Most companies that send employees to the United States on short-term assignments or business trips have the “183-day rule” ingrained in their consciousness. Many of these companies believe that as long as their employees do not spend more than 183 days in the US each year, they have no US tax liability or tax filing requirements. However, under the new protocol to the Canada-US Treaty, which is generally effective from January 1, 2009, they might be mistaken.
Obtaining an Exemption under the Updated Treaty
Under US domestic law, a non-resident performing services in the US is subject to tax based on workdays unless all of the following criteria are met:
- They are an employee of a foreign corporation or office.
- They are temporarily present in the US for no more than 90 days during the tax year.
- They pay relating to their services does not exceed US $3,000.
Employment income is generally allocated according to the ratio of US workdays to total workdays in the year, with the standard number of total workdays being 240. For example, this means that a Canadian employee earning the equivalent of US $100,000 a year would be liable to US federal tax if they work for eight or more days in the US in a given tax year. Under the old provisions of the Canada-US tax treaty, short-term visits to the US could be exempted from tax if either of the following tests were met:
- The employee’s remuneration relating to their US services did not exceed $10,000, or
- The employee was in the US for no more than 183 days in the calendar year, and the related remuneration costs were not borne by a permanent establishment or fixed base that the employer had in that country.
The $10,000 limit test has not changed under the new protocol. However, the second exemption test has been revised so that employment income is now exempt from tax only if an individual spends no more than 183 days in the host country during any 12-month period beginning or ending in a given tax year. (For this purpose, even part of a day is generally counted as one day).
Imagine that a Canadian employee visits the US for three months, from September to November 2009. None of their costs are recharged to the US entity, therefore no US federal tax liability is created for the duration of their visit. The employee then makes a five month trip to the US from February to June 2010, and once again, no costs are recharged to the US entity. As a result of this second trip, however, a federal tax liability is created. That’s because during the 12-month period from September 1, 2009, to August 31, 2010, the employee has spent more than 183 days in the US, thereby creating a US federal tax liability in respect of both short-term trips.
In cases such as this, the administrative requirements to file a US tax return for both years and obtain an Individual Taxpayer Identification Number can be onerous. Even if the employee’s income is exempt by virtue of the treaty, they are still required to file a US tax return to formally claim the exemption.
In addition to the changes to the 183-day period, there is a change involving remuneration. The reference to a “permanent establishment of an employer” has been removed from the new version of the treaty, and the reference to remuneration being “paid by” has been added. Now, in order to claim exemption from US federal tax, the remuneration must not be paid by, or on behalf of, a personal resident in the US, and it must not be borne by a permanent establishment in the US. These conditions create a wider “catch-all” than in the previous version of the treaty.
Company Responsibilities
Company obligations to report income and withhold tax should be distinguished from the actual liability due on the employee. Just because there is no ultimate liability as a result of a treaty exemption does not mean that companies should not withhold tax, or at least complete some forms for payroll files. In the case of a Canadian employee on a short-term assignment in the US: If a treaty exemption is available, a specific form (#8233) should be completed and retained in the US payroll file to support the claim for exemption from withholding tax.
When a treaty exemption is not available, companies should withhold US federal tax and pay it over to the Internal Revenue Service (IRS). In such cases, it is likely that companies will also have state tax reporting and withholding obligations. (It is important to remember that not all US states follow the terms of the treaty. An employee who is exempt from federal tax under the Canada/US treaty can still incur a state tax liability – from the state of California, for example).
As well as the US tax withholding obligations, companies must remember that there is a continuing requirement to withhold and pay over to the Canada Revenue Agency the Canadian taxes on all of a resident individual’s employment income. In cases where US tax is also payable, however, it is possible to obtain a specific waiver from the Canada Revenue Agency; this confirms that the Canadian tax withholding can be reduced by the anticipated foreign tax credit amount to ease cash flow. However, because it can take several months for waiver requests to be processed, the employee could return from assignment before the request is even granted!
Another issue created by the new 183-day test is that a subsequent US visit can trigger a retrospective tax liability, as in the example just described, with the related tax withholding requirements for the company and potential penalties for failure to withhold and pay over the appropriate taxes. We are still awaiting guidance from the Canadian and US tax authorities regarding whether penalties will be applied in such circumstances.
Companies should also consider the issue of social security when dealing with short-term assignments and business trips. There is a separate social security agreement between Canada and the US, which states that if a Canadian employee is assigned by their home employer in Canada to work in the US for a period of no more than 60 months, they shall remain subject to social security in Canada only.
In order to support this arrangement, the employer should apply for a certificate of coverage from the Canada Revenue Agency that confirms their employee’s exemption from US social security. That said, the IRS has indicated that employers do not need to apply for such certificates if the employee spends no more than 183 days in the US in a calendar year.
Revisit Internal Procedures
Given the current business environment, in which corporate governance and reputational risk management are key, companies should review how they track employee business travel between Canada and the US. In our experience, companies have used a variety of effective methods, such as reviewing expense claims on a regular basis, getting reports from a central travel agency, or maintaining a separate visitor sign-in log for company employees that is reviewed on a regular basis. These are just a few of the options for companies to consider.
Companies should also note that the changes in the treaty provision coincide with an increased focus on payroll compliance by both the Canada Revenue Agency and the IRS, with business visitors being on the “hit list” of items to review.
Awareness of these issues is just the first step. The second is to implement solid processes to ensure that all compliance obligations are being met.
Conclusion
Over the years we have dealt with many unique situations and developed some simple and effective ways of dealing with the filing requirements.
If you have any questions about your particular situation please call Joe Truscott at 905 528 0234, Extension 224 or email Joe at [email protected].
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