Section VII: Tax

1. Typical Organizational Structures

1.1 - Organizational Structures

A number of forms of organization could theoretically be used by a U.S. entity in establishing a Canadian business enterprise.

Of these, however, the three most commonly considered are:

Sales representatives based in Canada
Canadian branch of the U.S. entity
Canadian subsidiary corporation

While there are some similarities in the basic rules for the computation of income subject to taxation under these possible forms of organization, it is most common for a substantial business undertaking to be organized using a Canadian-incorporated subsidiary.

In some cases, a British Columbia, Alberta or Nova Scotia “unlimited liability company” might be chosen to achieve U.S. tax objectives. The decision will, of course, depend on the circumstances of each case and consultation with both Canadian and U.S. tax counsel is essential, particularly if the U.S. entity has a special U.S. tax status. The Canada–U.S. Tax Convention (Convention), however, contains rules that adversely affect the tax treatment of some structures involving unlimited liability companies.

If the U.S. entity is a “limited liability company” or “LLC” not treated as a corporation for U.S. tax purposes, there have been special problems with entitlement to benefits under the Convention, so it is sometimes not desirable for such an LLC to hold an investment in Canada or carry on activities in Canada. The Convention contains relieving provisions that should allow qualifying U.S. resident members of an LLC to obtain treaty benefits on a “look-through” basis in some cases, but there are still issues where an LLC is the shareholder of an unlimited liability company.

1.2 - Limitation on benefits of treaty

The Convention includes “Limitation on Benefits” rules. To qualify for benefits under the Convention, a U.S. entity must be both a resident of the U.S. for purposes of the Convention, and also be a qualifying person or otherwise entitled to the particular benefits under the Limitation on Benefits rules.

1.3 - Sales representatives based in Canada

1.3.1 - Are entities with representatives exempt from tax if activities are limited?

It is possible for a U.S. entity to extend the scope of its business to Canada without becoming subject to Canadian tax on its business profits if the types of activities carried on in Canada are sufficiently limited.

Under the Canadian Income Tax Act (ITA) every non-resident person, as defined by the ITA, who carries on a business in Canada is required to file a Canadian tax return and to pay an income tax computed in accordance with the ITA on the taxable income earned in Canada by such non-resident person for the year.

However, the provisions of the ITA relating to income tax on Canadian source business profits (but not the requirement to file a Canadian return) are overridden, in the case of a U.S. enterprise qualifying for benefits under the Convention, by Article VII of the Convention, which provides as follows:

“The business profits of a resident of a Contracting State shall be taxable only in that State unless the resident carries on business in the other Contracting State through a permanent establishment situated therein. If the resident carries on, or has carried on, business as aforesaid, the business profits of the resident may be taxed in the other State but only so much of them as is attributable to that permanent establishment.”

1.3.2 - How is a “permanent establishment” defined? Does an office or a sales agent create this status? What about a storage facility?

The term “permanent establishment” is defined in Article V of the Convention to mean a “fixed place of business through which the business of a resident of a Contracting State is wholly or partly carried on,” and there is also a concept of a deemed permanent establishment that can result from performing services in Canada.

The Convention goes on to specifically include the following in the definition of permanent establishment: any place of management, a branch, an office, a factory, a workshop and a mine, an oil or gas well, a quarry or any other place of extraction of natural resources or the presence in Canada of a non-independent agent who has and habitually exercises the authority to contractually bind the non-resident corporation. The Convention then goes on to specifically exclude the following from the definition of “permanent establishment”:

Facilities for the purpose of storage, display or delivery of goods or merchandise belonging to the resident (i.e., the U.S. entity)
The maintenance of a stock of goods or merchandise belonging to the resident for the purposes of storage, display or delivery
The maintenance of a stock of goods or merchandise belonging to the resident for the purpose of processing by another person
A purchase of goods or merchandise, or the collection of information, for the resident
Advertising, the supply of information, scientific research or similar activities which have a preparatory or auxiliary character, for the resident

Therefore, a U.S. entity will not have a permanent establishment in Canada by reason only of having sales representatives in Canada to offer products for sale, provided that these agents (i) do not have the authority to conclude contracts on behalf of the U.S. entity or (ii) are independent and acting in the ordinary course of their business.

