International Taxation Explained

1. Tax Residency

Tax residency determines the country in which an individual or corporation is liable to pay taxes. For individuals, residency is often based on physical presence or citizenship. For corporations, it is typically determined by where the company is incorporated or where its central management and control are exercised.

Example: An individual who spends more than 183 days in Canada in a calendar year is considered a tax resident of Canada. A corporation incorporated in the United States but managed from Canada would likely be considered a tax resident of Canada.

2. Double Taxation Treaties

Double Taxation Treaties (DTTs) are agreements between two countries to avoid the situation where the same income is taxed by both jurisdictions. These treaties often include provisions for credit or exemption methods to prevent double taxation.

Example: Canada and the United States have a DTT. If a Canadian resident earns income from a U.S. source, the U.S. taxes that income. The Canadian resident can then claim a foreign tax credit in Canada, reducing the Canadian tax liability on that income.

3. Permanent Establishment

A Permanent Establishment (PE) is a fixed place of business through which the business of an enterprise is wholly or partly carried on. If a foreign company has a PE in a country, it may be subject to tax on the income attributable to that PE.

Example: A U.S. company sets up a sales office in Canada. This office constitutes a PE in Canada, and the company may be taxed on the income generated by that office in accordance with Canadian tax laws.

4. Transfer Pricing

Transfer pricing refers to the pricing of goods, services, or intangible assets transferred between related entities, such as a parent company and its subsidiary. Tax authorities scrutinize transfer prices to ensure they reflect arm's length transactions to prevent profit shifting.

Example: A Canadian parent company sells goods to its U.S. subsidiary. The transfer price set for these goods should be at market value to ensure that the profit is not artificially shifted to a lower-tax jurisdiction, avoiding Canadian taxes.

5. Controlled Foreign Corporation (CFC) Rules

CFC rules are designed to prevent multinational enterprises from avoiding tax by shifting profits to low-tax jurisdictions through controlled foreign corporations. These rules require residents of a country to include in their taxable income a portion of the undistributed profits of a CFC.

Example: A Canadian resident owns 100% of a corporation in a tax haven. Under Canadian CFC rules, the resident must include in their taxable income a portion of the corporation's undistributed profits, even if those profits are not repatriated to Canada.