CHAPTER 08 Tax Considerations
Although withholding tax is imposed on the non-resident recipient, the resident payer is required to deduct the tax and remit it to the CRA on behalf of the non-resident, failing which the resident payer becomes liable for the tax. The CRA expects – although this is not required by law – Canadian payers to obtain Forms NR301, NR302 and/or NR303 (depending on the legal status of the non- resident payees) from non-residents in respect of which withholding tax rates are reduced by an applicable tax treaty. A non-resident carrying on business through a Canadian branch may be deemed to be a resident of Canada for purposes of the withholding tax rules. The effect of these rules is to make certain payments made by the non-resident to another non-resident subject to Canadian withholding tax. A 15% “backup” withholding obligation is also imposed on payments made to non-residents in respect of services performed in Canada. This backup withheld amount may be refunded or credited to the non-resident when it files a Canadian tax return. A similar 9% backup withholding obligation applies to payments made to a non-resident for services performed in Québec. Canadian Branch Versus Canadian Subsidiary In general, from the perspective of taxation of business income, there is little difference between carrying on business through a Canadian branch of a non-resident entity and carrying on business through a wholly owned Canadian subsidiary of a non-resident entity. However, most branch assets are typically “taxable Canadian property” whereas shares of a Canadian subsidiary may not be (depending on the subsidiary’s assets). Consequently, the sale of a subsidiary is much less likely to be subject to Canadian tax and the section 116 certificate requirements, discussed above, than the sale of a branch. As discussed below, the thin capitalization
rules also apply to a non-resident carrying on business in Canada through a Canadian branch. A non-resident branch performing services in Canada is also subject to the backup withholding discussed above. A Canadian incorporated subsidiary of a non-resident corporation is a Canadian resident for Canadian income tax purposes and is therefore subject to tax in Canada on its worldwide income. Certain types of payments (including dividends, rent and royalties) made by a subsidiary to its non-resident parent are subject to withholding tax, as discussed above. Similarly, Canadian tax will apply to the profits attributable to an unincorporated branch of a non- resident carrying on business in Canada. The allocation of items of income and expense between head office and the Canadian branch may be unclear and can result in ambiguity in the computation of branch income for purposes of the Tax Act. In addition, the Tax Act imposes a branch profits tax of 25% on the profits of a Canadian branch of a non-resident corporation not reinvested in Canada, subject to an applicable tax treaty. The branch profits tax is intended to replicate the dividend withholding tax that would be applicable in respect of a Canadian subsidiary. Hybrid Entities The corporate laws of Nova Scotia, Alberta and British Columbia permit the establishment of unlimited liability companies (ULCs). These entities are treated like regular Canadian resident corporations for Canadian tax purposes, but in the United States are eligible to be treated as flow-through entities for U.S. tax purposes. This dual or “hybrid” tax characterization can be a useful planning feature. However, as a result of specific provisions in the Canada-U.S. tax treaty, the use of a ULC by a U.S. resident must be carefully considered and may require additional steps or intermediate entities in order to be beneficial.
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