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Canadian Tax for U.S. and International Businesses

Canadian Tax for U.S. and International Businesses

International companies face 3 types of Canadian tax when they do business in Canada.

  1. income tax and withholding tax
  2. sales tax (GST/HST/QST/PST)
  3. payroll taxes

 

Tax planning can often reduce Canadian taxes significantly. Use this guide as your roadmap to pay less tax in Canada as an international business.

 

A Cautionary Tale

The Deel Disaster
In 2020, a fast‑growing U.S. software start‑up wanted to save HR headaches. The founders hired ten Canadian engineers through Deel (a company that helps hire workers globally). Deel promised they would take care of all the payroll taxes but they were silent about any other taxes.

Three years later the Canada Revenue Agency (CRA), Canada’s version of the IRS, audited and said the start‑up had a Permanent Establishment (PE) because a salesperson in Toronto was signing contracts on the company’s behalf.

The Result: back taxes, interest, penalties totalling CA $1 million.

What they should have done:

  1. Ask “Do we have to pay tax in Canada?” – Upon hiring Canadians, they should looked into whether they would need to file and pay taxes in Canada. If a Canadian employee can close deals for you, the answer is probably yes.
  2. Find out how to pay less Canadian tax – They should have sought advice to find out if there is a better structure available where they could either pay less Canadian tax or avoid it altogether. For example, if someone in the U.S. has to review and sign off on all their sales, that could potentially avoid Canadian tax. Or if they set up a Canadian subsidiary, they could identify the limit their Canadian tax exposure.

 

Book a call with CoPilot Tax to see if your company has to pay Canadian tax.

 

1 Income Tax for International Businesses

1.1 When Do You Have to Pay Tax in Canada?

Generally, a business will have to file a tax return and potentially pay tax in Canada if they are ‘carrying on business in Canada‘.

There’s no clear definition on what carrying on business in Canada means. But generally, we can assume that making advertising and making sales to Canadians for your product and services may tilt the threshold to ‘carrying on a business in Canada’.

Canada has tax treaties with other countries including the U.S., most of Europe, most of Asia, etc. These tax treaties will override that basic rule and they usually say that a business in those countries will only pay tax in Canada to the extent they have permanent establishment (PE) in Canada.

If you’re from a treaty country, you do business in Canada, but you don’t have a PE in Canada, you may need to still file a ‘treaty-based return’ in Canada but you won’t have pay income tax in Canada.

Trigger Why It Matters Simple Example
Carrying on business in Canada (domestic rule) You will have to file a tax return in Canada. If your country does not have a tax treaty with Canada, you will also have to pay tax in Canada. Drop‑shipping Etsy prints to Toronto
Permanent Establishment (PE) – fixed place or dependent agent You will have to file a tax return and pay tax in Canada, even if your country has a tax treaty with Canada. Sales rep in Vancouver signs sales contracts on behalf of company

 

PE Explained

PE usually means one of two things. In the U.S., there is a third category. An international business that has a PE in Canada will have to pay tax in Canada.

  1. Fixed place – office or regular use of a coworking desk.
  2. Employee or contractor that concludes contracts – person in Canada can sign off on contracts (of any nature) on behalf of the U.S. company.
  3. Services PE (for U.S. businesses only)
    1. a) services provided by people who spend more than 183 days in any 12‑month period in Canada and more than > 50 % of revenue are from the services provided in Canada.
    2. b) services provided by people who spend more than 183 days in Canada in any 12-month period with the same project for customers that are in Canada

 

1.2 When Do You Have to File a Tax Return?

You must file a Canadian corporate return whenever you carry on business here, even if the final tax is $0.

  1. T2 Corporate Return – mandatory once business is carried on in Canada.
  2. Schedule 91 – must be included with your return for all non-Canadian corporations.
  3. Schedule 97 – include if you’re from a treaty country and rely on the treaty (i.e. no PE) to reduce your taxes (treaty‑based return).

 

A “treaty‑based return” is simply a T2 return, schedule 91, and Schedule 97 claiming that the treaty exempts your income (i.e. because you don’t have a PE).

 

1.3 Branch vs Subsidiary

When an international company carries on business and has a PE in Canada, they are considered to have a ‘branch’ in Canada.

The international company may instead set up a subsidiary in Canada. This is usually preferable because it can more accurately dictate the profits earned by the Canadian corporation. If an international company keeps a branch in Canada instead, then CRA (the tax authority) could argue that more profits were attributable to the PE. This is especially true if the Canadian employees are primarily providing back office support.

  • Branch – no incorporation needed. Pays regular corporate tax on income ‘attribute to PE’ plus Branch Profits Tax (BPT) on after‑tax profits repatriated.
  • Subsidiary – a new Canadian corporation. Pays Canadian corporate tax on its earnings; dividends face standard withholding.

