There are special payroll challenges when directors of Canadian corporations are not Canadian residents. The large amount of direct foreign investment in Canada, either in wholly owned subsidiaries or as minority direct investment, means many foreigners sit on the boards of Canadian employers. Sometimes, membership on an employer’s board of directors is not a function of ownership, but expresses a Canadian employer’s interest in securing access to that director’s contacts or expertise. Whatever the reason, such appointments create special payroll challenges.
The close relationship between the US and Canadian economies also means that many of these non-residents are from the US. While some of the material covered in this article applies to residents of other countries covered by tax treaties with Canada, this article focuses on directors subject to the Canada-US tax treaty. Specifically, on the payroll challenges that relate to source deduction and reporting in Canada, for such non-resident directors. These payroll challenges can be grouped into three distinct areas:
- federal and provincial income tax;
- the Canada and Quebec Pension Plans; and
- Employment Insurance, including Quebec’s Parental Insurance Plan.
These topics cover more material than can be handled in an article of this size, so we will split them into two parts. First, we consider federal and provincial income tax withholding on behalf of the CRA. In the second part, we look at withholding for the other taxes above, especially where this involves Quebec. The CRA administers federal income tax source deductions for all of Canada, as well as the source deduction of personal income tax in every province and territory except Quebec. Revenue Quebec administers the source deduction of personal income tax within that province.
The rules that determine whether, in the situations covered by this article, the CRA may tax income at source are laid out in the tax treaty between Canada and the US. This treaty defines what is termed residence for income tax purposes. It’s very important to understand that when we use the terms “residence” or “resident” these aren’t necessarily defined by the geographic location where a person ordinarily lives. Instead, the Canada-US tax treaty imposes a series of tests to determine a person’s residence for tax purposes. Looking at these tests in any detail is beyond the scope of this article. In particular, if there is any doubt about a person’s residence status under this tax treaty, appropriate advice should be sought from a knowledgeable legal or tax professional.
If a director is a Canadian tax resident, under this treaty, CRA income tax source deductions apply. In this situation, it does not matter whether director’s fees are the only payments or there is also other taxable income. Similarly, if a director is a Canadian tax resident, the geographic location where the director performs services does not affect the CRA’s jurisdiction. Whatever the type of taxable income, or wherever in the world the director attends meetings, a director who is a Canadian tax resident is subject to the same income tax source deductions as any other Canadian employee.
However, the fact that the CRA has jurisdiction does not mean that income tax source deductions will always be required. As for any other Canadian employee, a director who is a Canadian tax resident may be eligible for personal credits against income tax otherwise owing. These credits are claimed on a TD1 form. If these personal credits exceed the projected taxable income for the year, a Canadian resident may claim an exemption from income tax source deductions. For 2012, the federal basic personal tax credit is $10,822, in Canadian dollars. If the taxable income paid to a director in 2012 is expected to be less than this, no federal income tax source deductions are required.
There are also provincial or territorial versions of the TD1. As has been mentioned, apart from federal income tax, the CRA also administers source deductions on behalf of all provinces and territories other than Quebec. Each province and territory sets the rates at which employers must deduct provincial income tax at source, as well as the personal credits that may be claimed for that jurisdiction.
The question is, for a director who is a Canadian tax resident, which province’s or territory’s TD1 and income tax rates apply? The rules for this purpose are termed the province of employment rules. These rules are based on what are known as permanent establishments. For example, an employer’s head office is a permanent establishment. Under the province of employment rules, the province that applies is determined by either the employer’s permanent establishment:
- to which the director reports for work; or
- from which the director is paid.
For a director who is also an employee or officer of the employer, “reporting for work” means the employer’s permanent establishment where the person physically presents him or herself at the start of each work day. For a person whose only connection with the employer is as a director, “reporting for work” may not be a very good description of the person’s activities.
For example, a director who physically attends a board meeting on the employer’s premises, is “reporting to work” at that permanent establishment. As such, that location determines the province of employment. However, presumably the same could not be said of a director who only participates in board meetings remotely, by conference or video call. Similarly, this would not include directors who only attend meetings at locations that are not the employer’s permanent establishment, such as at meeting rooms rented on a short-term basis. In these situations, the province of employment is determined by the employer’s permanent establishment from which the director is paid.
Even though we use the term “province”, these rules also cover employment outside of Canada. For example, a director that under the Canada-US tax is a Canadian resident may attend meetings at an employer’s permanent establishment in the US. Where the province of employment is outside Canada, there are special income tax rates and province of employment codes that apply, “US” and “ZZ”. The later means any “province of employment” outside of Canada, other than the US.
Once you know whether CRA income tax deductions are required, and which provincial income tax rates to use, you have to look at how to calculate the amount of any federal and provincial income tax owing at source. These calculations are determined based on whether or not a director’s taxable income is paid on a periodic basis. For example, director’s fees are paid on a periodic basis if the employer pays them every month. For this purpose, it doesn’t matter whether director’s fees are the only taxable income or whether a director is also an employee or officer or other taxable income is owing.
If taxable income is paid on a periodic basis, the normal income tax methods apply. Information on these can be found in a variety of places, including:
- online versions of the income tax tables, CRA publication T4032, organized by province of employment;
- the CRA’s online source deduction calculation tool, http://www.cra-arc.gc.ca/esrvc-srvce/tx/bsnss/pdoc-eng.html; and
- the CRA publication, T4127, that defines the calculations that software developers must implement.