If the U.S. entity contemplates establishing a fixed centre for its Canadian operations, care should be taken to ensure that the centre is not a permanent establishment. For example, it could be limited to functioning as a warehouse for the storage of goods awaiting delivery or processing, or as a display area. Any significant presence the U.S. entity will have at a Canadian location needs to be reviewed to determine whether it amounts to a permanent establishment. A building site or construction or installation project is a permanent establishment if, but only if, it lasts more than 12 months. The provision of other types of services in Canada for 183 days or more in any 12-month period may result in a permanent establishment. If the U.S. entity has a permanent establishment in Canada, it will be subject to Canadian tax on business profits attributable to the permanent establishment.

1.4 - Canadian branch

If it is undesirable for the U.S. entity to restrict its Canadian business in the manner described above to avoid having a permanent establishment in Canada, an alternative would be to establish and operate a Canadian branch out of office premises situated in Canada.

1.4.1 - Advantage of a branch operation

One advantage to the use of a branch operation would normally arise when it is anticipated that the branch will incur substantial losses in the first several years of operation. In this case, organization through a branch might enable such losses to be included in the consolidated tax return of the U.S. entity or its parent corporation and deducted against income from other sources. In general, a branch may be useful where a “flow-through” structure is desirable from the U.S. tax perspective.

An alternative would be to consider incorporation of a Canadian entity that might be treated as a branch for U.S. tax purposes, such as a British Columbia, Alberta or Nova Scotia unlimited liability company. The use of such entities, however, may be adversely affected in some cases as a result of “anti-hybrid” rules in the Convention.

If a Canadian subsidiary is used, for Canadian tax purposes, non-capital losses can be carried forward within the Canadian corporation for a maximum of 20 taxation years and used as a deduction in computing taxable income during that time.

1.4.2 - What are the disadvantages? How would a branch be taxed as between the U.S. and Canada?

It is clear that if a U.S. enterprise were to establish a branch office in Canada, it would have a “permanent establishment” within the meaning of the Convention, and would be required, pursuant to the ITA, the Convention and Canadian provincial tax legislation, to pay Canadian income tax on taxable income earned in Canada, which is attributable to the branch. Any employee resident in Canada and, subject to certain exemptions in the Convention, branch employees not resident in Canada, would be required to pay Canadian income tax, and the U.S. enterprise would be required to deduct and remit to the Receiver General amounts from the wages and salaries of such persons.

Despite potential tax savings, our experience has been that there are, in some cases, a number of practical difficulties with a branch operation. The most important has been the problem of preparing financial statements for the branch, which determine its income earned in Canada in a manner satisfactory to both the Canada Revenue Agency (CRA) and the U.S. Internal Revenue Service.

Particularly difficult is the allocation of head office charges, executive compensation and other common costs. In addition, in a branch situation, the CRA may conduct an audit of the U.S. corporation’s books of account to satisfy itself as to Canadian-source income. The tax compliance obligations of a Canadian branch are sometimes more onerous than for a Canadian subsidiary in other respects. For example, if the branch disposes of capital assets used in the Canadian business, it must obtain a tax clearance certificate, and if it receives amounts of the type normally subject to non-resident tax withholding (such as service fees, rentals or royalties), the branch may need to apply for a waiver of withholding.

Finally, Canada imposes a branch tax on the after-tax income of the branch operation of a U.S. corporation, subject to a lifetime exemption, which the U.S. corporation may qualify for under the Convention for the first C$500,000 of Canadian income. The branch tax rate under the ITA is 25%, but this rate is reduced under the Convention to 5% for qualifying U.S. residents. The branch tax is effectively the equivalent of the 5% non-resident withholding tax which would be applicable under the Convention if the U.S. corporation carried on business in Canada through a subsidiary corporation and the subsidiary repatriated its retained earnings to the parent by means of a dividend.

1.4.3 - If a branch turns profitable, how can it become a subsidiary corporation?

It would be possible, if a branch were initially used, to transfer the Canadian business to a subsidiary corporation after it becomes profitable. There are, however, several difficulties in accomplishing this result and, in particular, there may be U.S. tax consequences. In addition, the complexity of a sale of assets, assignment of contracts and transfer of employees to a new corporation after a significant business has been established may be considerable.

A non-resident may transfer real property, interests in real property and most other assets used in the business of a Canadian branch to a Canadian corporation, as part of the incorporation of the branch, on a Canadian income tax deferred basis. However, the transfer by a U.S. entity to a Canadian corporation of real property or interests in real property not used in the business of a Canadian branch would have to take place at fair market value, giving rise to a potential recapture of capital cost allowance (i.e., depreciation) and/or capital gain.

