Similiar to the U.S. rules, Canada may tax personal services provided in Canada by U.S. persons who are not residents of Canada for income tax purposes. The provisions governing this are regulations 102, 105 and section 115 of the Income Tax Act (‘ITA”).
The Treaty-Employment Income
Article XV of the Canada/U.S. tax treaty may exempt from Canadian taxation, personal services that is employment income where the income is not more than $10,000 earned in the source country (ie., Canada) or more than $10,000 if the remuneration paid by the U.S. employer that does not have a permanent establishment in Canada and the individual is not present in Canada more than 183 days in the 12-month period ending in the calendar year. If the treaty does not apply, a Canadian tax return is filed under Section 115 of the Act to tax on a combined federal and provincial graduated tax rate on the income sourced to Canada.
The Treaty-Self-Employment Income
Article V of the treaty may exempt independent personal services (i.e., self-employment income) if the individual (i.e., the proprietor) does not carry on business in Canada through a permanent establishment (“PE”) situated therein.
Under the treaty, the taxation of independent personal services provided in Canada depends if the proprietor has a PE situated in Canada. If it were not for the “deemed PE” provision in Article V, paragraph 9, most unincorporated businesses of this nature would not generally have a PE in Canada. On a simplistic basis, if the individual is physically in Canada for more than 183 days in a 12-month period ending in the calendar year and more than 50% of the gross business revenues consist of income derived from services provided in Canada, then there is a deemed PE and therefore no treaty exemption.
Where the individual has a PE in Canada without considering this deeming service provision, the combined tax rate outlined earlier would apply. However, where the deeming provision is applicable, CRA has said that the otherwise provincial tax rate applicable to income in a tax bracket would not apply. This is because the definition of PE within the provinces would not apply. This makes sense in that the provinces like individual U.S. states generally and do not have to follow treaty provisions.
As the business income from independent personal services is not allocated to a PE, it is taxed as income not earned in a province with an additional federal surtax of 48% times the federal tax as opposed to the provincial marginal tax rate on that income.
For the self-employed individual, the savings on filing with an Ontario PE or without an Ontario PE depends on the tax bracket you are in. For example, using 2016 tax rates, there is a savings of about $953 with no Ontario PE on $50,000 of business income as opposed to a savings of only $35 on $100,000 of business income. The savings is greater at lower tax brackets. Note that the savings noted here take into CPP contributions that are payable on the business income if no exemption is claimed under the Canada/U.S. social security agreement.
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