Double taxation can make cross‐border profits feel like a double‐edged sword. While many Canadian corporations pay tax in two countries without realizing it, there are ways to reduce this tax burden.
In this article, we will discuss how this happens and what can be done to cut the final tax bill. But if the numbers get too taxing, businesses should consult Lexpert-ranked corporate tax or cross-border lawyers.
What is double taxation?
Double taxation can occur when the same income is taxed twice by different countries (e.g., first by Canada, then by the US). This can result from dual citizenship or operating a business in two countries. Domestically, it can also happen when a taxpayer is taxed twice (e.g., corporate taxes plus estate taxes).
For Canadian corporations with sales or operations in the US, that often means a profit is taxed in the US by its Internal Revenue Service (IRS), and then again in Canada by the Canada Revenue Agency (CRA).
Double taxation in Canada and US
Applying both Canadian and US tax laws can result in double taxation for corporations, citizens and residents of either or both countries (e.g., dual citizens). Here’s how the tax laws work, resulting in double taxation:
- Canada’s residency-based tax: Canada imposes corporate and personal income tax on its residents, including Canadian subsidiaries of foreign entities, on income and capital gains earned worldwide
- residence and citizenship basis in US taxation: at the federal level, the IRS taxes non-US corporations for their “effectively connected income” (ECI), which is profit connected with a US trade or business; non-US corporations may also face separate state income taxes, as each state has its own tax rules
In other words, Canadian residents (including corporations) operating businesses in the US are taxed by both Canada and the US on their ECI.
This video below discusses the double tax treaty myth and other related topics:
If you’re a business owner caught up between two taxing countries, you can reach out to the best corporate tax lawyers in Canada as ranked by Lexpert for guidance.
Effectively connected income (ECI)
Canada-based corporations doing business in the US must understand the meaning of ECI and its tax implications. Three conditions must be met for income to be considered ECI:
- it must be earned by a non-resident alien or foreign entity (e.g., a Canadian corporation)
- the non-resident alien engages in a trade or business in the US
- The income is derived from active conduct of a US trade or business
When all these happen, the income by the Canadian-based corporation will be taxed in the US. If it is also taxed in Canada, then double taxation occurs.
What are the ways to prevent double taxation?
Whether you’re a dual citizen or own a Canadian business with operations in the US or another country, there are several ways to prevent profits from being taxed twice. These include:
- tax treaties or conventions
- tax credits and deductions
- legal tax avoidance
- corporate structuring
We will discuss these things below. For more information, consult a corporate tax lawyer or a cross-border lawyer in Canada.
Tax treaties
Generally, Canada’s tax conventions with foreign countries aim to prevent two situations: double taxation and tax evasion. These treaties define:
- who counts as a resident
- which taxes are covered
- how each country can tax business income and other items
They also set limits on when one country can tax a resident of the other, often tying business tax to income from a permanent establishment in that country.
A good starting point in learning about treaties is the consolidated Canada-US tax treaty, formally called the Canada-United States Convention with Respect to Taxes on Income and on Capital. Several countries also have a tax treaty with Canada but for this article, we will focus on the Canada-US tax treaty as an example.
Watch this video to learn more about how you can prevent double taxation if you’re a dual citizen of Canada and the US:
You can also consult the best cross border lawyers in Canada as ranked by Lexpert if you want to know more about tax treaties with other countries.
Below are some of the highlights of the Canada-US tax treaty:
Taxes based on permanent establishment
Under the Canada-US tax treaty, the permanent establishment of a corporation that is a resident of Canada will matter on which of the two countries will tax its business profits:
- if there’s a permanent establishment in the US: the business’s income is taxable in the US if income is derived from the permanent establishment, but only to the extent attributable to that establishment
- if there’s no permanent establishment in the US: the business’s income will only be taxable in Canada; as such, no federal taxes apply, even if the corporation sells products or services in the US
Reduction of withholding tax rates
The treaty also reduces withholding taxes on cross‐border payments to help prevent double taxation. Withholding taxes from interest, dividends, and royalties are often reduced if it’s paid by a resident of one country to the residents of another country.
For Canadian businesses with US operations, this matters when either:
- a US subsidiary pays dividends or interest back to a Canadian parent
- a Canadian company licenses intellectual property to a US affiliate and receives royalties from it
Tax credits and deductions
The Canada-US tax treaty provides several methods to prevent double taxation based on the perspective of the two countries. One method is to allow tax credits or deductions in one country when tax has already been paid in another country:
- the US shall allow tax credits to the following against their income taxes in the US, if it’s paid or accrued to Canada:
- US citizens and residents, including domestic corporations
- a US resident corporation, which owns at least 10 percent voting stock in another corporation in Canada and receives dividends from it
- the following shall be deducted from a person’s or a corporation’s tax payables in Canada:
- income tax paid or accrued to the US on the profits arising in the US
- as for individuals, any Social Security taxes paid to the US on its income (except for taxes relating to unemployment insurance benefits)
- dividends received by Canadian resident corporations out of the exempt surplus of a foreign affiliate, which is a resident of the US
- capital gains tax from the alienation of a property, if it would not be taxable in Canada, and if it’s paid to the US
Tax avoidance
Aside from properly using tax treaties, credits, and deductions, Canadian businesses operating in the US can use other legal methods to prevent double taxation. Also called tax avoidance, these can include the following:
- using the correct corporate structure: certain structures can result in double taxation; for example, a Canadian resident who directly owns a limited liability company (LLC) in the US may be taxed twice and unable to use tax credits
- choosing the right state in the US: Canadians should consider state-level taxes, as these vary, and some states may be more favourable than others.
Read next: Tax evasion vs. tax avoidance: How CRA draws the line
How can lawyers help Canadian corporations deal with double taxation?
Cross‐border lawyers and tax advisers help map where income is taxed, how treaties apply, and where does the CRA or the IRS step in when it comes to corporate taxes. If double taxation occurs, lawyers can also help resolve it up by designing legal solutions or using the Mutual Agreement Procedure under the Canada-US tax treaty, if applicable.
Double taxation: When in doubt, do not double up
Double taxation does not have to result in lost profits for Canadian corporations with cross-border operations. With the right structure and legal advice, the same income does not need to be taxed twice. The rules are complex, but the goal is simple: keep more of the after‐tax profit working inside the business. As such, early advice from a corporate tax lawyer can help identify and address issues before they reach the CRA, the IRS, or other tax authorities.
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