Entrepreneurship & Small Business

Registering a US LLC or C-Corporation

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Registering a US LLC or C-Corporation

Hi all,

I spent most of the day on the phone with lawyers and accountants and I am left more confused than ever.

I am currently running a sole proprietor business that I need to incorporate. That decision is made - the area I'm in has a fair amount of exposure to liability so I need to get the liability protection. It's too bad, because in all other respects being a sole proprietor is fantastic.

98% of my business is in the US. I have no physical presence in the US, however.

So I've been considering whether to incorporate as/in:

- Alberta
- Federal
- Delaware LLC
- Delaware C-Corp

If I had a perfect world I'd just register as an Alberta/Federal LLC. I love the ability to keep my personal name on accounts (they're all set up) and just "flow-through" my income like a sole proprietor for tax purposes. Alas, Canada strikes again by not offering anything like it.

So, I spoke at great length to an accountant and he provided some really interesting (but problematic) advice.

I initially was leaning towards a Delaware LLC, but the trouble is the CRA does not recognize an LLC as sole proprietor income. That means I'd get double taxed - as a sole proprietor in the US, then again as a corporation when the profits returned to Canada. He estimated doing this would make a tax liability of approximately 49%, which is crazy.

He suggested a solution I can find nobody else using online - using a bare trust to "hold" the LLC and maintain my status, for tax purposes, as a sole proprietor in Canada.

He suggested this would avoid double taxation issues and still afford me liability protection. He estimated this would reduce my tax liability to about 42%, which is still crazy.

I am leery - he seems ultra knowledgeable, maybe even to a fault! I am hesitant to use complicated instruments that I do not completely understand. I am not a fan of being at the mercy of my accountant or law firm if something went sour, because I do not understand how to manage it myself.

Does anyone else have experience incorporating in the US, and how did you handle the tax problems?
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Aug 17, 2011
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It seems to me that you're in the "perfect" niche that most clients dream of:

-You're physically located in Canada;

- You have no US presence;

- You do 98% of your billings in the US;

In this scenario, simply incorporate an AB Corp and be done with it. Remember to not bill GST on your sales, and that's about as complicated as things have to be here.

Also should note that a "federal" incorporation does nothing for you in that you still would have to incorporate provincially in order to get a provincial business number so you can file your taxes. All a Fed incorporation does is lock down a corporate name Canada-wide.
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Oct 24, 2010
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Ottawa
Do your clients force you to have a US company?

Otherwise, I don't understand why you can't operate via a Canadian corporation (provincial or federal).
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Hansol wrote: It seems to me that you're in the "perfect" niche that most clients dream of:

-You're physically located in Canada;

- You have no US presence;

- You do 98% of your billings in the US;

In this scenario, simply incorporate an AB Corp and be done with it. Remember to not bill GST on your sales, and that's about as complicated as things have to be here.

Also should note that a "federal" incorporation does nothing for you in that you still would have to incorporate provincially in order to get a provincial business number so you can file your taxes. All a Fed incorporation does is lock down a corporate name Canada-wide.
But what about the taxes? My accountant was suggesting the taxes would be horrendous if I did this.

I may not have understood him entirely (he's one of those guys who talks ultra fast about really complicated stuff) but the short story I gleaned:

- My corporation would be taxed at the very high US federal tax rates on US-source income
- My corporation would then be taxed in Canada if any leftover taxes could not be offset by US-paid taxes
- Any disbursements to me personally would be taxed again

So I would end up with taxes in the range of nearly 50%. He also said for an accounting firm to manage annual compliance would run be about $2000/yr.

I appreciate the advice about federal, with that in mind I'll rule it out.
AlexandruCAN wrote: Do your clients force you to have a US company?

Otherwise, I don't understand why you can't operate via a Canadian corporation (provincial or federal).
See above, but my extra consideration is I've found it very difficult to get Canadian insurance for a business like this. I finally found some but it's insanely expensive - more than 5% of my entire gross income, aka nearly 1/6th of my entire profit margin.

