Every now and then a client with U.S. customers or U.S. sales agents will ask us if they are required to file a U.S. tax return. As a foreign corporation, the IRS requires you to file Form 1120-F if, during the tax year, your corporation:
- was engaged in a trade or business in the U.S.—regardless of whether or not you had U.S. source income from that trade or business, or whether or not the income from that trade or business is exempt from U.S. tax under a tax treaty (such as sales to U.S. customers, rental property, royalty, or licensing fees)
- had income, gains, or losses effectively connected with the conduct of a U.S. trade or business
- did not fully satisfy the tax liability of income from any U.S. source through tax withholding
- is claiming a refund for an overpayment of U.S. tax
- is claiming any U.S. tax deductions or credits
- is claiming that an income treaty overruled or modified any provision of the Internal Revenue Code with respect to income derived by your business
- had sales agents based in the U.S.
The good news is that any taxes paid in the U.S. can generally be claimed as a foreign tax credit on your Canadian return.
Exceptions from filing
Unless your corporation (or any of its branches) is a QDD (Qualified Derivative Dealer), you do not need to file Form 1120-F if any of the following apply:
- you did not engage in a U.S. trade or business during the year, and any required U.S. tax was withheld at source
- your U.S. source income is exempt from U.S. taxation under section 881(c) or (d) of the U.S. tax code
- you are beneficiary of an estate or trust engaged in a U.S. trade or business, but would otherwise not need to file
Doing business in vs with the U.S.
Doing business in the U.S. means your corporation is actively engaged in activities for the purpose of financial gain or profit from U.S. sources. Examples of these activities include maintaining a showroom in the U.S., advertising or hosting trade shows in the U.S., and making direct calls or sending printed or digital brochures to U.S. customers. If your company is doing business in the U.S., it is required to file both Federal and State tax returns, as your activities may deem you a permanent establishment in a particular State as well as federally.
Doing business with the U.S. means your corporation took no active steps in the U.S. to promote sales. Examples of doing business with the U.S. may include client referrals, or a call from a U.S. customer that results in an order placed online or over the phone. No U.S. filings are required if you are only doing business with the U.S. However, if the IRS disagrees with your position, it may result in a tax of 21% on U.S. sales and the loss of tax deductions or credits.
If you conduct limited activities in the U.S. that do not give rise to income subject to U.S. tax, you should still file Form 1120-F and attach Form 8833 to report the income exempted by treaty or code. This is considered a protective return, since if you don’t file a return, you will lose the right to take deductions and credits against effectively connected income (ECI). You may also be subject to significant penalties for failure to file, even if no tax is due.
U.S. tax compliance is not straightforward, and there are many additional factors that need to be considered. The U.S. tax experts at S+C Partners would be happy to speak with you about your U.S. tax reporting obligations.