Where director’s fees are not paid on a periodic basis, CRA suggests that withholding be based on the length of time between payments. For example, if a director is only paid fees for attending meetings, and the resulting payments occur on an irregular basis, the first step is to determine the number of months between payments. If one payment is made on March 15 and the next on May 4, it would be reasonable to use 1.5 as the number of months between payments. If the second payment was $12,000, divide by 1.5 to get $8,000. Look up this amount in the T4032 tax table for the correct province of employment and find the income tax to deduct for the claim codes on the federal and provincial TD1s. Where the province of employment is Alberta, and the federal TD1 claim code is 2, for 2012 the federal income tax deduction required is $1,347.05. Similarly, the same claim code on the Alberta TD1 results in provincial income tax of $618.95. Add these two together and multiply by 1.5 for a total CRA income tax deduction of $2,949. Something similar would be achieved by using the bonus method described in T4127.
Note, the same rules apply to determine “province of employment” whether payments are made on a periodic basis or not.
However, there are vastly different rules if, under the Canada-US tax treaty, a director is not a resident of Canada for tax purposes.
First, for non-residents, director’s fees, and any other earnings from the employer, are only subject to CRA income tax withholding for services performed in Canada. If no director’s services are performed in Canada, no CRA income tax withholding is required. Where a non-resident director performs part of his or her services in Canada and part elsewhere, the employer has to allocate any taxable income between the services performed inside and outside of Canada. The CRA considers a reasonable allocation of taxable income is one based on days worked. For example, a non-resident director may be paid $500 a day for attending meetings. If 6 such meeting were held in Canada, then $3,000 is the taxable income subject to CRA income tax source deductions. Similarly, where taxable income isn’t attached to a specific day, proration is required. If a non-resident director had what would be recognized under Canadian law as a $100,000 benefit from the exercise of stock options, this amount should be prorated over the number of days in the tax year for which the director performed services. If services were performed for 12 days in the tax year, 5 days in Canada and 7 days elsewhere, $41,667 would be the taxable benefit allocated to service in Canada ($100,000 times 5 divided by 12).
For the above attendance means being physically present at a meeting. For CRA purposes, a non-resident director is not considered to have performed services in Canada if attendance at a meeting is by conference or video call, when the director is physically outside of Canada. This also applies for the $10,000 and 183 day tests described below.
Second, if a director is a non-resident, the CRA will consider waiving the employer obligation to withhold income tax. The major requirement for granting such a waiver is that the director be ultimately exempt from tax in Canada on the income. A non-resident’s income is not taxable in Canada, under the Canada-US tax treaty, if any one of the following conditions are met.
The first condition is that any income from services performed in Canada be less than $10,000 in the tax year concerned. Note, it’s the value of the services performed in the tax year that is measured, not any payment for such services, received on a cash basis. Further, this must be the value of these services in Canadian dollars. For example, a non-resident director may earn CAN $1,000 a day for attending board meetings. In 2012, this director may have attended 9 such meetings in Canada. However, the director may have received payment in 2012 for attending a total of 12 Canadian meetings, including payment in 2012 for meetings attended in 2011. Under these circumstances, a non-resident director may still qualify for the CRA waiver.
The second condition has two parts. Both parts must be met to qualify for the waiver. The first part of this condition is that the non-resident director can not have physically been in Canada for more than 183 days. For this purpose, any part of a day is rounded up to a whole day. In other words, stepping across the boundary between Vermont and Quebec, even just for a few seconds, counts as a day in Canada.
The other part of this condition tests who bears the final expense of any taxable income paid to a non-resident director. For example, a US parent may make the actual payment of director’s fees for its appointees to a Canadian subsidiary’s board of directors. To recover these costs, the US parent may make an inter-company charge to a Canadian subsidiary, meaning such fees are ultimately expensed in the Canadian subsidiary’s financial statements. The CRA will not grant a waiver if director’s fees are ultimately borne by a Canadian employer.
Third, there are separate rules that deal with director’s fees paid to non-resident individuals versus non-resident corporations. As above, a Canadian subsidiary may credit its US parent, in their inter-company accounts, with the director’s fees for services performed on the Canadian employer’s board of directors. The US parent may then use the credited amounts to pay the actual director who sits on the Canadian board. In these circumstances, the CRA regards the individual director as the person ultimately paid. As such, the rules above apply. But, if the ultimate recipient of director’s fees is not an individual, the Canadian payer is subject to a flat 15% withholding tax. This would apply, for example, if the US parent retained the director’s fees credited to it, instead of passing them on to the individual concerned.
Lastly, none of the personal income tax credits on the federal or provincial TD1 forms are available to a non-resident director, with one exception. This exception is if the director is prepared to be taxed in Canada on at least 90% of his or her world income. In that situation, a non-resident director is eligible for the TD1 personal tax credits. Mind you, this scenario might only make sense where the combined, net Canadian and foreign income tax would be less than if the person’s world income were just taxed elsewhere.
Once the taxable income subject to CRA withholding has been determined, using the above rules, the next step is to calculate the actual federal and provincial income tax deductions required. These calculations are the same as for Canadian resident directors, including determining which province of employment applies.
So far we have been looking at CRA income tax withholding. In the next part of this article we will look at situations where Quebec is involved, particularly for the Quebec Pension Plan and the Quebec Parental Insurance Plan.