When a person (whether a corporation or natural individual) crosses a border to perform services, Canada and the US have detailed taxing rules, aimed at ensuring that the person entering the other country properly reports those activities. These rules often come with mandatory "withholding taxes" on the payer of the services resident in the country where the services are being performed.
Canada has recently fine-tuned its position on Regulation 105 withholding, which may come as a surprise to many involved in the cross-border provision of services.
The Regulation 105 Withholding Tax
Under paragraph 153(1)(g) of the Income Tax Act, and specifically Regulation 105 thereof, a 15% withholding tax applies to fees, commissions and other amounts payable to non-residents for services rendered in Canada. Specifically, the 15% withholding tax must be deducted by the Canadian payer from the amounts payable to the non-resident and the non-resident is usually required to file Canadian income tax returns to get that tax back (and/or account for additional possible taxes owing).
Based on a 2007 Tax Court of Canada decision, clarifying that this rule only targets payments to non-residents having the "character of income" earned in Canada, the CRA took the position that the tax did not apply to reimbursements for non-residents' expenses – like fees for services and travel costs paid to hired subcontractors.
Now, the CRA says the tax does apply to subcontractor fees.
Example
A typical scenario illustrating the change is as follows:
- Canadian resident ACo enters into an agreement with non-resident BCo for the provision of services to be performed in Canada;
- Under the agreement, ACo agrees to reimburse BCo for all direct and indirect travel and meal costs;
- BCo subcontracts the services to be performed in Canada to its Canadian resident subsidiary CCo;
- After the services are rendered, CCo invoices BCo for its fees for services and travel/meal costs, all of which BCo pays; and
- BCo then includes in its invoices to ACo these same fees for services and travel/meal costs invoiced by CCo.
In the CRA's new position, published in a 2024 Document, Regulation 105 withholding IS applicable to the fees for services reimbursed by ACo to BCo, but not the travel/meal costs. Formerly, according to a 2009 CRA Document, Regulation 105 withholding would NOT have applied to either the travel/meal costs or the fees for services, provided that information about these reimbursements was properly documented.
This change will undoubtedly impact many cross-border service arrangements. Fortunately, the CRA has delayed the application of the new position to reimbursements for subcontractor fees made after September 30, 2024.
For now, those who rely on the old position should ensure they meet all of the documentary requirements in the 2009 CRA Document to avoid penalties and interest.
Takeaways
Canadian resident companies contracting for services with non-residents need to plan for their cross-border service arrangements. Without proper planning, CRA assessments for penalties on account of taxes not withheld can be an unpleasant surprise.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.