In order to comply with FACTA (Fair and Accurate Credit Transactions Act), Canadian corporations are increasingly being asked to complete form W8-BEN-E by their US customers. Failure to fill out the form at your customers request could lead to up to a 30% withholding tax on payment for goods and services. The W8-BEN-E form is used to determine if any withholding taxes are required on payments; basically, your US customers are asking you to complete the W8-BEN-E so they can determine the proper tax treatment for the payment you are receiving. The idea behind the withholding tax is to ensure that foreign entities are paying their share of taxes in the US.
For example, let’s assume that a US company uses the services of a software engineer located in Russia. Upon completion of the project the software engineer will charge the US company for work completed. If the invoice is for $100, a percentage of that may be withheld by the US vendor and remitted to the IRS. The withholding tax provides a monetary incentive to the Russian company to file a US tax return reporting their US sourced income and potentially recover, either a portion, or all of the payments withheld. This example provides a general outline of the rules, the following will dig a little bit deeper into the technical rules.
For private Canadian corporations, providing goods and services to US corporations we rely on the Canada-US Tax Treaty to determine where the income should be taxed. From a Canadian tax perspective, Article VII of the treaty, business profits, goes on to state that business profits of a Canadian resident corporation should only be taxable in Canada unless it carries on business in the United States through a permanent establishment. If the corporation has a permanent establishment in the United States, the business profits directly attributable to that foreign permanent establishment can be taxed in the United States.
A permanent establishment defined in Article V of the Canada-US Tax Treaty includes:
- A physical office located in the US.
- Travel of corporate executives to participate in marketing events, sign agreements or perform other key duties.
- Presence of corporation’s employee or agent performing business duties in the US for 183 days or more in any 12-month period.
- Providing services with respect to the same project or connected projects for 183 days or more in any 12 month interval.
As a result, in the absence of a permanent establishment in the US, a Canadian resident corporation with US customers will only be taxes in Canada on their business profits. For most active Canadian resident corporations the Canada-US Tax Treaty will deem that no withholding taxes are required on payment. Under these circumstances Canadian corporations would typically indicate that they are NFFE (Non-Financial Foreign Entity), earning more than half of their income from active business operations and therefore not subject to foreign withholdings. Once complete, the W8-BEN-E can be signed and sent to your US customer confirming that payment can be made in full without the requirement of withholding taxes.
Please note that specific rules apply on the shipment of products to the US and this article serves to provide only a general outline and therefore you may want to seek a professional opinion.