Your Canadian corporation or business is subject to income tax in Canada because that’s where you are. Location is the basic requirement or connection for the tax authorities of a country or jurisdiction to impose a tax.
But what if you are a Canadian-based company with customers in the US? Or has other connections to the US? When do the US tax authorities say there’s sufficient connection to the US such that the IRS—the US Internal Revenue Service—can impose a tax on your business? US tax law has a test of “income effectively connected with the conduct of a US trade or business.”
What does that mean in English?
Any time you do business with someone in the US, you could be taxable. However, tax law has not caught up to the digital age, and the US follows a test of “permanent establishment.” Simply selling to US customers does not automatically cause those sales to be taxable in the US. Income earned in the US by a Canadian business can be taxed by the US only when the income is earned by or linked to a “permanent establishment.”
What’s that? A fixed place of business located in the US—an office, for example. A physical location where your business can be easily located or found. Warehouse storage, on its own, with no other location is not a permanent establishment.
What if you send an employee to the US to start a business or handle sales?
If there are no other connections, no permanent office place, AND if the employee does not have the authority to sign contracts for the business, the employee generally will not cause a permanent establishment.
There is a ‘catch’ for consulting-type businesses
If the employee performs services in the US for your US customers on the same project (or closely related projects) for more than half the time in any twelve months, that time—more than half the year, in essence—will create a permanent establishment for your business.
To recap—selling into the US or sending an employee to the US, absent an office or other place of business, will not cause the US to tax that income you earn from the US. However, longer-term consulting—where an employee with seniority accepts contracts for the business or a physical location/office/business place—will expose the earnings from the US to US tax.
You’re not double taxed if you do find you must pay US tax. Canada should grant a foreign tax credit, reducing the Canadian tax on business.