In summary, therefore, unless there are important U.S. tax reasons to the contrary, it may be advisable to organize the Canadian business through a subsidiary corporation. We note again that the choice of organizational form depends on individual circumstances and that consultation with U.S. and Canadian tax counsel is advised.

1.5 - Canadian subsidiary corporation

If the Canadian business enterprise is carried on through a corporation incorporated in Canada (including a British Columbia, Alberta or Nova Scotia unlimited liability company), the corporation will be a “resident” within the meaning of the ITA and will be required to pay Canadian income tax on its worldwide income each taxation year. Canadian provincial income taxes will also apply. Where dividends are paid by the subsidiary corporation to a qualifying U.S. resident parent corporation that owns 10% or more of the voting stock, the Canadian withholding tax rate applicable to the dividends under the Convention is 5% (except in some cases where the subsidiary corporation is an unlimited liability company). The following comments address several of the most important provisions of the ITA, which would apply to the new corporation.

2. Income Computation

The computation of income from business for Canadian tax purposes starts with a computation of the profit from the business. A number of rules must then be applied to adjust the profit computation to arrive at taxable income. The main provisions in this regard are set out below.

2.1 - How is depreciable property amortized?

2.1.1 - Capital cost allowance

The ITA’s system for amortizing the cost of depreciable property is known as capital cost allowance. All tangible and intangible depreciable assets must be included in one of the classes prescribed by Regulation. Each class is given a maximum rate, which may or may not be based on the useful life of the assets in the class. The rate for a class is applied to the total capital cost of the assets in that class to calculate the maximum deduction that may be claimed in each year. The actual deduction taken in a year may be any amount that is equal to or less than the maximum deduction available. The capital cost of a class is reduced by the amount of the actual deduction taken with respect to that class each year. Therefore, unused deductions are effectively carried forward as they do not reduce the capital cost of the class. There are also provisions as to the recapture of capital cost allowance from the disposition of capital assets that have been depreciated for tax purposes below their realizable value.

2.2 - Licensing fees, royalties, dividends and interest

2.2.1 - Transfer pricing rules for related corporations

Particular scrutiny is normally given by the CRA to licensing fees, royalties, interest, management charges and other amounts of a like nature paid to non-residents with whom the Canadian taxpayer does not deal at arm’s length. For this purpose, if a U.S. entity controls a Canadian company, either by owning a majority of the voting shares or by having sufficient direct or indirect influence to result in control, the two entities will be considered not to deal at arm’s length. The tax authorities’ first concern will be to determine whether the amount paid by the Canadian corporation should be allowed as a deduction in computing income.

Canadian transfer pricing rules require that, for tax purposes, non-arm’s-length parties conduct their transactions under terms and conditions that would have prevailed if the parties had been dealing at arm’s length. The rules also require contemporaneous documentation of such transactions to provide the CRA with the relevant information supporting the transfer prices. The rules provide that taxpayers may be liable to pay penalties where the transfer pricing adjustments under the rules exceed a certain threshold and the taxpayer did not make reasonable efforts (including contemporaneous documentation) to use appropriate transfer prices.

2.2.2 - What are the withholding tax rules?

Under the Convention, the Canadian entity must withhold 10% of some “royalties” paid to U.S. residents. The Convention provides exemptions from withholding tax on “royalties” paid to qualifying U.S. residents which are payments for the use of or the right to use (i) computer software or (ii) any patent or any information concerning industrial, commercial or scientific experience (but not including information provided in connection with a rental or franchise agreement).

Reasonable management fees for services rendered outside Canada are not subject to withholding tax as the CRA regards these as business profits of the U.S. entity and therefore not taxable under Article VII of the Convention. The CRA will allow a management fee to include a mark-up over the U.S. entity’s costs only in limited circumstances.

Under the Convention, the rate of withholding tax on dividends is 15%, although a lower rate of 5% applies if the shareholder is a qualifying U.S. resident company that owns 10% or more of the voting stock (except in some cases where the payer is an unlimited liability company).

There is no Canadian withholding tax on arm’s-length (unrelated party) interest payments, other than certain types of participating interest. Withholding tax on interest paid by a Canadian resident to a related U.S. resident qualifying for the benefits of the Convention is eliminated by the Convention (except in some cases where the payer is an unlimited liability company).

2.3 - What are limits on deducting interest and finance expenses?

A statutory thin capitalization provision limits the amount of interest-bearing debts that may be owed by a Canadian corporation to certain non-resident creditors. The limit is set by requiring the Canadian company to have a debt-to-equity ratio of not more than 1.5:1 where debt and equity have particular definitions. In making the necessary calculation, equity includes the paid-up capital of shares of the Canadian corporation owned by non-resident shareholders described below as well as retained earnings and other surplus accounts.