From what I've seen, comparable US policies would be 1, maybe 2% of my gross sales.

If I had a US corporation, I believe I'd be eligible for US insurance policies.
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Oct 24, 2010
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Ottawa
I must have misunderstood you. Do you mind sharing the industry you are in?

99% of my business comes from US. I have no physical presence in US, as in I never step a foot in US to provide my services. I provide my services through a Canadian federally incorporated company. I don't charge HST since my sales a HST exempt (buyer is not in Canada).

In terms of liability, it is possible that you get a high number/premium because you are exposed to a lot of liability. So you could possible get the same numbers in US as well, best to check for sure.

In the area I am, IT, I think the quote for General Liability I got was around 2K per year for 1mln in coverage.

Avoid at all costs if possible opening a business in US, especially if you rarely go there.

Depending on the numbers, if I were you, I would probably eat the costs of the insurance, or keep looking for a better rate.
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AlexandruCAN wrote: I must have misunderstood you. Do you mind sharing the industry you are in?

99% of my business comes from US. I have no physical presence in US, as in I never step a foot in US to provide my services. I provide my services through a Canadian federally incorporated company. I don't charge HST since my sales a HST exempt (buyer is not in Canada).

In terms of liability, it is possible that you get a high number/premium because you are exposed to a lot of liability. So you could possible get the same numbers in US as well, best to check for sure.

In the area I am, IT, I think the quote for General Liability I got was around 2K per year for 1mln in coverage.

Avoid at all costs if possible opening a business in US, especially if you rarely go there.

Depending on the numbers, if I were you, I would probably eat the costs of the insurance, or keep looking for a better rate.
I sell toys, collectible action figures, that sort of stuff. Toys of course comes with a lot of liability, even though I am not the manufacturer.

I'm not sure if I could get quoted without the business actually existing in the US - nobody wants to waste their time doing a fictional quote. That being said, you're right, I shouldn't automatically assume it'd be cheaper. In my circles of people who sell in ways like I do, most Americans seem to be paying 70-80% less in insurance than I do, but who knows... their circumstances could be different.

I tried 3 separate brokers and 2 direct writers and nobody else would insure me, so I am unfortunately fairly confident this is the best rate I can get in Canada.

You say your business is to Americans, how does your tax work? Is it ridiculous with paying US taxes, Canadian taxes, then personal taxes?
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Oct 24, 2010
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Ottawa
I see. It's possible that it's because you sell tangible good they give you such high rates.

My tax is pretty simple, since I have no physical presence in US I don't pay tax there and I have no company registered there. I only pay Canadian tax. If I were to provide my services while in the US, then it would be completely a different story.

I'll through another wrench at you - when you get your US GL insurance quotes - how do you think the insurance companies will react when you'll tell them you are physically located in the US?
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AlexandruCAN wrote: I see. It's possible that it's because you sell tangible good they give you such high rates.

My tax is pretty simple, since I have no physical presence in US I don't pay tax there and I have no company registered there. I only pay Canadian tax. If I were to provide my services while in the US, then it would be completely a different story.

I'll through another wrench at you - when you get your US GL insurance quotes - how do you think the insurance companies will react when you'll tell them you are physically located in the US?
See, for me, since I'm selling physical goods, the US government will want to tax me. I have, at least to some degree, Nexus in the US so they'll nail me.

That's the trouble.

As for the insurance, I'm not sure how that'd work. They may be hesitant to insure me as a Canadian, even if I had a US corporation. I talked to one broker and he seemed to think it was doable, but you never know.
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I am in exactly the same situation with a new business I am setting up as we speak. Sales are starting very shortly.

