Bringing Foreign-Based Consultants to Canada –
Avoiding Tax Disputes
CompassTAX - March 2005
With the global marketplace currently a viable source for professional services, it is becoming increasingly common to find foreign-based consultants wandering the halls of Canadian companies. Corporate lawyers will often draw up employment contracts for inbound foreign-based consultants, unfortunately with frequent omission of tax requirements. As a result, disputes and misunderstandings regarding tax withholding for these consultants are rampant.
If not informed by their Canadian employer, inbound foreign-based consultants are often shocked to discover that they are obligated to file an income tax return in Canada. This discontent can lead to the consultant’s surprise departure and the resultant loss of investment in that individual. A lawsuit would be quite probable. Either way, the company is still responsible for remitting the foreign-based consultant’s income tax to the Canada Revenue Agency (CRA).
The CRA Eyes the Earnings of Foreign-Based Consultants
Billions are currently being spent in North America on renewed border security, and this effort is being financed, in part, by substantial increases in tax revenues. There is recent evidence of an apparent new connection between the issuing of work permits by Citizenship and Immigration Canada, and heightened tax department scrutiny of inbound foreign-based consultants. Current tax legislation ensures the possibility of collecting tax on the earnings of foreign-based consultants rendering services in Canada, and there is every indication that this opportunity is now being maximized by the CRA.
The Need for Tax Clarity in Inbound Contracts
Faced with this possibility of increased tax liability and potential financial penalties, prudent Canadian companies are now making themselves aware of their corporate responsibilities regarding the hiring of inbound foreign-based consultants, and including their Canadian tax obligations. Doing so can save time, energy, and money, and allow for the preservation of international business relationships.
The best way to achieve this clarity is by way of an appendix to the consulting contract which lays out the tax responsibilities of both the Canadian corporation and the inbound foreign-based consultant. Not only does this specific division of tax obligations ensure compliance with Canadian tax laws; it also makes the consultant aware of business practices which might seem unusual compared to their home country, and avoids potential misunderstandings.
Canadian tax law regarding inbound foreign-based consultants is simply stated. According to Regulation 105 (“Reg 105”) of the Income Tax Act:
“Every person paying to a non-resident person a fee, commission or other amount in respect of services rendered in Canada, of any nature whatever, shall deduct or withhold 15 per cent of such payment.”
Regardless of whether the non-resident source of the services being rendered in Canada is an individual or a consulting company, Canadian corporations must withhold 15% from all payments made for those services. If Canadian companies fail to remit and report on this tax, they face significant monetary penalties. It is possible, however, for non-residents from countries with whom Canada has an established tax treaty, to apply for a waiver which would eliminate or reduce this tax withholding.
“Fee, Commission or Other Amount”
Reg 105 is not intended to be an imposed tax, but rather a payment on account of a potential Canadian income tax liability, which clearly rests with the payer for the services provided. Particular attention should be paid to the wording of Reg 105, which refers to any “fee, commission or other amount” paid to a non-resident. This highlights the fact that any payments made to non-residents should be reviewed as to compliance with Reg 105 withholding requirements. Certainly there is adequate incentive to do so.
“Services Rendered in Canada”
Reg 105 is also very emphatic about the range of non-resident services which should be taxed if rendered in Canada – all services, “of any nature whatever”. This means that there is no need to question whether a particular service qualifies for Reg 105 taxation. If a service is provided by a non-resident in Canada, then the recipient Canadian corporation must remit and report on taxes for those services.
Failure to comply with Reg 105 equates to significant monetary penalties. Delinquent Canadian corporations are subject to a penalty of 10% of the amount that should have been deducted, and 20% for all subsequent offences in the calendar year. The corporation may even be liable for the actual tax that should have been withheld, in addition to the penalty. If it were to come to this, the corporation would possibly have to approach the consultant for Canadian income tax due, a move which would undoubtedly strain the business relationship.
Waivers for Reg 105 Tax Withholding
Some foreign-based consultants may be able to obtain a waiver to reduce or eliminate Reg 105 tax withholding. Waivers are generally obtained under two premises – for reasons of a protective tax treaty between Canada and the country of residence, or income and expenses. An application must be made to the CRA for such a waiver, but the process is time-consuming and not guaranteed. The CRA has increased its scrutiny of payments to non-residents, and turnaround time for obtaining a waiver can be several months.
It is wise to start the waiver application process well in advance of the services being rendered in Canada, and since waivers are usually only granted for a one-year period, applications for extension should be made with ample time to avoid a lapse in the waiver.
Treaty-Based Reg 105 Waivers
Treaty-based waivers are only granted if the non-resident consultant can prove that he/she does not have a fixed base or permanent establishment in Canada. Determination of “fixed base” is ambiguous, taking into account whether the number of days worked in Canada over a seven-year period exceeds 240 days, and whether the living/working arrangements are perceived as permanent.
Lack of Fixed Base
The case of Dudney vs. the Queen highlights the scrutiny that can be placed on fixed base. In this case, it was determined that Dudney, an American consultant working temporarily in Canada, was not subject to Canadian income tax because his customer’s office where the work was being rendered could not be considered a fixed base in Canada for the purposes of the Canada-US tax treaty. The CRA had argued that “use of space” was sufficient to constitute fixed base; that it was not necessary to rent or own the office space. However the Federal Court of Appeal concluded that Dudney was not identified with the office space as he had no control over the premises.
Income and Expense-Based Reg 105 Waivers
If no tax treaty is in effect with the consultant’s country of residence, an application for a waiver based on income and expense can be made to reduce withholding. In some cases, the CRA accepts a Letter of Guarantee from a Canadian financial institution for an amount equal to the reduced withholding. This option has the benefit of preserving the consultant’s cash flow, and it is generally in the Canadian corporation’s best interest to consider the consultant’s perspective, given the potential for misunderstandings regarding Reg 105 withholdings.
Without adequate information at the contract stage, it is natural for there to be debate over non-resident tax between the corporation and its inbound assignees. In this scenario, the Canadian corporation does not want anything to do with non-resident tax withholding, believing it to be the foreign-based consultant’s personal issue, and the non-resident consultant is surprised to discover that he/she will be subject to tax and extensive reporting in Canada.
At CompassTAX™, we advise our clients employing foreign-based consultants that they include a tax appendix in all employment contracts. To this end, we provide a template which clearly lays out the tax responsibilities of both the Canadian corporation and the foreign-based consultant, and avoids any ambiguity that could affect the granting of a Waiver of Reg 105 tax withholding.
CompassTAX™ also offers a “Foreign-Based Workers in Canada Tax Flowchart”, published by CompassGUIDES™, which clarifies Reg 105 tax obligations for companies bringing in foreign talent to their Canadian projects. All combinations of employment type and home-country treaty scenarios are covered in the flowchart.
Contact us at 1-866-531-2281, (403) 531-2200 or www.compasstax.ca for assistance in dealing with this assignment issue and developing tax appendices to non-resident inbound employment contracts.