Tuesday, May 5, 2015

2015 Budget: Source Deductions and Non-Resident Employers

If a non-resident employee performs duties of employment in Canada, the employer must deduct and remit source deductions made on account of income tax.  This is the case even if the employee’s salary is expected to be exempt from Canadian taxation by virtue of a tax treaty between Canada and the non-resident employee’s home country.  If the employment income is exempt from Canadian tax under a treaty, the employee pays tax on the income in the employee’s home jurisdiction but must file a tax return in Canada in order to claim a refund of the source deductions withheld from his or her paycheque.

This source deduction requirement applies whether the non-resident employee works in Canada for a foreign employer or a Canadian employer.

To avoid the source deduction requirement, the non-resident employee (not the employer) must apply to the Canada Revenue Agency (the CRA) for a waiver from the source deduction requirement.  If granted, the waiver applies on an employee-by-employee basis and applies for only a specific period of time.  This makes for an inefficient system.

In an attempt to address this administrative issue, the 2015 budget proposes a statutory exception to the normal source deduction requirement for salary paid by qualifying non-resident employers to qualifying non-resident employees.  The statutory exception will apply for salary paid after 2015.
A non-resident employee will qualify for the exemption from source deduction requirements if the employee
  • is exempt from Canadian income tax under a tax treaty between Canada and the home country of the employee; and
  • is not physically in Canada for more than 89 days in any 12-month period that includes the time of the salary payment.
A qualifying non-resident employer must be resident in a country with which Canada has a tax treaty. If the employer is a partnership, at least 90% of the partnership’s income for the fiscal period that includes the time of the salary payment must be allocated to persons that are resident in a treaty country.  In either case, the employer must not carry on business through a Canadian permanent establishment and must be certified by the CRA.
This new statutory exception will not cover all cases in which the employment income is likely to be exempt from Canadian income tax.  Most of Canada’s tax treaties provide an exemption for Canadian employment income earned by a non-resident if the employee is present in Canada for no more than 183 days.  As noted, the employee must be present in Canada for no more than 89 days in order to obtain the source deduction exemption.  As a result, at least some non-resident employees will still have to apply for the waiver.
The source deduction exception does not apply if the employer is resident in Canada.  This likely means that foreign employees on very short-term Canadian assignments (less than 90 days) will remain employed by a foreign employer.  Only foreign employees who are likely to be in Canada for 90 days or more will end up being seconded to a Canadian affiliate of the foreign employer.
Even if not required to make source deductions, a qualifying non-resident employer will continue to be responsible to file information slips with the CRA reporting all income paid to non-resident employees.