My Ontario corporation will be selling physical products 95% to the US and 5% to Canada, with the US goods being shipped from overseas to a Buffalo, NY logistics warehouse and then 5% of it by a trucker to Toronto. I sell off a website with the US goods being paid for in $USD and being shipped from the US warehouse and the Canadian goods being paid for in $CDN and shipped from a Canadian warehouse with the money (99% by credit card or PayPal and 1% debit) going into each respective countries bank accounts domiciled in each country from the credit card payment processor in 1 day for US and 2 days for Canada. As such there will be no currency conversion (and I pay my manufacturer in $USD anyway). If I do need to convert from USD to CDN or vice-versa I transfer the USD to my Canadian USD bank account and use Norbert's Gambit to convert it to $CDN (or to $USD if going the other way) without paying any commission.

I don't need a US corporation to get the US bank account, to collect NY State tax (which is the only US tax I need to collect) or to do business there. I might have some form of 'nexus' from the point of view of the IRS because even though I have no employees in the US I do hold inventory in a warehouse there. So, my accountant will have to file a US corporate return which then gets credited against the Canadian tax my corporation pays. So, why worry about the taxes you have to pay there if that is the case?

My accountant charges $2-$3K to prepare the Canadian and US return. I will do the NY State tax filing myself.

As for liability, I am still checking on this but apparently if you do not modify the product at all then you have no liability, the manufacturer does. Again I am just checking on this as we speak. Of course when something happens that doesn't stop anyone from suing you as plaintiffs add everyone as a party to the lawsuit that is even remotely connected to the product. That is the case whether you are ultimately liable or not. You still have to provide a defense and pay some lawyers fees unless the insurance contract pays for the lawyers fees too in addition to any damages awarded (not sure about that). Anyway, no way around not getting sued but liability insurance is what could protect your corporation from not having to pay the damage award.

So, you do not have to incorporate in the US.

One question I have is given it appears you ship your products to the US from Canada, doesn't that incur a huge brokerage and shipping fee for the customer which would it seems be quite disproportionate to the value of the items you are selling. Even with my product selling in the thousands I can't be bothered with both the cost and delay of shipping from Canada to the US and then burdening the customer with more brokerage fees.
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scouzer wrote: See, for me, since I'm selling physical goods, the US government will want to tax me. I have, at least to some degree, Nexus in the US so they'll nail me.

That's the trouble.

As for the insurance, I'm not sure how that'd work. They may be hesitant to insure me as a Canadian, even if I had a US corporation. I talked to one broker and he seemed to think it was doable, but you never know.
If you don't have any presence in the US and ship from Canada you cannot have US nexus.
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eonibm wrote: I am in exactly the same situation with a new business I am setting up as we speak. Sales are starting very shortly.

My Ontario corporation will be selling physical products 95% to the US and 5% to Canada, with the US goods being shipped from overseas to a Buffalo, NY logistics warehouse and then 5% of it by a trucker to Toronto. I sell off a website with the US goods being paid for in $USD and being shipped from the US warehouse and the Canadian goods being paid for in $CDN and shipped from a Canadian warehouse with the money (99% by credit card or PayPal and 1% debit) going into each respective countries bank accounts domiciled in each country from the credit card payment processor in 1 day for US and 2 days for Canada. As such there will be no currency conversion (and I pay my manufacturer in $USD anyway). If I do need to convert from USD to CDN or vice-versa I transfer the USD to my Canadian USD bank account and use Norbert's Gambit to convert it to $CDN (or to $USD if going the other way) without paying any commission.

I don't need a US corporation to get the US bank account, to collect NY State tax (which is the only US tax I need to collect) or to do business there. I might have some form of 'nexus' from the point of view of the IRS because even though I have no employees in the US I do hold inventory in a warehouse there. So, my accountant will have to file a US corporate return which then gets credited against the Canadian tax my corporation pays. So, why worry about the taxes you have to pay there if that is the case?

My accountant charges $2-$3K to prepare the Canadian and US return. I will do the NY State tax filing myself.

