A corporation that is not resident in Canada may still be subject to corporate income tax in Canada if it has income from carrying on business in Canada. Such tax is levied under Part I of the Income Tax Act (“the Act”) and if the corporation’s profits are attributable to a permanent establishment (“PE”) in a province, provincial income taxes may also apply.
However, there is also a secondary level of tax that may apply in such circumstances that is levied under Part XIV of the Act.
This tax is quite similar to the tax that the U.S. levies under section 884 of the IRC, and, in fact, that provision was likely largely modelled after Canada’s version, which was around long before the U.S. enacted such a tax.
In general terms, the purpose of a secondary level tax of this nature is to put a foreign corporation, which operates in Canada via a branch, in the same position as if it had formed a Canadian subsidiary corporation. Namely, tax would be paid on the profits under Part I of the Act, and, again under Part XIII when the after-tax profits were distributed as a dividend. In the case of the tax under Part XIV, it is effectively applied when the profits are no longer used in the business of the branch.
More specifically, and subject to the application of tax treaties, as discussed below, the tax under Part XIV for any year is equal to 25% of the profits from carrying on a business in Canada, net of tax payable under Part I and provincial income taxes.
To the extent that the profits remain in the business of the branch, this tax is deferred. This is achieved by allowing an “investment allowance” to be claimed at the end of each year, which is then added back to the calculation of the amount subject to Part XIV tax in the next year. In general terms, the “investment allowance” is the cost base of assets, net of certain liabilities, still used in the business of the branch.
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Most of Canada’s tax treaties provide for a reduced rate to be applied to the tax, which is generally consistent with the tax rate that applies to dividends paid by a Canadian corporation to a parent corporation resident in that treaty jurisdiction. However, even if a reduced rate is not explicitly provided in the relevant treaty, section 219.2 of the Act has the effect of reducing the rate from the statutory 25% to the rate for such dividends under the relevant treaty.
In addition, many treaties provide for a complete exemption from Part XIV tax until the cumulative after-tax profits exceed a certain amount (e.g. under Article X(6) of Canada’s tax treaty with the U.S., this exemption level is $500,000 CDN).
Furthermore, tax treaties will generally also limit the imposition of this tax to profits attributable to a PE in Canada. In this connection, an interesting situation can arise in connection with US resident entertainers who earn income from performing in Canada via a US C or S Corporation. Even though there may not be a PE in Canada, tax may be levied under Part I of the Act because of the special provisions in Article XVI of the US Treaty relating to Artistes and Athletes. However, Article X(6) would still preclude Canada from levying any tax under Part XIV in such situations in the absence of a PE.
ABOUT THE AUTHOR OF THIS ARTICLE
Michael I. Atlas, CPA,CA,CPA(ILL),TEP
Michael Atlas is one of the most prominent international tax experts in Canada. He advises accounting and law firms all across Canada, as well as select private clients (corporate and personal) worldwide. He can be reached by phone (416.860.9175) or email (matlas@TaxCA.com).