Debt includes only interest-bearing debt held by non-resident shareholders who, alone or together with affiliates, own shares of the capital stock of the corporation representing 25% or more by votes or fair market value of all shares of the corporation or their affiliates. There are special timing rules regarding when the different debt and equity elements are determined.

Not included as debt are amounts owed to residents of Canada or amounts owed to non-residents who are neither shareholders nor related to shareholders (unless they are part of a “back-to-back” arrangement, including whereby the non-resident shareholder or related party lends to a third party on the condition that it make an advance to the Canadian corporation). Also excluded from the definition of debt for this purpose are amounts loaned to the Canadian corporation by arm’s-length entities where the loans are guaranteed by a shareholder.

The sanction for exceeding the maximum ratio is that interest on the amount of debt in excess of the permitted limit is not allowed as a deduction in computing the Canadian corporation’s income. In addition, the excess interest is treated as a dividend for Canadian withholding tax purposes.

In addition, a complex new interest and finance expense deductibility regime known as “EIFEL” very generally limits the amount of any net interest and finance expenses that a Canadian corporation or Canadian branch of a non-resident taxpayer may deduct to no more than a fixed percentage of a corporation’s taxable income before interest expense, interest income, income taxes and depreciation. The EIFEL regime applies in addition to the existing thin capitalization, transfer pricing and other interest and finance expense deductibility rules in the ITA. Deductions for expenses denied under EIFEL can be claimed in other taxation years in certain circumstances.

2.4 - How can operating losses be used?

Operating losses from a particular source can be used by the taxpayer to offset income from other sources. In addition, if an operating loss is realized for a particular year, it may be carried back three taxation years and carried forward 20 taxation years as a deduction in computing taxable income of those other years. If the loss is not used within this statutory period, it expires and can no longer be used in computing taxable income. Special rules restrict the availability of these losses following an acquisition of control of the corporation.

2.5 - Capital gains and losses

Under current rules, one-half of any capital gain realized by a Canadian taxpayer (referred to as a “taxable capital gain”) is included in the taxpayer’s income and is subject to tax at normal rates. One-half of any capital loss may be deducted in computing income, but only against taxable capital gains.

Under proposed amendments to the capital gains regime, the one-half inclusion rate and one-half deduction rate will be adjusted to be two-thirds for corporations.

Capital losses, to the extent that they cannot be used as a deduction in the year in which they are incurred, may be carried back three years and carried forward indefinitely. Capital losses of a corporation are extinguished on an acquisition of control of that corporation.

2.6 - Should a single subsidiary be used when there are several lines of business?

Under the Canadian tax system, it is not possible under any circumstances for two or more corporations to file a consolidated tax return. As a result, the profits of one corporation in a related group cannot be offset by losses in another. It is generally desirable, therefore, unless there are compelling reasons to the contrary, to carry on as many businesses as possible within a single corporate entity. As well, non-residents establishing a corporate group in Canada should consider planning to minimize Canadian provincial income tax.

2.7 - How is income taxed among the different provinces?

The taxable income of a corporation with operations in more than one province is allocated for provincial income tax purposes among those provinces in which the corporation has a permanent establishment. The allocation is achieved by means of formulae that are generally based on the salaries and wages paid to employees associated with each permanent establishment and gross revenues attributable to each permanent establishment.

3. Rates of Taxation

Corporate income tax is levied in Canada by both the federal and provincial governments. The effective rate of federal tax is currently 15%, after taking into account a reduction in rate that partially offsets the impact of provincial taxation.

Provincial tax rates can vary substantially depending on the province and the type of income earned by the corporation. For example, the general rate imposed by the province of Ontario is currently 11.5%. In some cases, Canadian provincial income tax liabilities may be substantially reduced by inter-provincial tax planning appropriate to the proposed Canadian operations.

Several reductions in federal and provincial rates are possible depending on the circumstances of the particular case. The most substantial of these reductions relates to active business income earned in Canada by a small “Canadian controlled private corporation” (CCPC).

However, a corporation will not be a CCPC if it is “controlled, directly or indirectly, in any manner whatever, by one or more non-resident persons.”

Another tax reduction occurs if a corporation carries on a manufacturing or processing business, as it may be entitled to provincial tax reductions.

4. Other Income Tax Considerations

4.1 - Are tax credits available for research and development?

