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Amend Regulation 105 Imposing WHT on Non-Residents for Services Rendered in Canada

Canada

A Canadian income tax provision is hampering Canadian businesses and prompting US companies to reconsider business opportunities in Canada. One year ago, this statement referred to Section 116 of the Income Tax Act ("ITA") which, for years, was a major deterrent to US private equity and venture capital investors looking to acquire Canadian targets. In the March 2010 budget, following calls for reform, the Canadian federal government proposed legislative amendments which provided relief for Canadian and foreign companies alike. Following these amendments, subsection 105 of the Income Tax Regulations ("Regulation 105") finds itself at the forefront of income tax provisions in need of amendment. In short, Regulation 105 imposes a withholding tax on non-residents for services rendered in Canada. Taxand Canada examines the scope of Regulation 105, its onerous characteristics, and an alternative approach to the current system it imposes.

Regulation 105 - General Requirements
Regulation 105 imposes a withholding tax on non-residents for services rendered in Canada. The tax withheld by the person paying the fee is not a final tax but rather a form of deposit or forced prepayment. It ensures that the non-resident receiving payment for rendering services in Canada fulfils its Canadian income tax obligations. The non-resident's tax liability is only determined following the filing of its income tax return. All or part of the amount withheld may be refunded to the non-resident.

Scope of Regulation 105
Payers subject to Regulation 105 include individuals, corporations, trusts, partnerships and legal representatives, whether resident or non-resident of Canada. Also captured are payments made by third parties and tax-exempt parties. If the non-resident service provider elects to subcontract a portion of the work in Canada, the initial payment made to the non-resident is subject to the full withholding, regardless of whether the work is subcontracted to a resident contractor.

Canada Revenue Agency Waiver Process
Canada relinquishes its right to Regulation 105 withholding through the waiver process but not through income tax treaties. A non-resident may apply for a waiver [1] if it can show that the tax liability is less than the amount to be withheld. Despite the perceived benefits, this waiver process is cumbersome and therefore rarely utilised.

Main Issues
Regulation 105 imposes a duty on the payer to withhold, remit and report. These requirements frustrate Canadian businesses facing administrative responsibilities for another person's tax liability. A payer who fails to deduct and remit the amount is liable for the entire amount together with interest and penalties [2].

Non-resident service providers often raise their fees to offset the Canadian withholding tax. Higher fees lead to greater costs for Canadian businesses and hinder their ability to employ foreign skilled workers.

Advisory Panel
In December 2008, the Advisory Panel on Canada's System of International Taxation submitted a report which examined Regulation 105 as well as the US approach pertaining to services performed in the US by non-residents. Simplified procedures are in place in the US to facilitate the exemption of payments if the recipient is exempt from tax on that amount by reason of a tax treaty. The Panel concluded that Canada should "eliminate withholding tax requirements related to services performed and employment functions carried on in Canada where the non-resident certifies the income is exempt from Canadian tax because of a tax treaty".

The Panel proposed an alternative approach:

i) the recipient files a form with the payer claiming a reduced or zero rate of withholding tax and certifying the amount is exempt under a tax treaty
ii) the payer reviews the form and assesses whether the exemption is warranted
iii) the payer files the form and an information return with the CRA describing the transaction.


Taxand's Take


A certification system would shift the compliance burden at the withholding stage from the Canadian payer to the non-resident recipient. Fewer withholdings and waiver requests would reduce the administrative burden for both the payer and the CRA. Non-resident service providers would no longer need to gross-up their fees to offset the withholding tax in order to avoid delayed revenues and cash-flow problems. While replacing the current system for a certification system may cause a decline in amounts collected, it would reduce the over-withholding of tax that can occur under the current system.

To maximise Canada's access to foreign expertise and relieve Canadian businesses from costly and time consuming procedures, action must be taken to amend Regulation 105 and adopt a certification system. Until such time, businesses will continue to seek alternative ways of circumventing Regulation 105 requirements. For instance, non-residents may consider incorporating a Canadian subsidiary or arranging for the secondment of its employees to avoid withholding. However, the jurisprudence has shown that these arrangements are not without risk. As was the case with Section 116, the need for change is clear, the solution is simple and the benefits significantly outweigh the costs. The Section 116 amendments were unanimously praised by Canadians and non-residents alike. A similar response should be expected if revisions are made to Regulation 105.

Your Taxand contact for further queries is:
Pierre G. Alary
T. +1 613 786 0132
E. pierre.alary@gowlings.com

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[1] The CRA may waive or reduce the withholding pursuant to the Undue Hardship provisions of subsection 153(1.1) of the ITA.

[2] The penalty is equal to 10% of the amount not withheld or 20% if the payer knowingly failed to comply with the requirements.

Taxand's Take Author