U.S. State and Local Tax Consideration for Canadian Businesses

September 1, 2015

Often Canadian businesses are surprised to learn about the reach of U.S. state taxing jurisdictions to assert tax on out-of-state taxpayers. Since none of the 50 states were signatories to the Canada-U.S. Income Tax Convention (the “Treaty”), they are not limited by the Treaty to taxing business activities in the U.S. It is not uncommon to find a Canadian business subject to a state’s taxing jurisdiction and completely exempt from U.S. federal income taxation because of the Treaty.

In contrast to the Treaty which limits U.S. federal tax to profits attributable to a “permanent establishment,” states are limited to exerting their taxing jurisdiction to out-of-state taxpayers that have “nexus” with the state. Nexus is the minimum contact with a state which will allow it to impose its taxes on the in-state business activities of an out-of-state taxpayer.

Traditionally, nexus required some minimum physical presence in the state by principals, employees or agents of the taxpayer. Minimum physical presence includes maintaining property or inventory in the state, attending client meetings and providing repair or warranty services in the state among other activities. More recently, some states have expanded their income taxing jurisdiction by exerting nexus on in-state business activities even where out-of-state taxpayers have no physical presence in the state. This definition of nexus is referred to as “economic nexus.”

U.S. federal law limits states from imposing income tax on some protected activities. They cannot impose income tax on interstate commerce involving the solicitation of personal property which is shipped by common carrier from outside of the state. However, this protection only applies to state taxes measured by income and does not apply to other taxes that may be imposed. Some states extend this protection to Canadian business entities and other states do not.

To make matters more complicated, most states impose a sales tax collection responsibility for out-of-state taxpayers that make sales of tangible personal property to customers in the state and who otherwise meet requirements of physical presence nexus. Sales taxes can be assessed at the state and local (county, city and other political subdivisions) level. Some states do not impose an income tax but impose some derivation of a gross receipts tax.

Andersen in Canada has several members on its team that have expertise in the area of U.S. state and local taxation. We assist Canadian businesses assess their exposure to U.S. state and local tax and provide consultation to minimize that exposure with careful planning. We also prepare state tax returns in addition to U.S. federal tax returns.