An “investment tax credit” against income tax otherwise payable is provided under the ITA in respect of certain expenditures on qualifying scientific research and experimental development carried out in Canada. An enhanced credit is available to CCPCs.

4.2 - How are distributions treated?

A corporation may generally return to a shareholder the shareholder’s investment in “paid-up capital” of the corporation (other than a public corporation) as a Canadian tax-free receipt. The ITA provides that all other distributions to shareholders of a corporation resident in Canada (including share redemptions and liquidating dividends) are treated as dividends to the extent that funds paid out of the company on a reorganization, share reduction or liquidation exceed the paid-up capital of the shares. Such distributions are treated as dividends regardless of the type of surplus or profits from which they are paid and regardless of whether the company has any undistributed income.

Dividends paid by a Canadian corporation to its non-resident shareholders are subject to withholding tax under the ITA. The withholding tax rate under the Convention is 5% for dividends paid to a qualifying U.S. resident corporation that owns 10% or more of the voting stock (except in some cases where the payer is an unlimited liability company). Stock dividends are equivalent to cash dividends and are generally valued at the related increase in the corporation’s paid-up capital.

The ITA contains other rules for dividends paid to Canadian residents that are beyond the scope of this Guide. Dividends between affiliated Canadian companies are tax-free in some cases.

4.3 - Loans to shareholders

A loan made by a corporation to any of its shareholders or to a person connected with such shareholders (other than a corporation resident in Canada) that is not repaid by the end of the taxation year following the year in which such loan was made is, with limited exceptions, (including a possible election out of this rule), considered to be income received in the hands of the shareholder.

More stringent rules apply to indebtedness of a non-resident to a Canadian affiliate arising under a “running account” between the two companies. Amounts deemed to be paid to non-resident shareholders as income are subject to non-resident withholding tax as though the amounts were dividends. There is, however, a refund of withholding tax to a non-resident if the debt is subsequently repaid, subject to certain limitations.

A loan that is not included in income as described above may give rise to imputed interest income for the Canadian corporation at prescribed rates and a taxable benefit in the hands of the shareholder or connected person (other than a corporation resident in Canada) if the rate of interest paid on the loan is less than the market rate applicable at the time of the loan. Some loans that rely on a special exception from the shareholder loan rules will result in imputed interest income for the Canadian corporation at higher prescribed rates.

5. Capital and Payroll Taxes

Employers are generally required to make contributions on behalf of their Canadian employees to the Canada or Quebec Pension Plan and to the federal Employment Insurance plan. Certain provinces also impose employer health taxes or premiums. Contributions to provincial Workers’ Compensation Boards are also obligatory for most businesses.

6. Commodity Tax and Customs Tariffs

6.1 - Federal sales and excise tax

The federal Goods and Services Tax (GST) is a form of value-added tax that applies to most goods and services at the rate of five per cent. Unlike income tax, the GST is a tax on consumption rather than profits.

6.1.1 - How is the GST collected?

Generally speaking, each registered supplier of taxable goods and services collects the applicable tax from its purchasers at the time of sale. The supplier must collect the GST as agent for the government, while the purchaser is legally responsible for the payment of the tax. Suppliers deduct from their collections any GST they have paid on their own purchases (called “input tax credits”) and remit the difference to the federal government. If the supplier paid more tax than was collected, the supplier is entitled to a refund of the difference. The result is that the tax is imposed on the value added to the product at each stage of production and distribution, and the final consumer ultimately bears the full amount of the tax.

Currently, five provinces (Ontario, Prince Edward Island, New Brunswick, Nova Scotia, and Newfoundland and Labrador) have harmonized their individual provincial sales tax bases with that of the GST. The combined tax is called the Harmonized Sales Tax (HST), imposed at rates ranging from 13 to 15 per cent; therefore, most of the discussion that follows applies equally to the HST. Quebec has also largely harmonized its provincial sales tax base with that of the GST; however, unlike the HST provinces, the Quebec Sales Tax (QST) is imposed pursuant to a separate Quebec statute at the rate of 9.975 per cent.

6.1.2 - Who is exempt from registration requirements?

Generally speaking, most persons who carry on business in Canada must register to collect and remit GST. By way of exception, small suppliers with sales of less than C$30,000 per year are generally not required to register for GST purposes and cannot claim input tax credits. In determining whether this threshold has been met, sales of associated corporations are included.

