What is regulation 105 withholding tax and what are the tax implications ?
A Regulation 105 withholding tax is a flat rate tax that must be withheld and remitted to Canada Revenue by a Canadian Corporation paying for services, fees, commissions or making other payments from a foreign entity who provides such services or work in Canada. Regulation 105 would only apply to products purchased from a foreign entity if there is a service (ie installation) included in the purchase prior to the completion of the transaction.
The purpose of withholding taxes is to ensure that the Canadian government gets its fair share of taxes on any income earned inside Canada. For corporations with a permanent establishment in Canada, this is usually not an issue, as the corporation can be tracked and taxed accordingly. However, corporations that have no footprint in Canada but generate income in Canada could escape taxation as they will have no easily traceable presence. To avoid this, Regulation 105 of the Income Tax Act insists that any Canadian resident corporation paying for services provided in Canada by a non-resident corporation must submit 15% of the gross receipts to Canada Revenue (CRA) by way of an annual Tslip and summary report submitted each February. For example, if a Canadian corporation pays $10,000 for services performed in Canada by a non-resident $1,500 would be remitted to CRA and $8,500 passed onto the non-resident supplier. (They may also be able to claim this as a foreign tax credit in their own jurisdiction, but this varies from jurisdiction to jurisdiction). The non-resident may then reclaim the amount by filing a Canadian tax return or as a credit against taxes in their own jurisdiction.
There are a number of remedies when dealing with Regulation 105 payments:
- Contracts with non-resident corporations should clearly differentiate the type of services being provided and where they are performed to restrict the withholding taxes to that income solely performed in Canada
- The non-resident corporation could set up a permanent establishment in Canada in which case it becomes a Canadian resident for tax purposes and Regulation 105 would not apply.
- The non-resident corporation can apply for a waiver from payment of the withholding taxes if they can demonstrate that the tax liability is less than the withholding. This may occur if the provisions in the tax treaty between the two countries or that the actual income less expenses earned by the non-resident results in a lower profit at which to apply the normal Canadian tax rates.
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