Selling grain to American buyers might earn Canadian farmers better profits, but it is important to structure the sale so that it cannot be considered a U.S.-sourced sale.
If it is, the proceeds will be considered “effectively connected income” in the United States under U.S. tax law and taxable at graduated U.S. federal corporate rates that can be higher than Canadian taxes.
Farmers must also be careful if they conduct business with American buyers on multiple occasions because that could lead to a “permanent establishment” designation under U.S. tax law.
Fortunately, there is a U.S.-Canada tax treaty. Otherwise, income from sources within the U.S. that is connected with the conduct of trade or business would be taxable by the Internal Revenue Service.
Canadian farmers who comply with the tax treaty properly can ensure that the IRS collects tax only if their activities rise to a level that creates a permanent establishment in the U.S.
Farmers who are deemed to have created a permanent establishment face having to pay up to 35 percent tax (or 39.6 percent for sole proprietor) on all shipments for each year that they have been deemed to have a permanent establishment.
Filing the return late could result in penalties of US$10,000 for a Canadian corporation and $1,000 for an individual.
Permanent establishment typically exists with a fixed place of business in the U.S. but can also exist if certain agents (including yourself) wrap up contracts in the U.S. on behalf of your business on a regular basis.
Farmers who regularly enter the U.S. to sell their products are probably creating a precedent for permanent establishment, even if they only take orders.
The key test is determining what is regular or habitual.
There can be problems if farmers or their agents enter the U.S. for a total of more than 182 days and the sales of more than half their product to U.S.-based customers arose from those activities.
Many of the test requirements rely on facts and circumstances that can be unique to each business and transaction. As a result, a permanent establishment determination might not be clear cut.
Many farmers who live near the border could be flirting with the designation if they cross the border often, even if they aren’t creating a permanent establishment in the U.S.
The rules regarding permanent establishment are especially tricky because the rules around individuals, partnerships and corporations are nebulous.
Partnerships can add more complexity: more than one entity or person might need to file tax forms.
Even if the activity does not rise to a level of a permanent establishment, the IRS still requires a formal disclosure that the activity is exempt from U.S. federal taxation.
Make sure to file the appropriate form to avoid the potentially stiff penalties for failure to file in time,
The only way to avoid the IRS is to be 100 percent sure you are selling to a Canadian company and the transaction is completed in Canada.
This means the contract is signed, you are paid in full in Canadian dollars and the grain is still in Canada.
An American company, even though it has offices in Canada, might not qualify.
This is Part 4 in a series on avoiding unnecessary taxes on U.S. grain sales.
See all the columns in this series: