Easing short-term tax pain on U.S. workers

Importing talent from south of the border can be expensive, but close attention to tax rules can ease the burden

Canadian organizations are becoming increasingly dependent upon foreign workers to help them remain competitive in the global marketplace. For example, petroleum companies in Alberta are importing professional white collar and skilled workers from the United States and other countries to address the boom in extraction and related development. As some of Canada’s top talent emigrates in search of global experience, employers in Canada are seeking the expertise of foreign workers to meet their immediate and future business development needs.

Importing employee talent to Canada can be an expensive alternative for an employer, especially in the absence of advanced tax planning and special attention to the tax rules on both sides of the border. This article is concerned only with such instances where the transferee maintains residential ties to the U.S. Significant additional complications arise when residential ties are established in Canada, and should be discussed with an income tax advisor.

The vast majority of U.S. employees that arrive in Canada are here on a short-term assignment basis — typically considered to last less than two years. In order to protect the short-term assignee from loss of home-country employee benefits, it is important to offer continuation of the employee’s U.S. payroll benefits and social security coverage while complying with Canadian laws. Also, since the family home may continue to be maintained, and the family may not relocate with the employee, temporary housing may be offered by the employer. These benefits, if planned properly, can be provided tax effectively.

Secondment arrangements

When transferring an employee on short-term assignment, effective continuation of home-country benefits can be achieved through a “secondment arrangement.” This is used to temporarily “borrow” a U.S. employee from a U.S. company to work at a related company in Canada for a specified period rather than hiring that U.S. employee directly to Canada. Secondment arrangements facilitate the continuation of U.S. payroll, and ensure that the employee continues U.S. benefits.

Canadian taxes still apply

Under this procedure the U.S. company remunerates the employee through U.S. payroll on behalf of the Canadian company. The Canadian company then reimburses the U.S. company for that remuneration, plus any related expenses. The U.S. company maintains the employment relationship throughout the period of secondment. The Canadian company must also report the remuneration element of the reimbursement as compensation for Canadian payroll purposes. Appropriate withholdings and remittances for Canadian taxes apply as if the employee were a Canadian resident.

The Canadian component of this simultaneous participation in the payroll of two jurisdictions is called a “shadow” or “phantom” payroll. The Canadian company reports compensation but does not pay the employee directly. For the length of the assignment, Canadian reporting form T4 should reflect only the Canadian source employment income and the withheld Canadian tax remitted to the Canada Revenue Agency. The U.S. form W-2 should report the employee’s global employment income, the amount of U.S. federal and state tax withholdings remitted, and the U.S. social security taxes withheld and remitted.

To avoid double-payment of income tax withholding and employer contributions to social security:

•the employer may request a certificate of coverage from the U.S. Social Security Administration exempting it from Canada Pension Plan contributions;

•the employer may document continuation of unemployment coverage in order to waive Canadian employment insurance premium payments; and

•the employee may complete Form W-4 to eliminate U.S. income tax withholding on wages paid for services rendered outside the U.S., which are subject to foreign withholding taxes.

Note that if a Canadian company reimburses a U.S. company for the services of an employee in Canada, the reimbursement itself is subject to a 15-per-cent Canadian withholding tax. This withholding tax can be eliminated, however, by strictly following the guidelines of a newly released Canada Revenue Agency Information Circular — IC 75-6R2 — detailing the requirements of a secondment arrangement.

Housing

Effectively providing temporary housing benefits to short-term assignees can also be challenging given the intricacies of the two jurisdictions’ systems.

Generally, temporary living expenses provided or reimbursed by the employer are considered taxable compensation to the employee for both Canadian and U.S. income tax purposes. However, the tax laws do provide some exceptions to allow for the effective provision of temporary housing benefits.

Tax exempt allowances

In Canada, reasonable allowances paid for board, lodging, and home leave in connection with a short-term assignment under specific situations are exempt from taxation under section 6(6) of the Income Tax Act. If the requirements are met, the employee should file Form TD4 with the employer and the employer can exclude these amounts from the employee’s Canadian T4 slip.

The U.S. provisions allow for “travel expenses away from home” to be excluded from income. These can include expenses for travel, meals, and lodging and are deductible from income (or excluded from income if expenses are reimbursed) if the taxpayer meets several requirements. These include that he be away from home for a period not exceeding 12 months, and be able to substantiate the expenses incurred, or receive a qualified per diem amount.

Tax equalization

Last, but certainly not least, careful consideration should be given to the impact of personal income tax compliance requirements. U.S. tax law allows a U.S. resident, who is taxed on global income, to take a credit against those U.S. taxes for taxes paid on income earned in Canada. Canada has the first right to tax employment income earned in Canada by a non-resident. No credits, therefore, are allowed in Canada.

This further complication allows for another avenue for an employer to offer assistance to the transferee. The implementation of a tax equalization program would allow the transferred employee to continue incurring a tax liability as though he had never left the U.S. by virtue of a hypothetical withholding tax equal to the tax he would have paid had he not taken the assignment. performed by the company. The employer would pay all actual taxes related to the assignment, and enjoy any tax savings arising as a result of effective compensation planning and foreign tax credits.

While only a few of the major complications of the short-term assignment have been discussed here, the complexities of payroll and tax legislation pose significant challenges to employers in Canada willing to acquire foreign talent. Payroll managers would be wise to consult tax planning professionals to ensure arrangements are properly implemented, and compliance is ensured in order to avoid future problems for both their organizations and their short-term assignees.

Tim Verbic is the national director, business development and marketing with Royal LePage Relocation Services in Toronto. He wishes to thank Samir Adatia of KPMG’s International Executive Services group for his assistance with this article. Tim can be contacted at [email protected] or visit www.rlrs.com.

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