Non-residents who in Canada solicit orders or offer for sale prescribed goods (such as books, newspapers or magazines) to be sent to persons in Canada by mail or courier are deemed to carry on business in Canada. Accordingly, they must register to collect and remit GST on their sales. Additionally, non-residents who make certain supplies of goods or services directly to consumers in Canada may have a requirement to register.

Non-residents who do not have a registration requirement are generally permitted to voluntarily register to collect and remit tax if, among other activities, they regularly solicit orders for the supply of goods for delivery in Canada (with some exceptions for certain non-residents engaged in various e-commerce activities in Canada). Non-residents may wish to register in such cases to obtain input tax credits in respect of GST paid on purchases in Canada.

6.1.3 - Zero-rated supplies

Certain supplies, defined as “zero-rated supplies,” are effectively tax-free supplies and taxed at a zero rate. These supplies include basic groceries, prescription drugs, most medical devices and, generally speaking, goods which are sold for export. Services of an agent on behalf of a non-resident are also tax-free in some cases as are legal and consulting services supplied to assist a non-resident in taking up residence or setting up a business in Canada. Suppliers of tax-free goods and services do not charge tax on their sales, but are entitled to input tax credits for the GST paid on purchases used in supplying taxable and tax-free goods.

6.1.4 - Exempt supplies

The legislation also provides for a class of goods known as “exempt supplies.” No tax is charged on exempt supplies. However, unlike zero-rated supplies, suppliers of exempt goods and services do not receive input tax credits for the GST paid on their purchases to the extent they are used in making the exempt supplies. Examples of exempt supplies include resales of residential property, long-term residential leases, many health and dental services, educational services, domestic financial services, daycare services and most supplies made by charities.

6.1.5 - GST on imports

GST is generally exigible on imported commercial goods based upon their duty paid value (HST is exigible on imported non-commercial goods). GST/HST is generally not exigible on imported services and intangible property (such as patents and trademarks), provided they are used exclusively in taxable commercial activities of the purchaser. Purchasers must self-assess GST/HST on imported services and intangible property if such services and property are not used exclusively in taxable activities. It should be noted that, although customs duties on U.S.-origin and Mexico-origin goods have been eliminated under CUSMA/USMCA, GST must still be paid on U.S. or Mexican goods imported into Canada.

6.1.6 - Special rules for non-residents

To encourage non-residents to do business in Canada, the legislation provides relief from the GST in connection with certain transactions.

6.1.6.1 - What if goods are imported by the non-resident and delivered in Canada?

A non-resident who sells goods to a Canadian customer on a “delivered” basis and also acts as importer of record will be required to pay GST on the importation of the goods, separate and apart from the GST/HST that the non-resident may need to collect from the Canadian customer on the sale of the goods. Where the non-resident is not a GST registrant, the non-resident will not be able to obtain an input tax credit (i.e., refund) of the GST it paid on the importation of goods. In effect, the GST legislation would increase the non-resident supplier’s costs and the price to the Canadian customer would include GST.

This is contrary to the intent of the GST legislation. As a result, the Canadian customer is permitted to claim an input tax credit in respect of the GST paid at the border by the unregistered non-resident supplier, where the customer obtains proof of payment of the GST from the non-resident. Therefore, its customer will reimburse the non-resident for the GST paid at the border, and the customer will claim the GST input tax credit as if the goods were purchased from a Canadian supplier. This levels the playing field between Canadian customers who deal with non-resident suppliers and those who deal with Canadian suppliers. This is referred to as the “flow-through” mechanism.

6.1.6.2 - Will the non-resident have to collect GST from its customer?

A second relieving provision is referred to as the “non-resident override rule.” This rule generally applies to a supply of personal property or a service in Canada made by a non-registered non-resident, and deems it to be made outside Canada and therefore beyond the scope of the GST. This provision applies where the non-resident supplier does not carry on business in Canada and is not registered for GST purposes. The “non-resident override rule” relieves the non-resident from any obligation to register and charge and collect GST on supplies that otherwise would be considered to be made in Canada. However, the Canadian customer may be required to self-assess GST on such supplies, in certain circumstances. Effective as of July 1, 2021, the non-resident override rule does not apply to certain non-residents engaged in various e-commerce activities in Canada, who are subject to registration, collection and remittance obligations.

6.1.6.3 - What if goods are sold by a non-resident, but sourced from and delivered by a resident third party?

