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U.S. Source Income Run Through a Canadian Employee

Expert: Gena Katz

Dan asked:

I am a Canadian citizen living & working in the USA. I have an unregistered sole proprietorship company back in Canada. I have an employee that performs work for me back in Canada. I have the possibility to get some work here in the USA. Can I still run this work through my Canadian company and pay Canadian taxes?

Gena Katz answered:

An unincorporated business is not a separate entity from its owner for tax purposes. The owner is subject to tax on net business income. Generally the owner will be taxed in the country of residence, although the country in which the business profits were earned may also tax the business income.

Based on the question, I assume you are a U.S. resident for tax purposes.

As a U.S. tax resident, all income, including Canadian business profits from your unincorporated business are taxable in the U.S. Under Canadian tax law, business profits earned in Canada by a non-resident are also taxable in Canada. However, under a Canada-US treaty, Canada will not tax business profits of a US resident unless the business is being carried on through a "permanent establishment" in Canada. I don't have sufficient information to determine if your single employee in Canada would be sufficient for you to be considered to have a permanent establishment. If your Canadian employee has the authority to conclude contracts on your behalf, you would be considered to have a PE in Canada, but if the employee is just filling orders that you negotiate or performs administration services in Canada, this would not be a PE.

If a PE does exist your Canadian business profits are taxable in both the U.S. and Canada, but to avoid double taxation, the U.S. will allow you to claim a foreign tax credit in respect of the Canadian tax paid.

Now in response to the specific question, U.S. source business income "run through" a Canadian employee, would not be taxable in Canada but would certainly be taxable in the U.S. If you are subject to Canadian tax, to determine the Canadian profits you will just report the income earned in Canada and claim deductions for the related expenses, excluding the portion of the Canadian salary costs relating to the US work.

About the author

Gena Katz is a tax specialist with Ernst & Young's National Tax Group in Toronto.

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