Doing business in Canada: tax compliance 101
For many US companies Canada can seem like another home market, with its largely similar culture, language and business environment. However, it’s important to pay attention to some key differences, especially when it comes to compliance with Canada’s patchwork of federal and provincial tax regimes.
The prospect of building a business in Canada is an enticing one for US firms, especially given the two countries’ proximity, cultural similarities and strong trade links. But, as similar as they may appear, there are distinct differences in accounting, tax, and legal requirements that need to be navigated carefully to maintain compliance – and avoid possible fines and interest charges.
One of the main potential pitfalls for US companies operating in Canada is the complexity of the tax system. The Canadian tax system is governed by federal and provincial/territorial laws, each with their own set of regulations and compliance requirements, for both sales tax and corporate income tax.
The first critical difference lies within Canada’s sales tax regime. Overseas businesses must register and understand the appropriate sales tax processes when operating within Canada, or risk facing financial losses, late payment penalties and interest charges.
One recent example saw a client company neglecting to register for sales tax for a number of years, and finding itself liable for the payment of the accumulated taxes it had failed to charge its own customers, as well as late payment fines – a substantial financial hit that should have been avoided.
Canada levies Goods and Services Tax (GST) at the federal level on most goods and services at a standard rate of 5%. On top of this, Canada’s provinces and territories also levy their own sales taxes at varying rates, and in a variety of ways, making things more complicated.
Sales tax reporting obligations and compliance procedures vary across Canada. Most businesses must file regular sales tax returns to the Canada Revenue Agency (CRA), reporting the total sales, sales tax collected, and eligible input tax credits. The frequency of reporting depends on the business's annual sales and remittance history. Simplified reporting options are available for small businesses.
The majority of Canada’s provinces and territories levy – known as the Harmonized Sales Tax (HST) – is a combination of federal and provincial sales taxes, which is levied on goods and services provided at the provincial level at a variety of rates. For example, the HST rate in Ontario is 13%, while in New Brunswick, Newfoundland, Nova Scotia, and Prince Edward Island it is 15%.
For these provinces, a single, combined GST/HST return is made to the CRA, showing all GST/HST collected, and all GST/HST paid in the participating provinces. Participating provinces do not require separate returns.
However, the provinces of British Columbia, Manitoba and Saskatchewan levy and separately administer a more traditional single-incidence retail sales and use tax (PST) on the provision (or use) of most goods and certain services in the provinces. The PST general rates are as follows: British Columbia 7%; Saskatchewan 6%; and Manitoba 7%. Separate returns for PST need to be made to the provincial tax authorities in these provinces.
A special case is the province of Quebec, where a value added tax called Quebec Sales Tax (QST) is levied on the provision of most goods and services in the province, as well as on certain imports. The QST rate is 9.975%, meaning the effective combined rate for companies selling in Quebec is 14.975%. Here, a combined QST¬–GST/HST return needs to be filed in French with a separate tax body, Revenu Québec. It is also now a requirement in Quebec for financial documentation, including invoices, to be in French by default.
Another potential pitfall is the variation in corporate tax treatment across Canada.
Canada levies a federal corporate income tax (CIT) at a general rate of 15%. In addition, provincial CIT is levied at rates varying from 8% to 16%, with the largest jurisdictions (Ontario, Québec and British Columbia) charging between 11.5% and 12% – meaning combined rates are most commonly 26.5% to 27%. In most provinces, companies can submit a single CIT return, which combines federal and provincial taxes to the CRA. However, in Alberta and Quebec, companies also need to submit CIT returns separately to the provincial tax authority.
US companies also need to be aware that they may be subject to both US and Canadian corporate taxes. The US has a worldwide tax system, meaning that US companies are generally taxed on their global income, regardless of where it is earned. Canada has a territorial tax system, which means that companies are taxed on their income derived from Canadian sources. This difference can lead to complications when determining tax obligations and may require careful planning to minimise tax liabilities.
Business structure is another key consideration. The choice of operating either as a branch or incorporating in Canada may have significant tax implications, specifically on CIT rates.
Overall, companies need to ensure that their accounting systems, and especially their Enterprise Resource Planning (ERP) system, are set up to properly calculate and charge the correct taxes to their customers, based on their province. Similarly, systems need to be set up properly to allocate purchase costs to the right tax account, so the appropriate amount of tax can be reclaimed, for example.
It is essential for US businesses to understand the nuances of Canadian accounting, tax, and legal systems – perhaps with professional help – before setting up shop. It's not as simple as extending US practices into the Canadian landscape. With proper preparation, sound advice, and appropriate compliance measures in place, US businesses can ensure a smooth transition into the Canadian market.
How can TMF Group help?
To learn more about how TMF Group can provide tailored accounting and tax compliance services for overseas companies doing business in Canada, please contact us today.