Canadian corporations doing business in the U.S. are viewed by the Internal Revenue Service (IRS) as ‘Foreign Persons’. The U.S. taxes Foreign Persons on income effectively connected with a U.S. trade or business activity as well as certain U.S.-sourced income not effectively connected with a U.S. trade or business activity (commonly known as FDAP or Fixed, Determinable, Annual or Periodic income). For further information on this subject, please refer to our companion article on our web-site entitled ‘Canadian CORPORATIONS doing business in the U.S.’. A corporation engaged in business in the U.S. has a federal filing obligation. Additionally, tax obligations may arise if the business is conducted through a permanent establishment (‘PE’) in the U.S.
Any foreign corporation carrying on business in the U.S. without a PE must file Form 1120-F (U.S. Income Tax Return of a Foreign Corporation) to report income connected with the U.S. trade or business activity. Canadian corporations without a PE can file a skinny-down version of Form 1120-F which entails completing only the information section. Canadian corporations are awarded this right by virtue of the Canada-U.S. Tax Treaty and Canadian corporations must complete Form 8833 (Treaty-Based Return Position Disclosure) should they wish to take advantage of this. Canadian corporations with a PE must file and complete the Form 1120-F in full which entails disclosing financial statement details and other data. The reporting requirements of Form 1120-F and supporting schedules, as well as IRS rules and regulations are fairly complex.
U.S. taxpayer identification
Forms 1120-F, and 8833 both require a U.S. taxpayer identification number in order for the IRS to process these tax filings. For corporations, the taxpayer identification number is the Employer Identification Number (EIN). To obtain an EIN a Canadian corporation must file Form SS-4 with the IRS. Obtaining an EIN can also be done by applying to the IRS on-line, by fax, mail or telephone. We recommend Canadian corporations apply for the EIN by telephone at 267-941-1099. If approved, the IRS will provide the EIN on that same phone call and it can be used immediately, with a hard copy to follow in the mail.
U.S. Corporate filing deadlines
Canadian corporations that maintain a PE (i.e. an office or place of business) in the United States must file Form 1120-F by the 15th day of the 3rd month after the end of its fiscal tax year. If this deadline is too pressing Form 7004 (Application for Automatic Extension of Time to File Certain Business Income Tax, Information, and Other Returns) may be filed by the 15th day of the 3rd month after the end of its tax year to request a 6-month extension (i.e. deadline extended to 15th day of 6th month post year-end).
Canadian corporations without a PE in the United States must file Form 1120-F (and Form 8833 if applicable) by the 15th day of the 6th month after the end of its tax year. Form 7004 has to be filed by the 15th day of the 6th month after the end of the tax year to request a 6-month file extension.
Form 1120-F must be filed in a timely, true, and accurate manner in order for a foreign corporation to be granted deductions and credits against its income. For these purposes, Form 1120-F is generally considered to be filed on time if it is no later than 18 months after the due date of the current year’s return. An exception may apply to foreign corporations that have yet to file Form 1120-F for the preceding tax year. These filing deadlines may be waived in limited situations based on the facts and circumstances where the foreign corporation establishes to the satisfaction of the Commissioner that they acted reasonably and in good faith in failing to file Form 1120-F.
Interest and Penalties
Interest is charged on taxes that are paid late even if an extension of time to file is granted. Interest is also charged on penalties imposed for failure to file, negligence, fraud, substantial valuation misstatements, substantial understatements of tax, and reportable transaction understatements from the original due date (including extensions) to the date of payment. A corporation that does not pay the tax when due may be penalized 1/12th of 1% of the unpaid tax for each month or part of a month the tax is not paid, up to a maximum of 25% of the unpaid tax. A Canadian corporation that does not file its tax return by the due date, including extensions, may be penalized 5% of the unpaid tax for each month or part of a month the return is late, up to a maximum of 25% of the unpaid tax. The minimum penalty for a return that is over 60 days late is the smaller of the tax due or $135. The penalty can be waived if the corporation can show that their failure to file on time was due to reasonable cause.
U.S. state income tax
A state has the right to impose any reasonable form of tax and to tax income of a Canadian corporation operating within the state as long as:
1. The entity has nexus (defined below).
2. Income is apportioned to the state.
Nexus is the minimum threshold of revenues at which a State is granted the right to impose a tax. The minimum threshold and other factors required for Nexus may differ from state to state, but generally some physical presence within the state is required. A Canadian corporation may still be subject to state taxation even in the absence of a permanent establishment because the Canada-U.S. tax treaty is a contract between the two governments at the federal level and not necessarily at the state level. In other words, not all states adopt the treaty and they are not required to do so. As such, each state must be considered separately when a foreign corporation is relying on the treaty for tax purposes.
A Canadian corporation carrying on business in a U.S. state must register with the state in which it carries on business. There may be a registration fee or other legal or administrative requirements. It’s also important to remember that each state has its own filing requirements and deadlines that may differ from the U.S. federal requirements and deadlines.
Canadians who own U.S. rental properties are essentially engaging in a trade or business in the U.S., and as such income generated from a rental property is reportable in the U.S. A common consideration is whether or not to own the rental property as an individual, or set up some other legal structure to own the property such as a Canadian corporation or trust. The decision has implications for both U.S. income tax, and U.S. Estate Tax. U.S. property rentals owned by a Canadian corporation would be taxed as a foreign corporation and Form 1120-F would need to be filed. Further the U.S. rental property is deemed to be a permanent establishment, and taxes would be calculated as outlined previously. For additional information on Canadian owing rental properties int he United States, see our article titled ‘Canadians with U.S. Rental Properties – Taxation of U.S. Rental Property Income‘
This article was written by Gary Schein, CPA, CGA, MBA