 

1.4 Tax Rates and benefits

Foreign corporations do not get the many benefits Canadian corporations get. Instead of paying the 9–13 % small‑business corporate tax rate, the tax rate is usually between 25% to 29%.  Also, many of the generous R&D credits are significantly reduced for them.

 

2 Repatriating Profits

2.1 Withholding Basics

Once an international company does business in Canada, they may want to repatriate some of the Canadian profits.

How do they do that?

They could pay dividends on their shares of the Canadian subsidiary. They could pay interest if the parent lent the subsidiary money. They could pay royalties if the Canadian company is using the IP of the parent.

Whenever a Canadian subsidiary does pay any of those payments to its non-Canadian parent, there could be withholding tax. Withholding taxes a tax of the non-Canadian parent but the Canadian subsidiary has to pay it on their behalf.

Imagine the withholding tax is 25%, that means if they pay their parent a $100,000 dividend, they would give their parent $75,000 and pay $25,000 to the CRA.

The withholding rate is typically set at 25%. But if your country has a tax treaty with Canada, it can reduce the withholding tax on various types of payments. See the chart below.

Payment Type Base Rate Typical Treaty Rate
Dividends 25 % 5–15 %
Interest 25 % 0–10 %
Royalties 25 % 0–10 %

Each of these payment must be reported on an NR4 slip.

 

2.2 Management Fees

Management or “head‑office” fees can sometimes escape withholding tax when charged by the parent. Many tax treaties say that management fees are not subject to withholding tax. However, if the management services are performed in Canada, then there could be tax. The fee must be reasonable, must reflect real services (e.g., accounting, HR), and must be documented.

 

2.3 Transfer Pricing Rules

If you charge your Canadian subsidiary anything (interest, royalties, management fees) it must match arm’s‑length (regular market rate) pricing. CRA can re‑price and levy 10 % penalties.

 

2.4 Branch Profits Tax

2.1 to 2.2 generally applies to international companies with Canadian subsidiaries. For branches, Canada levies 25 % on after‑tax profits you wire home. Tax treaties often reduce this amount. For example, the Canada-U.S. treaty cuts this to 5 %.

 

3 Funding Your Canadian Subsidiary

Once you set up your Canadian subsidiary, international companies may want to give the subsidiary money to pay for its initial and ongoing expenses. There are many questions around this? Should they fund with equity (shares) or a loan? If they do a loan, should they charge interest? How much interest should they charge?

There are important concepts to know. Generally, a mix of debt and equity is preferable. To make sure your interest deduction is not capped, you make to make sure you also put equity into the Canadian subsidiary.

Debt vs Equity

Debt Equity
Cash outflow Interest payments (fixed or variable schedule). Dividends (only when declared).
Canadian tax deduction Interest is generally deductible if paid or payable within the year and not denied by thin-cap or EIFEL rules.

Because of thin cap rules, you should inject some equity as well.

 Dividends are not deductible.
Withholding tax (WHT) 25 % Part XIII on non-arm’s-length interest; treaty rates may drop to 0% – 20 %. 25 % Part XIII on dividends; treaty often 5% – 20%.
Return of capital Principal repayments are not subject to WHT but reduce debt balance. A paid-up-capital (PUC) return is WHT-free; amounts in excess of PUC are deemed dividends and attract WHT.
Balance-sheet optics Leverage increases; may breach covenants. Improves solvency ratios.

 

  • Paid‑Up Capital (PUC) – Cash you invest as share capital creates PUC. You can later return PUC to the parent tax‑free. If funding your subsidiary with equity, you want to make sure you are capitalizing your PUC.
  • Withholding Tax – Generally, interest has lower withholding tax than dividends. Also, dividends from a Canadian subsidiary might be tax-free depending on your country’s tax rules. That means you may not be able to get credit for withholding tax on dividends.
  • EIFEL – Large corporate groups face an EBITDA‑based cap on net interest (30 %).
  • Thin Cap – A limit to the deduction on interest that is based on the equity. Generally, you need a 1.5 : 1 debt-to-equity ratio to get the full interest deduction (but then EIFEL rules could still apply).

 

4 Other Income Tax Traps

4.1 Regulation 102 – Payroll Withholding on Wages

If a foreign employee (can include a director) comes to Canada to perform employment duties (i.e. board meetings), Canadian payroll taxes may need to be withheld.

There could be a waiver available.

 

4.2 Regulation 105 – 15 % Withholding on Services

If a non-Canadian comes to Canada to perform services, the Canadian payer must withhold 15% of their pay. This means they give the non-Canadian 85% of their pay and they give the CRA 15% of their pay.