As for liability, I am still checking on this but apparently if you do not modify the product at all then you have no liability, the manufacturer does. Again I am just checking on this as we speak. Of course when something happens that doesn't stop anyone from suing you as plaintiffs add everyone as a party to the lawsuit that is even remotely connected to the product. That is the case whether you are ultimately liable or not. You still have to provide a defense and pay some lawyers fees unless the insurance contract pays for the lawyers fees too in addition to any damages awarded (not sure about that). Anyway, no way around not getting sued but liability insurance is what could protect your corporation from not having to pay the damage award.

So, you do not have to incorporate in the US.

One question I have is given it appears you ship your products to the US from Canada, doesn't that incur a huge brokerage and shipping fee for the customer which would it seems be quite disproportionate to the value of the items you are selling. Even with my product selling in the thousands I can't be bothered with both the cost and delay of shipping from Canada to the US and then burdening the customer with more brokerage fees.

eonibm wrote: If you don't have any presence in the US and ship from Canada you cannot have US nexus.
I have a 3PL provider doing my warehousing and fulfillment in the US (like your situation), so that's unfortunately my Nexus in the eyes of the IRS and sales tax.

But in your example don't forget, you'll end up paying US Corporate Taxes which will offset (some or all) of your Canadian Corporate Taxes. But then, when you go to pay yourself from the corporation, you must pay yet another level of taxes as personal income. That's the kicker and cannot be dodged with tax treaties. That's why cross border incorporation (or any incorporation for essentially a sole proprietor) does not seem to be very tax efficient at all.

My accountant also quoted me $2-$3k for Canada/US tax returns so at least we're in the right playing field.

It's very interesting what you advise about liability. I want to ask my US Lawyer about that, because if you're right I may not even incorporate at all. I only want the headache of incorporation to prevent liability concerns, it does not seem like a good vehicle for a company without employees otherwise.

To answer your questions about brokerage: I do ship US to US, however the brokerage costs are very minimal for US-bound shipments. I exclusively use UPS and it's free brokerage below $200 USD in value, then a pretty nominal fee above that. You can also deliver duty paid to make it seamless to your customers.
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scouzer wrote: I have a 3PL provider doing my warehousing and fulfillment in the US (like your situation), so that's unfortunately my Nexus in the eyes of the IRS and sales tax.

But in your example don't forget, you'll end up paying US Corporate Taxes which will offset (some or all) of your Canadian Corporate Taxes. But then, when you go to pay yourself from the corporation, you must pay yet another level of taxes as personal income. That's the kicker and cannot be dodged with tax treaties. That's why cross border incorporation (or any incorporation for essentially a sole proprietor) does not seem to be very tax efficient at all.

My accountant also quoted me $2-$3k for Canada/US tax returns so at least we're in the right playing field.

It's very interesting what you advise about liability. I want to ask my US Lawyer about that, because if you're right I may not even incorporate at all. I only want the headache of incorporation to prevent liability concerns, it does not seem like a good vehicle for a company without employees otherwise.

To answer your questions about brokerage: I do ship US to US, however the brokerage costs are very minimal for US-bound shipments. I exclusively use UPS and it's free brokerage below $200 USD in value, then a pretty nominal fee above that. You can also deliver duty paid to make it seamless to your customers.
No. Your salary is an expense of the corporation so the corporation gets a deduction from income and you get an equal increase in that same income. So you are not paying 'yet another level of taxes' for 'any incorporation for a sole proprietor'. You are paying one level or rate of taxes and it is the same rate you pay if you are a sole proprietorship. Also, if you pay yourself dividends in addition to salary then you also pay the same income tax as a sole proprietor because of the concept of 'integration' that is embedded in the Income Tax Act which basically ensures that a dollar earned through a corporation and then paid out as a dividend incurs the same income tax as if an individual had earned it directly as a sole proprietor.

You should incorporate for many other reasons.

