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Regulation 105 Squabbles: Fallout from the Trend to Inbound Workers

CompassPOINTS - January 2007

By Diana Matwichuk, Manager Assignment Planning Services

Consultants to Canada are often not aware of Canadian tax responsibilities, and neither are the companies they provide services to, particularly when they are foreign-based but in Canada temporarily rendering services. Given the record number of inbound workers to Canada in 2006, many in a consultant capacity, the Canada Revenue Agency (“CRA”) is sure to be hot on the trail of companies not complying with Regulation 105 withholding responsibilities for inbound consultants. Regrettably, naïveté is not an excuse with the CRA.

Any corporation doing business in Canada, whether Canadian or internationally-based, should evaluate their applicability to Regulation 105 withholding requirements, or those of the foreign consultants servicing them, and ensure compliance for inbound consultants brought to Canada to perform the work. In the absence of this approach, a potentially soured relationship can develop between the Canadian company and the foreign-based consultant, who was never informed that the CRA would be dipping into his paycheque.

Regulation 105 Withholding Requirements

According to Regulation 105, any time that fees, commissions or other amounts are paid to a non-resident for services rendered in Canada, a withholding of 15% of the amount paid must be made and remitted to the CRA.

This withholding is not the final tax payment, but rather a deposit against the ultimate tax liability. Non-resident workers in Canada must still file a Canadian tax return by April 30 of the year following that in which the services were rendered. Inbound consultants from “tax havens” do not often understand the need to file tax returns.

Regulation 105 withholdings must be made, regardless of whether the corporation paying for the services is a resident or non-resident corporation. Also, there is no restriction on the time span over which the services were rendered in Canada – even business trippers to Canada may be subject to non-resident withholding tax.

Waivers of Withholding Requirements

Certain tax treaties with Canada include provisions for the option to apply for reduced amounts of withholding from amounts earned by inbound consultants to Canada, and advance waiver applications must be submitted to the CRA.

Evaluation of applicability of Regulation 105 withholding requirements and eligibility for waivers or reduced withholdings, centre around residency and assignment classification issues. Canadian tax residency should be reviewed as standard practice for any assignment.

Dudney v. The Queen

A “famous” case in the world of Regulation 105 and fixed base is that of William A. Dudney v. The Queen, who was appealing an original decision by the Tax Court of Canada that had assessed tax on his Canadian income.

Mr. Dudney lived in Houston, Texas, and worked at PanCanadian Petroleum Limited in Calgary. He was contracted through a US company to conduct object-oriented technology training to computer personnel on PanCanadian premises, but during the course of the contract, he never had a fixed base there. His training sessions were delivered in conference rooms from which he was not permitted to make personal phonecalls, and his deskspace was repeatedly moved. Mr. Dudney maintained a home office in Houston, from which he continued to pick up voicemail messages, and his pay cheques were deposited in a Houston bank account.

In February 2000 the Federal Court of Appeals ruled that Mr. Dudney was actually exempt from Regulation 105 withholdings on the grounds that he had no fixed base while working in Canada as an engineering consultant. He therefore did not have to ultimately pay tax to Canada on his income on the filing of a tax return.

Hinkley v. Minister of National Revenue

Not so fortunate in Canadian tax decisions was Mr. Hinkley of Hinkley v. Minister of National Revenue, another classic case in expatriate taxation issues. Mr. Hinkley, a structural engineer resident in the UK, was employed by a Toronto-based company to work as a consultant at Canadair in Montreal. An office was regularly available to him at Canadair’s plant, he worked regular hours and was supervised by his superior.

The Canadian company, however, should have done its homework on his behalf prior to the commencement of the contract, and made appropriate arrangements with Canadair to ensure eligibility for a waiver of Regulation 105 withholdings. In the absence of such planning, it was ruled in October 1991 by the Tax Court, that Mr. Hinkley had been duly assessed with Regulation 105 taxation, as he had a fixed base regularly available to him during his Canadian contract. He was then required to file a tax return with Canada and pay tax to Canada on the income earned.

Wolf v. the Queen

The CRA seems to have had a bit of a field day with consultants to Canadair in the 1990’s. Mr. Wolf of Wolf v. the Queen was a mechanical engineer specializing in aerospace. Living in Florida among consultants, and engaged to be married, he was lured to Canadair in Montreal by the potential to earn a signifi cant “nest-egg” while working as a consultant through a Calgary-based contracting company to Canadair in Montreal.

Despite having no job security in this working arrangement, and working long hours, Mr. Wolf was actually caught in a workforce planning issue. The CRA deemed that his position was structured as an employee, not a consultant. His work was supervised and delegated, he was expected to interact with Canadair staff, stat holidays were paid even if he did not work them, and his overtime rate of pay was higher than indicated in his agreement. Further, he worked with tools belonging to Canadair.

Mr. Wolf had wanted to be considered an independent contractor to qualify under Article XIV of the Canada-United States Tax Convention Act. If he could have proved that he were, as a US resident working in Canada, an independent contractor with no fixed base in Canada, his income would only have been taxable by the US authorities, and the 15% Regulation 105 withholding which were taken from his paycheques would not have been applicable. Instead, based on this ruling, the taxation would have been duly assessed.

The message to assignment managers in this case is the lack of clarity in the assignment classification and assignment taxation, and the lack of communication of this to Mr. Wolf. The Calgary-based employer of Mr. Wolf, and Canadair, could have avoided this misunderstanding and the associated negative publicity through comprehensive upfront assignment planning.

Taxation and Accounting Protocol

We find that it is helpful in many assignments involving contracts to include a Taxation and Accounting Protocol, which identifies and assigns responsibility for all accounting and tax matters related to the assignment. This ensures that all parties are aware of and in agreement with tax and accounting arrangements, as they are distinctly identified as terms of the agreement that is being signed, and there is therefore no cause for miscommunication on these points. Determining the content for these documents is critical and we assist companies with this task.

In Summary

At CompassGUIDES, we aim to ensure that inbound assignments to Canada are free of nasty tax surprises. At the outset of an assignment, we conduct a Corporate Tax Review and International Assignment Planning Review which, among other important tax-related issues, include a review of business presence, assignment classification, withholding requirements, treaty evaluation and eligibility for Regulation 105 waivers.

Our assignment planning approach is comprehensive and includes a distinct focus on Canadian tax compliance, as the absence of tax squabbles and assignee anxiety over Canadian tax matters are indicators of a successful assignment.

You can contact at CompassGUIDES with assignment planning concerns at 403-531-2200 or via our CompassGUIDES International Assignment Planning Helpdesk.

 


Tel: (403) 531-2200 
Fax: (403) 263-1826


Web: www.compasstax.ca
Suite 600, 1333 8th Street SW
Calgary, Alberta Canada  T2R 1M6


Tel: (403) 531-2200 
Fax: (403) 263-1826


Web: www.compassguides.ca
Suite 600, 1333 8th Street SW
Calgary, Alberta Canada  T2R 1M6