The non-Canadian may have to then file a tax return to either pay the difference or get back the withholding.

Alternatively, the non-Canadian can apply for a waiver if they’re treaty‑exempt.

 

5 Sales Tax (GST/HST/QST/PST)

What is it?
Goods and Services Tax (GST) is a 5 % federal VAT tax on most goods and services. Some provinces combine GST and Provincial Sales Tax (PST) into a single Harmonized Sales Tax (HST) of 13–15 %. Quebec runs its own QST at 9.975 %.

Input Tax Credit (ITC): Businesses can recover GST/HST they paid on expenses by claiming ITCs on their return.

 

Normal Regime

A Canadian subsidiary and foreign company that carries on business in Canada would be subject to the regular GST/HST rules. A foreign company that does not carry on business in Canada but still sells to Canada has some more intricate rules under the simplified regime.

Generally, you must register once Canadian revenues exceed CA $30 000 in any 12‑month period.

If you don’t have a PE in Canada, you may need to post bond equal to half their estimated net tax when first registering. But there are some exceptions.

 

Simplified Regime for Non-Canadian company that does not carry on business in Canada

  1. Classification – This is called the simplified regime.
  2. Registration – Similar to the regular rules, you must register once Canadian revenues to non-GST/HST register customers exceed CA $30 000 in any 12‑month period.
  3. ‘Digital’ Sellers – Since 2021, any non‑Canadian seller of ‘digital’ products or services (it doesn’t mean digital related items but even remote services) must register and charge GST/HST to Canadian consumers, even with no PE and no inventory in Canada.

 

6 Payroll Taxes

Employee vs. Contractor
In Canada, the legal classification depends on the facts of the working relationship, not the title in the contract. CRA looks at factors such as control over work, ownership of tools, chance of profit, and risk of loss. If the arrangement is more like an employee relationship, the company must treat them as an employee for tax purposes, even if the agreement calls them a contractor.

Deductions
If the worker is deemed an employee, the employer must register for a Canadian payroll account and remit:

  • Income tax (federal and provincial)

  • CPP contributions (both employer and employee portions, unless in Québec where QPP applies)

  • Employment Insurance (EI) premiums (both employer and employee portions; in Québec, QPIP also applies)

Employers must issue a T4 slip annually.

Exceptions and Special Cases

  • Non-resident employers may be exempt from withholding if they qualify for the CRA’s non-resident employer certification (requires no permanent establishment in Canada and employee exemption under a tax treaty).

  • Independent contractors: No withholdings required if genuinely self-employed, but misclassification can lead to retroactive payroll liabilities, penalties, and interest.

  • Short-term assignments: Some deductions may not be required if covered by a treaty exemption and certification.

 

Stock Options
Issuing Canadian tax-compliant stock options can be tricky if you’re using a global EOR platform like Deel, as some do not support equity issuance directly in Canada. Options granted by a non-resident company to Canadian employees may trigger complex reporting (T4/T4A) and tax events. Structuring through a Canadian subsidiary or a compliant equity plan is often required for proper withholding and reporting.

 

7 Transfer Pricing for your Canadian Subsidary

When a foreign parent has a Canadian subsidiary, intercompany pricing must meet the arm’s-length principle. This means it must be charge a rate that is equivalent to what you would charge an unrelated company. Four common methods are:

1. Comparable Uncontrolled Price (CUP)
Uses prices charged in the open market for the same or similar product/service. Highly reliable if truly comparable transactions exist, but often hard to find.

2. Resale Price Method (RPM)
Starts with the resale price to third parties and subtracts an arm’s-length gross margin to determine the buy-in price from the parent. Works well for distribution businesses where functional comparability (assets, risks, functions) matters more than identical products.

3. Cost Plus Method (CPM)
Adds an arm’s-length markup to production or service costs. Often used for contract manufacturing or routine service centers. The key is selecting the right cost base and comparable markup.

4. Transactional Net Margin Method (TNMM)
Tests that the subsidiary earns a net margin consistent with comparable independent companies. Useful when product comparability is weak but functional comparability exists.

Practical tip: Choose the method that best matches the subsidiary’s functions, assets, and risks, ensure contemporaneous documentation, and refresh comparables annually to stay compliant.

8 Framework to Assess Your Canadian Tax Exposure

  1. MAP your Canadian touch‑points: sales, people, warehouses, etc.
  2. MEASURE each tax front: income tax, GST/HST/QST, payroll withholding.
  3. MITIGATE with treaty‑based returns, waivers, PE‑light structures, or incorporation. Seek advice from tax advisors.

Need help applying the framework? Contact CoPilot Tax today.