Does a Non-Resident Corporation Have to File a T2 in Canada?

Does a Non-Resident Corporation Have to File a T2 in Canada?

Almost always yes, and the reason surprises people: the filing obligation and the tax liability are separate questions.

Paragraph 150(1)(a) of the Income Tax Act requires a corporation to file a T2 return for a tax year in which it was a non-resident but carried on business in Canada, realised a taxable capital gain, or disposed of taxable Canadian property. The words that matter are what follows. The return is required whether or not tax is payable, and whether or not a tax treaty exempts the income entirely.

So a company with a treaty exemption is not excused from filing. It is required to file and to claim the exemption on the return. The claim is made on Schedule 91, which exists for exactly this purpose, and on Schedule 97 giving the additional information the CRA wants about a non-resident carrying on business here.

This is the single most common error we see on cross-border files. A founder is correctly told that the treaty means no Canadian tax, concludes that means no Canadian return, and discovers three years later that the CRA disagrees about the second half of that sentence.

There is one practical mercy. The late-filing penalty is calculated on unpaid tax, so a return that would have shown nil owing attracts no penalty however late it is. What it does attract is an open year that never starts closing, and a much harder conversation if the CRA later decides a permanent establishment existed after all.

What Counts as Carrying On Business in Canada

This is a domestic law question, and the threshold is lower than most people expect. It is answered before any treaty is considered, because the treaty only comes into play once Canadian law has said the income is taxable here.

Section 253 extends the ordinary meaning. A non-resident is deemed to carry on business in Canada where it produces, grows, manufactures, improves, packages or constructs anything in Canada, where it solicits orders or offers anything for sale in Canada through an agent or servant, or where it disposes of certain Canadian property.

Soliciting orders in Canada through an agent is the wide one. A sales representative in Toronto, even a contractor rather than an employee, can put a foreign corporation into carrying on business in Canada under that provision.

What does not amount to carrying on business is selling to Canadian customers from abroad with no presence here. A company shipping goods into Canada on orders taken on its own website, with no agent, no premises and nobody here, is not carrying on business in Canada for this purpose, whatever its Canadian sales volume. That company may well have HST obligations, which is a separate regime with its own rules.

Permanent Establishment Under a Tax Treaty

Once Canadian law says the corporation is carrying on business here, the treaty decides whether the profits are actually taxable. The business profits article in Canada’s treaties, following the OECD model, allows Canada to tax the business profits of a resident of the other state only where the enterprise carries on business through a permanent establishment situated in Canada, and then only so much of the profit as is attributable to that establishment.

A permanent establishment is a fixed place of business through which the business is wholly or partly carried on. An office, a branch, a factory, a workshop, a mine, a quarry. A building site or construction project counts where it lasts beyond a period set by the treaty, commonly twelve months.

There is also a dependent agent permanent establishment. Where a person acting on the enterprise’s behalf habitually exercises authority to conclude contracts in the enterprise’s name, the enterprise is treated as having a permanent establishment even with no office at all. That provision is missed constantly, and it is the one that catches a company with a single commissioned salesperson in Canada who signs deals.

An independent agent acting in the ordinary course of their own business does not create a permanent establishment. The distinction turns on whether the agent is economically dependent on the enterprise and subject to its detailed instructions.

Certain activities are excluded even at a fixed place: storage, display or delivery of goods, purchasing, and activities of a preparatory or auxiliary character. A warehouse used only to hold stock for delivery is generally outside. A warehouse that also takes orders and handles customer relationships is not.

The Canada-United States treaty adds a services provision. A US enterprise can be deemed to have a permanent establishment in Canada where an individual is present in Canada for 183 days or more in a twelve month period and more than half the enterprise’s business revenues in that period come from services performed by that individual in Canada, or where services are provided in Canada for 183 days or more in a twelve month period for the same or connected projects for customers who are Canadian residents or who have a permanent establishment here.

Branch Tax at 25 Per Cent in Canada

Where a foreign corporation operates in Canada through a branch rather than a subsidiary, it pays ordinary corporate income tax on the profits attributable to the branch, and then Part XIV adds a second layer.