A third relieving provision is referred to as the “drop shipment” rule. In general, this rule applies where an unregistered non-resident sells goods to a Canadian customer, sources those goods (or certain services in respect of those goods) from a Canadian supplier, and arranges for delivery of the goods by the Canadian supplier directly to the Canadian customer. In these circumstances, the Canadian supplier must collect GST from the non-resident seller on the non-resident seller’s re-sale price to its Canadian customer. The drop shipment rule applies to deem the sale by the Canadian supplier to the non-resident re-seller to be made outside Canada and therefore not subject to GST, where the non-resident’s customer is registered for GST purposes and provides a “drop shipment certificate” to the Canadian supplier. The drop shipment rule is also available in certain cases where multiple intermediary purchasers are involved in the supply chain, or where the goods will be exported out of Canada.

6.1.6.4 - What if the goods are sold by a GST registered non-resident in a sale made outside Canada?

Where the non-resident supplier of goods delivers the goods or makes them available outside Canada, no GST/HST is payable on the goods sold. In such a case, the non-resident should avoid also acting as the importer of record of the goods, as the non-resident will not be permitted to claim an input tax credit in respect of the GST paid at the border. There is an exception to this rule where the supplier and customer in Canada enter into an election to permit the non-resident to claim the credits, however, the non-resident will also be required to charge and collect the GST/HST on the invoice price of the goods sold to the customer.

6.1.6.5 - How do the GST rules apply to non-residents engaged in e-commerce activities in Canada?

As of July 1, 2021, the following businesses are subject to a new specified GST/HST regime, separate from the regular GST/HST regime, to register, collect and remit GST/HST with respect to the supplies they make or facilitate:

Non-residents who would otherwise be subject to the “non-resident override rule”, if they make supplies of intangible personal property or services to recipients whose usual place of residence is in Canada and who are not registered for GST/HST purposes, except where such supplies are made through a digital platform, as set out below;
Operators of digital platforms which facilitate the supplies described above; and
Operators of digital platforms which facilitate supplies of short-term (e.g., less than a month) residential accommodation by any supplier to a recipient, provided that both are not registered for GST/HST purposes.

Registrants under the new specified GST/HST registration regime are not considered to be GST/HST registrants under the regular regime. As such, they are not able to claim any input tax credits to recover any GST/HST paid on their business inputs. However, certain exemptions from GST/HST do apply with respect to their activities; for example, service fees charged by the platform operators to the non-resident suppliers in relation to the supplies that the non-resident suppliers make on the platform are not subject to GST/HST.

The new e-commerce rules also expand the regular GST/HST regime. Non-resident suppliers who would otherwise benefit from the “non-resident override rule” are now required to register, collect and remit GST/HST as a regular GST/HST registrant if they make taxable supplies of tangible personal property in Canada which is not sent by mail or courier from an address outside Canada to a recipient who is not registered for GST/HST purposes (other than a non-resident person who is not a consumer of the property). Examples of such supplies may include goods which are in a fulfilment warehouse in Canada at the time of sale. The operators of digital platforms are also required to collect and remit GST/HST with respect to such supplies they facilitate.

6.1.7 - Other federal excise taxes

In addition to GST, a limited range of goods is subject to excise duties or taxes at various rates based on the manufacturer’s selling price. Examples of items subject to the Excise Act, 2001 include certain types of alcohol and tobacco. Examples of items subject to the Excise Tax Act include certain insurance premiums, air conditioners for motor vehicles, certain fuel-inefficient passenger vehicles, certain gasoline and other petroleum products.

6.1.7.1 - Cannabis taxation

As part of federal legislative initiatives to legalize the recreational use of cannabis, the federal government introduced legislation to establish a framework for the taxation of cannabis. The legislation, which received royal assent on June 21, 2018, imposes excise duties on cannabis pursuant to the Excise Act, 2001. Similar recent amendments also impose excise duties on vape products. The rules include a new tax licensing regime for cannabis producers, stamping and marking rules, ongoing reporting requirements, and applicable excise duties payable by licensed cannabis producers on both recreational and medical cannabis products.

6.1.7.2 - Fuel charge

On June 21, 2018, the federal government passed a legislation to administer and enforce minimum standards in a fuel charge and an output-based carbon pricing system. The standards are scheduled to become more stringent each year, and any additional province or territory which does not meet the standard will become subject to its fuel charge and carbon pricing regime.

