Canadian businesses and the users of their financial statements are well acquainted with Canadian generally accepted accounting principles (GAAP). GAAP has been based on recording transactions and the related balances at their historic cost, with no subsequent recognition of changes in value. This model has served us well, as the resulting accounting information has been objective and verifiable. During the highly inflationary era of the 1970s, the accounting profession made a brief foray into price-level adjusted financial reporting, but that was soon abandoned as economic conditions changed and it was recognized that the benefits of implementing such a model would not exceed the related costs.

Business travelers can be the life blood of an expanding company, since they bring a company’s products and services to new markets and help a company do business where their customers are located. However, when these business travelers cross international boundaries, they venture into new tax jurisdictions with tax implications to their employer as well as to themselves.

An employee is an integral part of a company. Therefore, when an employee crosses a border, the company is deemed to cross that border as well. If the employee conducts business in another country, the company may be deemed to conduct business due to the activities of the employee.

Most developed countries have tax treaties with Canada. Tax treaties typically have a provision stating that a company of one country (i.e., Canada) will not be taxable in the other country (i.e., United States) unless the company has a permanent establishment in that other country. Treaties typically define a permanent establishment to include a place of management, a branch, a factory, and other defined business endeavours. An employee could inadvertently create a permanent establishment for its employer, unless he/she is carefully advised on what to avoid. However, various jurisdictions do not have treaties. For example, the 50 states in the US are not covered by treaties even though the US federal government is bound by them. If a business traveler crosses into a state and performs activities beyond the mere solicitation of sales (such as services, training, quality control), the company could have “state tax nexus”, potentially creating state income, sale, or use tax exposure.

Employees working in another country may also be subject to income tax in that country. Fortunately, most tax treaties provide exemptions for limited services of employees working across the border. For example, the Canada/US Treaty provides that a Canadian resident employee will not be taxable in the US if that employee passes one of two tests:

The employee’s earnings in the US from that employer do not exceed US$10,000, or

He/she is present in the US for no greater than 183 days during the calendar year and the compensation is not borne by an employer in the US or by a permanent establishment that the employer has in the US.

A protocol to the Canada/US Treaty signed during September, 2007 changes this provision to make it somewhat more restrictive to qualify for an exemption, which could be effective as soon as 2009. Under the protocol, a Canadian resident employee will be taxable in the US under the second test above if he/she is present in the US for greater than 183 days in “any 12 month period” or the compensation is “paid by or on behalf of” a person resident in the US or by a permanent establishment in the US

In addition to the income tax implications, an employee working in another country may create an obligation for the company to comply with payroll reporting and withholding obligations in that other country. For example, a Canadian company has an obligation to report compensation of an employee working in the US, if the compensation allocated to the US work days exceed US$3,400 for 2007. Unless the employee files US federal form 8233 claiming treaty exemption, the employer is also liable for withholding income taxes and reporting and can face severe penalties for failing to comply. Even if the employee files the form, the company must still report the income and the employee must still file a tax return.

The Canadian government has even stricter rules. An employer (whether Canadian or foreign) must withhold Canadian income taxes on compensation paid to a non-resident of Canada for services rendered in Canada, even if the payment is made outside of Canada and the payment is exempt from tax pursuant to a tax treaty. The employer can avoid withholding if the employee or employer obtains a waiver from the Canada Revenue Agency (“CRA”). However, once a waiver application is filed, the waiver can take weeks or over a month to obtain. Even with the waiver, the employer must still file a “Statement of Remuneration Paid” (T4 slip) and the employee must file a Canadian income tax return to report the exempt income.

Many companies unknowingly have “stealth” employees. A stealth employee is an employee who travels across international borders without the knowledge of the company’s tax department. Although a stealth employee may be successful in bringing new business opportunities to a company, he/she can create havoc to the company’s tax situation. The stealth employee can leave a trail of tax problems wherever he/she goes. More sophisticated employers try to capture the stealth employee by getting a list of cross border travelers from their travel services department, who may have access to this information from their records. Tax compliant employers also properly communicate the requirements to comply with the various tax rules to their employees through appropriate internal channels to stress the importance of proper compliance and may hold employees responsible for ignoring their obligations. Many companies also require cross border travelers to complete travel diaries, so that international travel is centrally managed.

The board of directors of a company should be concerned with proper compliance, as failure to comply with payroll withholding could result in personal liability to them. Furthermore, in certain extreme situations, the unrecorded liabilities of failing to comply could result in a qualified audit report. For this reason, complying with business traveler issues should get board level attention.

Complying with the rules and insulating a company from the adverse tax consequences are not impossible tasks. A company can insulate itself from adverse tax consequences by loaning an employee (frequently called “seconding”) to a related company. This may insulate the parent company from the adverse tax consequences and move the tax issues to a company with less tax consequences. Companies are also tracking their cross border employees’ compensation and complying with all the reporting and withholding requirements, and helping their employees with their compliance requirements.

Although it does take an extra effort to be onside with all the rules, proper structuring and compliance allows a company to legally expand into new and profitable business areas, while insulating the company from adverse tax consequences. There is a cost of doing business across international borders. For most businesses, this should really be seen as a small price to pay for new opportunities.

Jim Yager is the practice leader for KPMG in Canada’s International Executive Services (“IES”) Practice. IES provides tax planning and compliance services to high net worth individuals, employees and their employers on cross border tax issues. Jim Yager may be reached by phone at 416.777.8214 or by e-mail: jyager@kpmg.ca.