Section 219 imposes branch tax at 25 per cent on the after-tax branch profits that are not reinvested in qualifying Canadian business property. The purpose is to put a branch in the same position as a subsidiary that pays a dividend to its foreign parent and suffers Part XIII withholding on it. Without branch tax, the branch structure would escape the second layer entirely.

Treaties cut the rate. Most of Canada’s treaties reduce branch tax to 5 per cent, matching the direct dividend rate. The Canada-United States treaty goes further and exempts the first five hundred thousand Canadian dollars of cumulative branch profits from branch tax altogether. That exemption is cumulative across the life of the branch rather than renewed each year, which is a point worth understanding before relying on it for more than the first year or two.

The reinvestment allowance matters as well. Branch profits genuinely ploughed back into Canadian business property reduce the base, so a branch building out real operations here may face much less branch tax than the headline calculation suggests.

Where no treaty applies, the full 25 per cent stands. A non-treaty corporation operating through a Canadian branch faces an effective combined rate that makes a subsidiary look attractive very quickly.

Regulation 105 Withholding on Services

This one catches almost every non-resident service provider, and it catches them through their customer.

Regulation 105 requires any person paying a fee, commission or other amount to a non-resident in respect of services rendered in Canada to withhold 15 per cent of the payment and remit it to the CRA. The obligation sits on the Canadian payer, not on the non-resident, and a payer who fails to withhold becomes liable for the amount plus penalties and interest.

Two things make this less painful than it first appears.

First, it is not a tax. It is a payment on account of whatever Canadian tax turns out to be owing. Where the treaty exempts the income because there is no permanent establishment, the entire 15 per cent is refunded on assessment of the T2. The money comes back, eventually.

Second, a waiver can be applied for before payment. Where the non-resident can show the treaty exemption applies, the CRA can issue a waiver relieving the payer from withholding on that engagement. Applying takes time and has to happen before the payment, which is why it is worth raising at the contract stage rather than after the first invoice.

The practical consequence of ignoring it is a cash flow problem rather than a tax problem. Fifteen per cent of every Canadian invoice sits with the CRA until a return is filed and assessed, which on a company that did not know it had to file a return can mean years.

Part XIII Withholding on Dividends and Fees Leaving Canada

Where a Canadian subsidiary pays money back to its foreign parent, Part XIII applies a flat 25 per cent withholding on dividends, rents, royalties and certain management fees, reduced by treaty.

For dividends, most treaties set two rates. A lower rate, commonly 5 per cent, where the recipient is a company owning at least 10 per cent of the voting stock of the payer. A higher rate, commonly 15 per cent, for portfolio holdings below that threshold.

For management fees the position is more nuanced. A genuine fee for services performed outside Canada by the parent is generally business profits under the treaty, and exempt where the parent has no permanent establishment here. A fee that is really a dividend dressed up as a deduction is another matter, and the CRA looks at intercompany charges with that in mind.

Which brings up the point that catches groups more often than the withholding rate does. Section 247 requires transactions between non-arm’s length parties to be priced as arm’s length parties would have priced them. A management fee has to be supportable by reference to what was actually done, and documented. Where it is not, the deduction in Canada is denied and a transfer pricing penalty can follow.

A T106 information return is also required where the aggregate of reportable transactions with non-arm’s length non-residents exceeds the reporting threshold for the year, and that return carries its own per-year penalties.

Branch or Subsidiary for a Non-Resident Founder

The choice comes up on every file and the answer is usually, though not always, the subsidiary.

A branch has one genuine advantage. Losses in the Canadian operation flow into the foreign company’s own results, which matters in a start-up phase where the Canadian activity loses money for a year or two and the parent has profits to shelter. Set-up is also lighter, since there is no new company to incorporate.

Against that, a branch exposes the foreign corporation directly to Canadian liabilities, brings branch tax under Part XIV, requires the foreign corporation’s own affairs to be presented to the CRA on the T2, and makes attributing profits to the Canadian operation an exercise in judgement rather than in bookkeeping.