The fuel charge is administered by the Canada Revenue Agency. Currently, the fuel charge applies to distributors, importers and various types of users (including commercial carriers) of fossil fuels and combustible waste in Saskatchewan, Manitoba, Ontario, Alberta, Yukon and Nunavut. A comprehensive mandatory and voluntary registration, reporting, payment and enforcement regime governs the fuel charge system per each applicable fossil fuel. Depending on the type and the manner in which a business uses various fossil fuels, the business may be subject to multiple registration, reporting and payment obligations. Exemption from payment obligation is available for certain qualifying uses for farming or fishing, or where the fossil fuel is not burned or flared and is not used to produce heat. The fuel charge was set at C$20 per metric tonne of carbon dioxide equivalent from April 2019 to March 2020 and increased by C$10 per year to C$50 from April 2022 to March 2023.

The output-based carbon pricing system is administered by Environment and Climate Change Canada. The output-based carbon pricing system applies to large industrial emitters in select provinces. See Section XIV, “Environmental Law.”

6.2 - Provincial sales and commodity taxes

6.2.1 - When does provincial sales tax apply?

As set out above, five provinces (Ontario, Prince Edward Island, New Brunswick, Nova Scotia, and Newfoundland and Labrador) have harmonized their individual provincial sales tax bases with that of the GST, and the combined tax is called the Harmonized Sales Tax or HST, imposed at rates ranging from 13 to 15 per cent. Alberta does not charge any provincial sales tax.

Quebec has also largely harmonized its provincial sales tax base with that of the GST; however, unlike the HST provinces, the Quebec Sales Tax or QST is imposed pursuant to a separate Quebec statute at the rate of 9.975 per cent.

Additionally, Quebec has implemented a new mandatory specified QST registration system for non-resident suppliers. Non-resident suppliers who are not registered for GST/HST purposes must be registered under the new QST system if they supply intangible personal property and services to Quebec consumers of over C$30,000 a year. Non-Quebec-resident suppliers who are registered for GST/HST purposes must be registered under the new QST system if they supply intangible personal property, services or tangible personal property to Quebec consumers of over C$30,000 a year. Supplies of intangible personal property or services made by these types of suppliers through a digital platform are accounted for by the operator of the digital platform, who must also be registered under the new QST system if the supplies made to Quebec consumers through the platform by such suppliers exceed C$30,000 a year.

Effective as of July 1, 2021, Quebec has amended and harmonized its existing rules for non-resident suppliers to the new federal GST/HST measures for e-commerce businesses. For the non-resident businesses and platform operators who are now required to register under the regular GST/HST and QST rules, Revenu Quebec announced that it will offer a simplified registration process by relieving them of the obligation to provide certain prescribed information already provided to the CRA.

Currently, only Manitoba, Saskatchewan and British Columbia continue to impose a sales tax at the provincial level. The following discussion provides general comments on provincial sales taxation in the referenced provinces. However, each province’s legislation should be referred to for specific issues.

As a general rule, the provincial sales tax is levied on the purchaser of most tangible personal property purchased for consumption or use in the province or imported into the province, including most computer software. Certain services are also subject to this tax. Generally, the tax is based on the sale price of the taxable goods or services being sold at the retail level, calculated on the purchase price excluding the federal GST (and the GST is calculated on an amount excluding all provincial sales taxes).

The relevant provincial sales tax statutes generally provide that the vendor of the taxable goods or services is required to act as the agent for the provincial government in collecting the sales tax. In some cases, a non-resident vendor without a physical presence in the province is nevertheless required to register for purposes of the tax, including in connection with e-commerce and marketplace facilitator businesses.

Various goods are exempt from the provincial sales tax, including certain foods, drugs and medicines, motor and heating fuels, certain production machinery and equipment, custom computer software, many items used in farming and fishing, and items to be shipped directly out of the province.

6.2.2 - Which goods are subject to provincial commodity taxes?

Various provinces impose taxes on specific goods such as gasoline, fuel, and tobacco. These taxes are usually imposed as a specific tax (cents per litre or cents per cigarette) rather than on an ad valorem (i.e., a percentage) basis. Certain provinces have enacted specific statutes to impose taxes on certain services such as accommodation, admissions, insurance premiums, gambling, etc. As well, land transfer taxes are imposed on transfers of land. See Section XII, “Real Estate.” In addition, the provinces also impose property taxes on landowners.

6.3 - Customs tariffs

6.3.1 - What are the treaties governing tariffs?

Canada is a member of the World Trade Organization (WTO). In accordance with the WTO, it grants most favoured nation tariff status to other WTO members. Goods are classified in Canada’s List of Tariff Provisions according to the Harmonized Commodity Description and Coding System Convention, which Canada adopted in the late 1980s See Section IV, “Trade and Investment Regulation.”