investments from outside the United States

– NOTE: selling widgets to U.S. customers from Canada could be doing business!

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What is “doing business”?

Low threshold

“Any personal service performed in the United States or any other activity within the United States that is regular, substantial, and continuous enough to constitute the conduct of a trade or business in the United States”

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What is “U.S. source income”?

Provision of services in the United States

Rents from U.S. property

Sale of inventory inside the United States

Ignoring investment income for now

Certain other income “effectively connected”

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Are you doing business IN the United States?

Are your activities sufficient to be a business?

Are your activities giving rise to U.S. source income?

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Third rule of cross-border business

Don’t let attempting to avoid a U.S. business drive your decisions

Think about the future, not just the present – marketing, expanding customer base, servicing your customers

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What is a permanent establishment?

Simple rule – No permanent establishment = no federal tax

Only it’s not so simple – Different rules for state taxes

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Two tests of permanent establishment

Fixed place of business – Office, branch, factory, workshop, construction site

– Note that a reserved space at a customer’s office can be a fixed place of business

Dependent agent – Someone who has the authority to negotiate contracts

– Who exercises that authority

– Who is not independent – say an employee

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Forth rule of cross-border business

If you believe that you have no U.S. permanent establishment, make sure you file a treaty-based return – $10,000 penalty for failure to comply

– No statute of limitations – the IRS can chase you for all back years

– May be taxed on gross income

Make sure you review your position each year – Is paying U.S. tax such a bad thing?

– Depends on what Canadian tax you’re paying, and what additional tax cost there would be to your business

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So you’re in the U.S. tax net!

Don’t panic yet

Need to determine what is the optimal structure – Minimize overall tax

– Maximize utilization of losses

– Keep things simple

– Allow flexibility for the future

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1. Branch Canadian taxpayer operates directly in the United States

Subject to same federal tax on U.S operations as U.S. person

U.S. tax paid will reduce Canadian tax dollar for dollar (up to amount of Canadian tax)

Losses from U.S. operations can be used in Canada

Can be difficult to determine profits/losses of branch, especially for deductions such as interest

Liability and other business issues

Canadian Corp

Canadian Individual

US Branch

US Branch

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2. Subsidiary Canadian taxpayer incorporates U.S. subsidiary

Taxed as U.S. person

U.S. tax paid do not reduce Canadian tax – but see later

Losses from U.S. operations cannot be used in Canada

May be easier to determine income and expenses of separate legal entry

Limited liability and other business issues

Canadian Corp

Canadian Individual

US Corp

US Corp

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Branch versus subsidiary

Branch Subsidiary Subject to same federal tax on U.S operations as U.S. person

Taxed as U.S. person

U.S. tax paid will reduce Canadian tax dollar for dollar (up to amount of Canadian tax)

U.S. tax paid do not reduce Canadian tax – but see later

Losses from U.S. operations can be used in Canada

Losses from U.S. operations cannot be used in Canada

Can be difficult to determine profits/losses of branch, especially for deductions such as interest

May be easier to determine income and expenses of separate legal entry

Liability and other business issues Limited liability and other business issues

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A couple of notes to remember

What’s an s-corporation? – “Like” a partnership for U.S. tax purposes

– No entity level federal tax

– Cannot be used by foreign shareholders

What’s an LLC? – Generally taxed as a partnership or “branch” for U.S. tax purposes

– No entity level tax

– Problems with Canadian tax

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Fifth rule of cross-border business

Don’t forget the tax on repatriation of profits! – US withholding tax or branch profits tax – 5%-15%

– Canadian tax on foreign income – 0%-43%

– If you’re leaving cash in the business, may be less of a concern

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Tax on repatriation to Canadian corporation

If using a branch structure, no tax on first C$500k, thereafter 5%

If using a U.S. corporation, 5% withholding, provided that Canadian corporation owns 10% of voting stock of U.S. corporation

Otherwise 15%

If U.S. corporation has “active business”, no Canadian tax on repatriated earnings (dividends)

If U.S. branch, likely no Canadian tax due to foreign tax credit

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Overall comparative maximum tax rates

Canada/BC Federal/WA Federal/CA

Sole Proprietorship 43% 35% 40%

U.S. Corporation 28.5% 34% 39%

Canadian corporation: Branch profits tax or dividend withholding tax

+5%

+5%

Individual Canadian investor

+14.5% +28% +26%

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Note on tax rates

United States has a lower rate for corporations with “small profits” – 15% to $50,000

– 25% on next $25,000

– 34% up to $10,000,000

– Benefit of lower rates is withdrawn

For individuals, maximum tax rates reached at significantly higher income than in Canada – 10%/15%/25%/28% to $104,625

– 33% to $186,825

– Add 0% to 9% for state income tax

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Sixth rule of cross-border business

Don’t forget about state tax – Each state has its own tax laws and collects its own taxes

– Localities within states have their own rules and may collect their own taxes

– No “harmonization” of state taxes – apart from multi-state tax compact rules

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State (and local) taxes

Income taxes

Franchise taxes (what’s that?)

Capital taxes

Turnover taxes

Sales taxes

Use taxes

Property taxes

Excise taxes

…..and so it goes on!

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Income and Franchise Taxes

Based on taxable income – Modified form of federal taxable income

– Tax deductible for federal income tax purposes

Based on “apportioned income”, not on determination of profits realized in a state

Need to have “nexus” to be subject to state income tax

If using a branch or permanent establishment, foreign tax credit in Canada

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What is “nexus”?

“Minimum” connection with a state

Not the same as “permanent establishment”

Specific rules for income tax – Public Law 86-272 – solicitation rules

Case law applies for sales taxes – States are becoming very aggressive in this area

Can you avoid nexus?

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Sales and use taxes

Sales tax “similar” to provincial sales tax

Tax on end-user – not value-added tax

Sales tax is NOT a taxpayer’s liability – should be added to price and collected from customer

Exemption certificates are used to avoid application to businesses

Use tax is “self assessment” of tax where items brought into a state and used in business rather than being sold

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Turnover taxes

Washington Business and Occupation Tax

Hawaii General Excise Tax

Taxes based on gross income

Far wider application than sales taxes, but generally significantly lower rate

Since not income tax, no protection for “solicitation activities”

No foreign tax credit for Canadian tax purposes

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The rules again…

1. Don’t let tax drive your business structure!

2. Determine whether you are doing business IN the United States or doing business WITH the United States

3. Don’t try too hard to avoid having a U.S. business

4. If you believe that you have no U.S. permanent establishment, make sure you file a treaty-based return

5. Don’t forget the tax on repatriation of profits!

6. Don’t forget about state tax

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And finally... if you are working in the USA

As an employee

– Earning over $10,000 in a year from U.S. activities?

– Costs of your employment paid by a U.S. company or branch?

– Spending significant amounts of time in any State?

As a sole practitioner

– Do you have a U.S. permanent establishment?

– Do you have nexus in any state?

GMM Delaware LLC


Mark Mitchell

GMM Delaware LLC

303-1860 Robson Street, Vancouver BC V6G 3C1

Tel. 604-562-0733 Fax. 604-357-1172

Email [email protected]

Contact details

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