A subsidiary is a separate Canadian corporation. It is resident here, taxed on worldwide income, files an ordinary T2, has no branch tax, and where the conditions are met can access the small business deduction on its first five hundred thousand dollars of active business income. It ring-fences the liability, and the accounts of the Canadian business are simply its own accounts.

The usual conclusion is a branch for a short, loss-making pilot, and a subsidiary for anything intended to last.

Non-Resident Incorporating in Ontario, and What It Costs

Where the answer is a subsidiary, the next question is where to incorporate it, and for a non-resident founder the answer is usually Ontario.

The reason is directors. A federal corporation under the Canada Business Corporations Act requires that at least twenty-five per cent of its directors be resident Canadians, which a sole foreign founder cannot satisfy without recruiting a Canadian director or entering a nominee arrangement. Ontario removed its resident director requirement, so a corporation incorporated under the Ontario Business Corporations Act can have a board made up entirely of non-residents.

That single difference is why most of the non-resident incorporations we handle are Ontario rather than federal.

The all-in cost is modest and is set out in the calculator above. The Ontario government incorporation fee is three hundred dollars. A NUANS name search for a named corporation is twenty-five dollars. A Canadian registered office address, which the corporation must have and which a founder living abroad does not, runs a thousand dollars for the year. Our professional fee for the filing and setup is thirty-five dollars including HST.

What that figure does not include is the ongoing cost, which is where the real money sits. Bookkeeping, the annual T2, HST returns if registered, payroll if there are employees here, and the registered address each following year.

Deadlines, Penalties and the Cost of Filing Late

A non-resident corporation files its T2 within six months of the tax year end, which is two months later than the general corporate deadline for a resident.

The balance of tax, though, is due two months after the year end. That mismatch trips people up. A return filed within the six month window can still be carrying two months of arrears interest, charged at the prescribed rate plus four percentage points and compounded daily.

The late-filing penalty under subsection 162(1) is five per cent of the unpaid tax plus one per cent for each complete month the return is late, to a maximum of twelve months. Where the corporation was assessed a late-filing penalty in any of the three preceding years and the CRA issued a demand to file, subsection 162(2) doubles it: ten per cent plus two per cent a month to twenty months.

Because both are calculated on unpaid tax, a treaty-exempt corporation filing a nil return years late owes nothing in penalty. That is genuinely the position, and it is the reason a company that discovers the problem should file the outstanding returns promptly rather than agonising over the exposure.

The risk that remains is the reassessment period, which does not start running until the return is filed. Years that were never filed never become statute-barred, and a permanent establishment argument the CRA raises a decade later is one the company still has to answer.

How We Handle a Cross-Border File

We start with two questions: what is actually happening in Canada, and who is doing it. Not the contracts, the activity. Where people are, what they do, who signs what.

From that we form a view on whether the corporation is carrying on business in Canada under domestic law, and then on whether a permanent establishment exists under the treaty. Those are two separate conclusions and both go on the file in writing, because a position taken now may have to be defended in five years by somebody reading the file cold.

Then we deal with the mechanics. The business number and the accounts, the Regulation 105 waiver where one is worth applying for, the structure choice between branch and subsidiary, and the intercompany pricing if there will be charges between the entities.

Where returns are already outstanding, we file them. Almost always that is the right answer and the exposure is smaller than the founder feared.

The fee is fixed and includes HST, set once we have seen the activity and the structure. Payment is by Interac e-Transfer to info@gondaliyacpa.ca, with the security question set to Not Applicable because auto-deposit is enabled.

What This Calculator Does Not Cover

It does not determine whether you have a permanent establishment. That is a conclusion on the facts, applying a specific treaty, and a checklist does not settle it.

It does not deal with GST and HST, which apply on their own rules and can require registration by a non-resident with no income tax presence at all.

It does not model transfer pricing, the T1134 reporting on foreign affiliates, thin capitalisation limits on interest deductions, or the treatment of Canadian real property, which has its own regime including section 116 on disposals.

It does not cover immigration. A founder needing to work in Canada needs a work permit, and that is a separate assessment from the tax position.

And it does not consider the tax position in the founder’s own country, where the Canadian structure has consequences that should be looked at alongside these rather than after them.