U.S. tax law provides that every corporation subject to taxation must file a return. In the case of a Canadian corporation engaged in a trade or business in the United States at any time during the taxable year, Form 1120-F must be filed. This requirement applies even in
situations where the corporation finds that its income is exempt from tax by virtue of a treaty. U.S. tax law generally provides that a foreign corporation that takes a position that a treaty overrules or modifies U.S. tax law is required to disclose the position by making certain filings with the IRS.
If a Canadian corporation has a U.S. Trade or Business and has no Permanent Establishment in the United States it has no U.S. tax liability under the protection of the Canada-U.S. Tax Treaty. However, the Canadian corporation must file Form 8833 along with Form 1120-F (completing only the relevant administrative information) in order to notify the IRS of the treaty-based position. Failure to file the appropriate U.S. tax forms and required information on a timely basis may result in losing tax treaty protection and potentially expose the corporation to severe penalties.
From a Canadian corporation’s perspective, it’s often beneficial to err on the side of enterprise risk management and file Form 1120-F for the following reasons:
1) It protects the benefit of deductions in the case that a U.S. liability is subsequently found to exist. A foreign corporation only obtains the benefit of claiming deductions for ordinary and necessary expenses incurred in generating income if it files a return, including all required information; and
2) It starts the statute of limitations for the year. This is a standard rule and applies to all taxpayers. Perhaps it is most relevant in the context of financial statement reporting, where, depending on the particular accounting rules, the assessment of liability may be based on different considerations. As a corporation assesses its exposure for U.S. income tax, it can be comforting to be certain that it need only assess risk for ‘open years’ as opposed to needing to review all years in which it has, or may have, had some connection to the United States.