As per the US-Canada tax treaty, a Canadian resident earning self-employment income in the US, this income is exempt from US federal taxation (Note that this does not mean you are exempt from state taxation). This is strictly under the condition that this income was not generated through a Permanent establishment (PE) in the contracting state. While previously you would be required to file a US-Canada tax treaty based return under Article XIV – “Independent Personal services”, the definition of PE has been further clarified leading to change in procedure effective January 1st, 2008. The former PE criteria did not account for the amount of time spent or revenue generated as self-employment income. Let’s have a look at the treaty’s current definition:
Permanent Establishment
A Canadian resident is deemed to have a PE in the US if:
- they spent more than 183 days in the contracting state during which time more than 50% of their gross revenue was as a result of services rendered in that state.
(or)
- if their services were rendered for more than 183 days during any 12-consecutive month period with respect to a project.
Current Taxation
With this revision, the blank exemption of self-employment income (not generated through a PE) from US taxation regardless of revenue generated and time spent is now not applicable. The profits from these self-employed personal services henceforth termed “Business profits”, are now taxable by contracting states proportional to the amount of business activity. This is as per Article VII (“Business profits”) of the United States-Canada Income Tax Convention.
Extremely Important US Tax Residence Rules For Every Canadian
Which Forms Do I File?
The forms you file depends on whether you have a PE or not. If you are
- a Canadian resident involved in self-employed business or trade in the US
- deemed to NOT have a PE in the contracting state in US
then you will have to file the following forms:
Forms in the US:
- Form 1040NR (Nonresident Alien Individual tax return) – required to be filed by the individual as per the treaty. Need not include your income
- Form 8833 (Disclosure of Treaty Based Position) – Enclosed with every treaty based return filed. If you fail to file this when claiming treat based exemptions, you will be required to pay a penalty.
- Form 8840 (Closer connection Exception statements for Aliens) – To avoid US tax liability on Foreign (outside US) earned income
- Form 8233 – used to claim exemption from withholding taxes on self-employment income as per the treaty
Forms in Canada:
- Form T1 (Individual income tax return) – used to file returns on US earned and world income
- Form CPT56 (Certification of Coverage of Employment under the Canada Pension Plan) – to avoid paying US social security and Medicare taxes. This is as per Article V of the agreement between the US and Canada.
If you are
- a Canadian resident involved in self-employed business or trade in the US
- deemed to have a PE in the contracting state in US
then you have to file the following forms:
Forms in the US:
Form 1040NR (Nonresident Alien Individual tax return) – Income tax return filing for US non-residents aliens*
*Here the return must be filed for income generated and expenses incurred with respect to the PE
Forms in Canada:
- Form T1 (Individual income tax return) – used to file returns on US earned and world income
- Form CPT56 (Certification of Coverage of Employment under the Canada Pension Plan) – to avoid paying US social security and Medicare taxes. This is as per Article V of the agreement between the US and Canada.
You must also read Independent Canadian contractors and Canadian corporations providing personal services in US and US Canada Tax Treaty.