You are worried about liability. Well then I don't know why you are not incorporated now. Do you know if someone sues you as the sole proprietorship you are now that you have unlimited personal liability? With a corporation your liability is limited and it is limited to the assets of the corporation at the time you are sued. So, any monies you paid out before cannot be touched unless it was a fraudulent conveyance in anticipation of a lawsuit. Yes there are times the court will 'lift the corporate veil' and attack your personal assets but it is in rare circumstances and certainly not where you are merely reselling a product not creating it. If you are worried about personal liability it is indeed surprising you prefer to operate as a sole proprietorship.

Another absolutely HUGE financial advantage of having a corporation is that you pay a lower tax on earnings on the first $400K (do you do over that after all expenses including your salary?) and instead of paying the retained earnings out, which would result in you paying the same tax you do as a sole proprietor you can keep it in the company and defer the tax and use the extra money to buy more inventory, invest, etc. Having a sole proprietorship is a huge disadvantage in this respect because all your earnings are taxed personally each and every year. No deferral. Also, because of this flexibility you can pay yourself the proper mix of dividend and income to minimize your tax burden as you get the dividend tax credit for paying dividends, which then becomes a part of your RDTOH (Refundable Dividend Tax on Hand) account in your company which is money you get refunded to the company.

Furthermore, if you ever sell your corporation you get a capital gains exemption of up to $800,000. Yup no tax on the first $800K of sale price. You cannot get that with a sole proprietorship. It's one of the best tax dodges the government has given us outside of our principal residences and TSFA.

Anyway, not to get into a complex discussion about corporate tax but the comments you made are way off base and you do not seem to be aware of any of the above if you think the only reason to incorporate is liability and that you get taxed more.
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scouzer wrote: To answer your questions about brokerage: I do ship US to US, however the brokerage costs are very minimal for US-bound shipments. I exclusively use UPS and it's free brokerage below $200 USD in value, then a pretty nominal fee above that. You can also deliver duty paid to make it seamless to your customers.
If you also ship Canada to US and the brokerage costs are minimal for those that's great, but a single one of my products sell for in the thousands so the free brokerage below $200 isn't going to help me in shipping from Canada to the US. Also, there is paperwork to do to ship to the US which adds another layer of bureaucracy and overhead regardless of whether there is no brokerage charge. On top of that the ship time extends by a few days. Then on top of even that a small % of my products will be returned for warranty service and they are better just returned to my US 3PL or else I'll have to fill out even more paperwork and pay more expense to ship them back to Canada. I also do drop shipments for some retailers and they also want the return address to show the US not Canada. I see zero advantage to shipping from Canada for me or my customers and a lot of extra cost especially since it's no extra sweat to just have the product delivered to my US 3PL in the first place. I am not sure what advantage it really has for you and your customers. But, if it is an advantage why do you ship US to US at all?
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scouzer wrote: I have a 3PL provider doing my warehousing and fulfillment in the US (like your situation), so that's unfortunately my Nexus in the eyes of the IRS and sales tax.
Your accountant needs to rewrite his UFFI's. His advice was the total opposite of what mine gave me and mine is also backed up by the actual facts. The following is a summary I did today from this BDO Tax Bulletin on Canadian companies doing business in the US (http://www.bdo.ca/en/Library/Services/T ... the-US.pdf) and echos my accountant's advice:

If you carry on a trade or business in the US to have to file a US tax return. There is no statutory definition of what that means. You might be carrying on a trade or business in the US if you sell into the US but it is not cut and dried. Page 2 of the report below from BDO Canada LLP outlines instances when that is the case. It doesn’t take much but ‘unsolicited purchase orders’ doesn’t count, whatever that means. Is someone buying something of your website unsolicited? Seems so and therefore you wouldn’t have to file if you aren’t caught by the other situations enumerated in that tax bulletin. Given we both have 3PL warehouses in the US I would err on the side that we are carrying on business in the US. It seems reasonable. However, even if you are not caught by that rule there are other rules that might mean you have to file.

