Hiring a professional with prior U.S. payroll experience might make for easiest transition when adding staff south of the border
When Exova, an international materials testing company based in Mississauga, Ont., acquired a thermal processing company to expand its business, 300 American employees were added to the payroll.
The additional employees became Lynne Harkness’ responsibility and she had to make sure the transition was seamless.
But she knew nothing about American payroll.
“The first thing I did was hire someone who did,” says Harkness, human resources manager of the Americas at Exova.
“What I did is I used the logic that I use here in Canada when I do an implementation. There’s certain best practices that you follow when you’re taking your payroll from one system to another,” she says. “Even though I may not know exactly what’s taxable and how everything works down there... I applied the same principles in setting up all of the accounts and making sure the year-to-date balances came over... inspecting through it with a fine-tooth comb.”
When a Canadian company makes the decision to take on American employees, whether the company is expanding its business into the U.S., or it’s taking on someone living south of the border, Harkness suggests joining an American payroll organization.
“I wanted to have a resource of information, so I joined the (American Payroll Association),” Harkness says, pointing out the Canadian Payroll Association also provides courses on American payroll. “I felt like I wasn’t alone. I had somebody to reach out to. I’ve gone to their conferences three times now, which helps me learn about different things that I might not be exposed to on a day-to-day basis.”
Having U.S. employees can be compared to having employees in Quebec, says Edward Rajaratnam, manager of human capital at tax firm Ernst and Young’s Toronto office. Residents who live in all provinces except Quebec have only one withholding on their payroll that goes to the Canadian Revenue Agency (CRA). The federal government then distributes the tax to each province accordingly.
“Quebec is the only province that has a separate tax regime. That means payroll obligations are also separate.” he says. “In the U.S., every state is similar to Quebec.”
If someone is working in the U.S. as a domestic employee, they will have two withholdings. There will be a withholding on the federal level with another withholding at the state level, with some exceptions.
“In the U.S., 95 per cent of employees will be filing two tax returns because the payroll withholdings would have been done in two buckets,” Rajaratnam said, noting it’s a difference that becomes pretty obvious when a company takes on a new employee based in the U.S.
Third-party companies offer software that allows an employer to categorize employees by region so the appropriate tax can be charged per employee.
“What’s very common here in the U.S. is for (a company’s) payroll function to be outsourced,” says Rafael Carsalade, director of tax at Pannell Kerr Forster of Texas, P.C. in Houston. “Usually when you hire these companies, they make it very easy because they’ll ask you where the employee is located.”
This is what Harkness has done with her company.
“Right now, I’m using Ceridian,” she says. “In my payroll, I have three different companies. I have one for Canada and the U.S. side is split up into two companies: one for salaries and one for hourly. There are two people that run it off the same system. So it really is like two systems in one.”
Canada and the U.S. first signed a tax treaty in 1980 in order to avoid double taxation and prevent fiscal evasion with respect to taxes on income. The Canada-United States Convention with Respect to Taxes on Income and on Capital ensures a resident of one country is not taxed by each of the two countries on the same income in the same year.
“When (a company is) expanding to the U.S. and they are (sending workers to be) physically working in the U.S., even though they are Canadian residents, even though they are Canadians, the first rite of tax is going to be in the U.S. for that income,” Rajaratnam says.
He is also quick to point out that should a Canadian employer have an employee working outside of the country for an extended amount of time, it may be required to apply to the CRA for special permission to have income tax paid out to another jurisdiction. This ensures companies will show all income paid out to an employee for the duration of the employee’s time with the company.
Benefit deductions differ greatly
One of the greatest challenges for Harkness was familiarizing herself with the different deductions in the U.S.
“When you have a Canadian payroll, you’re looking for provincial tax, you’re looking for federal tax, you’re looking for EI… you know what the maximums are and you can easily spot something that’s wrong,” she says.
Benefit deductions are what surprised Harkness the most.
“The benefit deductions are far different than the Canadian benefit deductions because benefits down there cost thousands of dollars where it might be hundreds up here,” she said. “If you’ve made an error up here with deducting somebody’s contribution to their dental plan, it might be $30. But down there, it might be $300.”
There is another treaty that exists similar to the income tax treaty, called the Agreement on Social Security between Canada and the United States, according to Rajaratnam.
“You need to get a certificate of coverage to tell the U.S. government that you’re covered under the Canadian (pension) plan,” he says. That way, the employee will not need to pay in to U.S. unemployment insurance or Medicare.
A small scale expansion will be easier than a larger one and speaking to a consultant or lawyer is the best way to identify ways to keep costs down for both the employer and the employee, Rajaratnam suggests.
“When you talk about cross-border (business), every item that is taxable in Canada is not necessarily taxable in the U.S.,” he says.
If an employer sends one of its workers to the U.S. and provides a housing allowance, but that individual’s family remains in Canada, an employer may mistakenly tax the housing allowance, Rajaratnam says.
“People end up taxing all that without even thinking is the item taxable or not?” he says.
Unless a business has a long history with employees on both sides of the border, it’s difficult to know all the tax differences, Rajaratnam says.
“We’re talking about compliance, but are there also opportunities to make sure that we can reduce the taxable income?” he says. “The usual payroll departments do not necessarily have the infrastructure or the resources to be specialists in cross-border (payroll).”