Tax Differences US & Canada | Payroll Taxes (2024)

April 24, 2024

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Business Tax Differences Between United States and Canada

The North American region offers exciting opportunities for businesses, but the tax landscape can be complex, especially when navigating the differences between the United States and Canada. Brandi Samuel, Windham Brannon’s International Tax Practice Co-Leader, recently talked with Paul Roberts and Glen MacMillan to delve into the key tax considerations for those venturing across the border, exploring income tax, sales tax, payroll and other crucial aspects.

Taxation Tale of Two Nations

Understanding the fundamental differences in taxation between the United States and Canada is the best place to begin your understanding of doing business with the two countries. For starters, the United States taxes individuals based on citizenship, while Canada taxes based on residency. This can present several challenges for the U.S. citizen living and working in Canada, or the Canadian national who has not established residency in the United States, while maintaining investments in Canada.

Corporate Tax Rates

From a corporate perspective, the United States has a flat 21 percent corporate tax rate, while Canada’s net corporate tax rate is 15 percent. While Canada’s corporate tax rate (after abatements for provincial taxes and general reductions) does vary across the different provinces and types of corporations, the rate begins at 38 percent and is adjusted to give provinces and territories the ability to impose their own corporate income tax. Due to the low corporate rates in both the U.S. and Canada, individual rates oftentimes exceed the corporate rate. Therefore, it is important for entrepreneurs and business investors to enter into each jurisdiction in the right corporate structure, according to Paul Roberts, a partner at Lipton LLP in Canada.

Entity Structures Differ

When it comes to entity structures, Canada, and the United States both offer a variety of business entity structures, from operating as a sole proprietor to partnerships to corporations. The entity most commonly used in the United States is a Limited Liability Company (LLC). The LLC is so unique to the United States because it is a transparent entity that can take on the form of different tax treatments depending on ownership and special tax elections. Understanding inbound structuring choices in the United States and Canada is crucial for businesses expanding north or coming south. One unique entity type in Canada that can be attractive to incoming U.S. investors is the Unlimited Liability Company (ULC). The ULC is a hybrid entity that is treated as a corporation in Canada but has the ability to be treated as a flow-through entity in the United States. In contrast, Canada disregards the U.S. LLCs as separate legal entities and treats the LLC as a corporation. This means that if a Canadian investor does business in the U.S. and Canada through a U.S. LLC, the Canadian investor would be able to flow-through the activity of that business to them individually; in Canada, however, the LLC would be taxed at the LLC-level. This structure presents some disadvantages against the use of foreign tax credits in Canada, as the LLC does not pay an income tax on its own.

Canadian Tax Considerations for American Companies

Per discussion with Glen MacMillan of Adams + Miles LLP, the top three tax considerations for American companies entering the Canadian market include income tax, sales tax, and payroll. Individuals may often assume that if they are doing business in Canada or driving revenue from Canada, they should pay income tax, therefore, they should register to do so. According to MacMillion, most companies during the early stages of cross-border activity may have salespeople in Canada, which generates minimal nexus in Canada. As the business begins to grow, they will need to consult with a Canadian tax advisor to determine if and how they are impacted from an income tax perspective and if there is a need to establish a subsidiary to do business in Canada. Therefore, companies may often have a sales tax nexus, but not an income tax nexus.

Other Key Tax Highlights

• Sales Tax:Canada’s Goods and Services Tax (GST) varies by province, while the United States utilizes state-specific sales taxes. Registering and collecting GST is crucial for businesses selling to consumers. U.S. consumers will get hit with GST if a product is being shipped to them from Canada. U.S. sales tax is governed at the state level, and there is no federal general sales tax that currently exists. Some states require registration based on physical presence or economic activity. Economic activity can include the volume of sales or transactions to their jurisdiction. There could also be additional tax required based on counties or cities in addition to the state-imposed sales tax.
• Payroll Tax: Canadian employers contribute to national pension plans and unemployment insurance, similar to the United States. Be sure to comply with payroll taxes and Canadian pension contributions after exceeding employee thresholds. Wages paid to a non-resident working in the United States by a U.S. or Canadian employer are subject to income tax, Social Security/Medicare tax and, in some cases, state taxes depending on the jurisdiction where the employee does work. There are certain exemptions for those on certain Visas, therefore it is important to consult with a tax advisor to make sure you are not overpaying, underpaying, or underreporting payroll taxes. U.S. companies should also note that establishing a Canadian entity might be unnecessary for just a few employees working and possibly living in Canada. An experienced advisor can help companies determine if structuring an entity is the most favorable option to accommodate any employees who are across the border.
• Tax Incentives:Canada and the United States incentivize green initiatives and offer accelerated depreciation for equipment. Charitable donation limitations exist in both the United States and Canada.
• Research & Development (R&D): Both countries offer generous R&D tax credits, however, Canada’s incentives in this area are generally less expansive than those offered in the United States.
• Estate Planning: Canada does not have an estate tax, but assets are deemed exposed at fair market value upon death, meaning taxpayers should consider inter-generational wealth transfer strategies like estate freezes to best plan for the future of their assets. The U.S. estate tax ranges from 18 to 40 percent and generally only applies to estates with assets over $13.61 million (as of 2024).
• Intellectual Property (IP): Generally, IP laws in Canada are complex to navigate, therefore, many businesses tend to keep IP out of Canada, opting instead to have their administrative and distribution operations in the country. Canada requires entities with over $1 million in revenue to file a disclosure form regarding their IP. It is important to also note that any U.S. trademark and patent registrations do not protect your IP in Canada, as those rights must be enforced under Canadian law. Therefore, entities should strongly consider how they protect any IP across country borders.
• Sale of Real Estate: Similar to the U.S. Foreign Investment in Real Property Tax Act (FIRPTA), Canada also imposes withholding taxes on sales of real estate by non-residents. The Canadian rate ranges from .02 to 5 percent of the sales price or assess value. Some provinces go as high as 20 to 25 percent. In the United States, the withholding rate is generally 15 percent, with some exceptions for reporting.
• Non-Resident Owned Housing: Beginning in January 2022, Canada began imposing a 1 percent annual rate at the federal level on the value of non-resident, non-Canadian-owned residential property considered to be vacant or underused. In the United States, while some states may impose this tax, it is not imposed at the federal level.

Conclusion

Understanding the tax intricacies of the United States and Canada is crucial for successful cross-border business ventures. Careful planning, consideration of entity structures, tax incentives and compliance obligations can pave the way for a successful cross-border expansion. For questions or more information, reach out to your advisor, or contact Brandi Samuel.