So, because of this we are taxed on ‘effectively connected income’ which includes business income and salaries attributable to the US. I will be able to deduct about 95% of my expenses because 95% of my trade comes from the US. So I am liable for US tax based on my US net income. However, because our tax treaty with the US we can seek relief from that US Federal tax but still have to file.

You can get relief from US federal tax on that effectively connected income if you do not have a US permanent establishment (PE), which is basically a 'fixed place of business through which a non-resident wholly or partly carries on business or where an agent acting an on behalf of the enterprise has and habitually exercises the authority to conclude contracts binding on the enterprise'. If you do have a PE then you are taxed on your US business profits. But the treaty specifically excludes as a PE ‘the use of facilities for storage, display, or delivery of goods or merchandise’. So, using a 3PL warehouse alone does not cause you to have a PE.

So, it seems to me that both you and I are:

1) Carrying on a trade or business in the US;

2) Therefore have ‘effectively connected income’ which is our US income less tax deductions attributable to the business we carry on in the US;

3) Therefore have to file US tax returns, Form 1120-F US Income Tax Return of a Foreign Corporation and Form 8833 – Treaty-Based Return Position Disclosure under Section 6114 or 7701(b) to claim relief under the treaty from U.S. federal taxation on income from U.S. activities because our corporations do not have a U.S. PE. because all we have are 3PL warehouses, nothing more and only sell stuff online and don’t negotiate contracts in the US; and

4) Therefore are not subject to US income tax on our ‘effectively connected income’.

In any event, the report mentions that if you are unsure about whether you are carrying on business in the US you should consider filing a U.S. return to protect yourself from penalties for failure to file and disclose a treaty-based filing position. That’s what I am going to do. Costs little, protects you and you won't pay US federal income tax anyway.

If you do have a PE in the US, which we don't, then you get a foreign tax credit on your Canadian return for the income tax you have to pay in the US. However, even though you avoid double taxation you could still end up being taxes excessively as the US tax could easily be greater than the Canadian tax if you are enjoying the small business tax rate in Canada which you would be up to $500,000 in net income.

On top of all this you may have to file state taxes, either or both of state sales tax and state income tax. I determined that I have nexus for sales tax purposes in NY State by virtue of my 3PL warehouse being in Buffalo and of course I only remit the NY sales tax I collect for sales into NY State as shipments out of NY State do not incur state tax (with some notable exceptions such as California where if you ship more than $500K/yr to you do have to collect state tax), but I determined that just having inventory in a 3PL warehouse does not qualify me to have nexus for state tax income tax purposes.

It seems the advice you were given was wrong about having to incorporate or pay US federal taxes.
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Woah now, you've taken many of my comments completely differently than intended. I was trying to have a positive, learning discussion (you know more than I do about this stuff, no question) I'm not trying to ruffle feathers.

The advice you've given seems like the best I've ever received. I really appreciate it.

To brokerage: I wasn't at all trying to argue shipping from Canada is better. Not at all! My point was simply brokerage isn't a huge problem if you need to do it for some reason. It's not like US to Canada imports which have crazy brokerage/taxes. That's all I was trying to say.

Again, your advice is outstanding and I'm really going to take it to heart. When I read what you're saying I think you're echoing most of what my accountant was trying to say, but he has a pretty thick accent so I think I completely misunderstood. He's one of those guys that kind of thinks as he talks too, so I think I completely misinterpreted his advice, because a lot of the key terms you're saying sound familiar.

However, he did think I have Nexus for sales tax for sure. He did not directly answer whether that's Nexus for state income taxes. He did advise I have Nexus for US Federal Income Tax... which is contrary to your advice. I will have to read further, but a lot of what you've said sounds familiar to my personal research.

To answer why I'm not incorporated yet: My business has exploded. I started with $2000 in February. Now I am looking at replacing my day job - in just five months of business. It's time to get serious, which is why I'm here & why I'm consulting the pros.
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You have to file a US tax return and you have Nexus for US Federal Income Tax and technically liable for them but because you do not have a PE you get credit for taxes owing under the tax treaty. Do you see the distinction?

Net result is you're not paying US taxes.

My accountant talks slowly and doesn't have an accent and is very familiar with all of this, not to mention I reviewed it all extensively myself and his advice echoes BDO's and what I read. I just don't think your accountant is very familiar with US tax rules as he disagrees with my (Chartered) Accountant, who does this all the time and BDO Chartered Accountants who do it even more.

Let us know what the very reason is that your accountant thinks you have to pay tax. It doesn't count if it's just a 'feeling'.
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eonibm wrote: You have to file a US tax return and you have Nexus for US Federal Income Tax and technically liable for them but because you do not have a PE you get credit for taxes owing under the tax treaty. Do you see the distinction?

Net result is you're not paying US taxes.

My accountant talks slowly and doesn't have an accent and is very familiar with all of this, not to mention I reviewed it all extensively myself and his advice echoes BDO's and what I read. I just don't think your accountant is very familiar with US tax rules as he disagress with my (Chartered) Accountant, who does this all the time and BDO Chartered Accountants who do it even more.

Let us know what the very reason is that your accountant thinks you have to pay tax. It doesn't count if it's just a 'feeling'.
Yes, I see the difference now. I have a call scheduled tomorrow with my accountant & lawyer. I think I'll just go for a simple Alberta incorporation thanks to your advice!
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eonibm wrote: Your accountant needs to rewrite his UFFI's. His advice was the total opposite of what mine gave me and mine is also backed up by the actual facts. The following is a summary I did today from this BDO Tax Bulletin on Canadian companies doing business in the US (http://www.bdo.ca/en/Library/Services/T ... the-US.pdf) and echos my accountant's advice:

If you carry on a trade or business in the US to have to file a US tax return. There is no statutory definition of what that means. You might be carrying on a trade or business in the US if you sell into the US but it is not cut and dried. Page 2 of the report below from BDO Canada LLP outlines instances when that is the case. It doesn’t take much but ‘unsolicited purchase orders’ doesn’t count, whatever that means. Is someone buying something of your website unsolicited? Seems so and therefore you wouldn’t have to file if you aren’t caught by the other situations enumerated in that tax bulletin. Given we both have 3PL warehouses in the US I would err on the side that we are carrying on business in the US. It seems reasonable. However, even if you are not caught by that rule there are other rules that might mean you have to file.

So, because of this we are taxed on ‘effectively connected income’ which includes business income and salaries attributable to the US. I will be able to deduct about 95% of my expenses because 95% of my trade comes from the US. So I am liable for US tax based on my US net income. However, because our tax treaty with the US we can seek relief from that US Federal tax but still have to file.

You can get relief from US federal tax on that effectively connected income if you do not have a US permanent establishment (PE), which is basically a 'fixed place of business through which a non-resident wholly or partly carries on business or where an agent acting an on behalf of the enterprise has and habitually exercises the authority to conclude contracts binding on the enterprise'. If you do have a PE then you are taxed on your US business profits. But the treaty specifically excludes as a PE ‘the use of facilities for storage, display, or delivery of goods or merchandise’. So, using a 3PL warehouse alone does not cause you to have a PE.

So, it seems to me that both you and I are:

1) Carrying on a trade or business in the US;

2) Therefore have ‘effectively connected income’ which is our US income less tax deductions attributable to the business we carry on in the US;

3) Therefore have to file US tax returns, Form 1120-F US Income Tax Return of a Foreign Corporation and Form 8833 – Treaty-Based Return Position Disclosure under Section 6114 or 7701(b) to claim relief under the treaty from U.S. federal taxation on income from U.S. activities because our corporations do not have a U.S. PE. because all we have are 3PL warehouses, nothing more and only sell stuff online and don’t negotiate contracts in the US; and

4) Therefore are not subject to US income tax on our ‘effectively connected income’.

In any event, the report mentions that if you are unsure about whether you are carrying on business in the US you should consider filing a U.S. return to protect yourself from penalties for failure to file and disclose a treaty-based filing position. That’s what I am going to do. Costs little, protects you and you won't pay US federal income tax anyway.

If you do have a PE in the US, which we don't, then you get a foreign tax credit on your Canadian return for the income tax you have to pay in the US. However, even though you avoid double taxation you could still end up being taxes excessively as the US tax could easily be greater than the Canadian tax if you are enjoying the small business tax rate in Canada which you would be up to $400,000 in net income.

On top of all this you may have to file state taxes, either or both of state sales tax and state income tax. I determined that I have nexus for sales tax purposes in NY State by virtue of my 3PL warehouse being in Buffalo and of course I only remit the NY sales tax I collect for sales into NY State as shipments out of NY State do not incur state tax (with some notable exceptions such as California where if you ship more than $500K/yr to you do have to collect state tax), but I determined that just having inventory in a 3PL warehouse does not qualify me to have nexus for state tax income tax purposes.

It seems the advice you were given was wrong about having to incorporate or pay US federal taxes.
Isn't the small business rate applicable for the first 500K of net income ? And isn't integration only valid on the first 500K of income ? Isn't that why we 'bonus down' to below 500K each year ?
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Aug 2, 2010
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Here 'n There
Yup, forgot. Used to be $400K but was increased to $500K. I edited that.

The reasons you bonus down to $500K are varied but the first one is that bonusing down results in a lower tax rate in your hands than if taxed in the corporation's because the tax rate to you personally is graduated up and in the corporation it is not and your marginal tax rate in most cases will always be lower than the corporations tax rate for taxable income above $500K. It also provides you, up to a point, with the maximum RRSP deduction as that is based on earned income. Of course you have to be lucky enough to have the kind of corporate profit that enables that.

Another reason is to shield the corporations money from creditors, although that can be achieved by paying the dividends up to a holdco which holds the corporation earning the Small Business Deduction (SBD)

Perfect integration is never achieved. It's always a bit over or under-integration with over meaning you can end up with more money when paid out as dividends vs salary and under meaning the opposite). This is because the federal government and the provinces keep changing the rates around slightly. Right now because the corporate small business tax rate, in Ontario anyway, is 15.5% there is over-integration, meaning that a $1 earned through the corporation and taxed and then paid out as eligible dividends (not salary) and taxed in your hands nets you more than if the same amount of dividend was paid out as salary. However the advantage right now is less than 1% in tax savings. That number moves up or down a slight bit depending on the budget that year and the new tax rates.

Keeping the money in the corporation that is only taxed at the SBD rate is, for the most part only a deferral and not the huge tax savings that people think it is. They think that because they are paying 15.5% that thats what they are paying. Nope. When that after tax money is finally paid out as a dividend it is grossed up and you pay tax on the grossed up amount not the amount of the dividend. And because the available cash to be dividended out is higher because you paid the lower SBD tax rate initially, well, more gets grossed up and therefore taxed. That's where the integration part comes in, but no it's not absolutely perfect. Btw, there is even a tax deferral advantage by not paying out all the net income above $500K because the corporate tax rate, 26.5% in Ontario for 2014, can easily be lower than your own marginal rate.

However, even so and even if there was perfect integration under $500K and not a slight benefit tax-wise, keeping the money in the corporation has benefits such as allowing you to have more money to invest in your business and increasing it's value if you sell it because there are higher retained earnings. Also, you can invest it in something that has nothing to do with your business like the stock market or other investment vehicles.

As always you should consult with a tax professional for your particular situation, which I am not. However, I know the general rules that apply and why things are done having operated a number of my own companies now.

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