Why is the W-8BEN-E Form required?
Foreign partners of United States companies are subject to the 30% withholding tax on U.S. source income and must complete the Form W-8BEN-E in order to comply with the Fair and Accurate Credit Transactions Act, or FATCA. For individuals (ex. sole proprietorship in your own name), you’ll need to complete Form W-8BEN.
FATCA requires any foreign company that receives payments from U.S. sources to complete the new Form W-8BEN-E and submit the form to the American payor, who must then withhold a flat 30% of the amount they pay to the foreign company. The payor then remits this withholding tax to the American government.
This reporting requirement was created in response to the increasingly popular and complex schemes employed by American taxpayers who shift income offshore through foreign businesses and investments firms in order to avoid paying tax. Some tax avoidance schemes may employ overseas partners, including Canadian firms with beneficiary owners located in the United States.
These provisions place emphasis on the type of business operations and transactions rather than the form designed to enable tax avoidance or evasion. This focus translates into the Form W-8BEN-E, which has sections dedicated toward Foreign Financial Institutions, or FFIs. All businesses not constituting (in substance or form) a foreign financial institution are referred to as Non-Financial Foreign Entities, or NFFEs.
How to complete W-8BEN-E Form for a Small Canadian Corporation?
The following guide provides an example of how a Canadian Corporation can complete the US W-8BEN-E form requested by their customer/client in the US. Please note that the way the sample form below is filled out does not apply to all Canadian companies and should be used as a reference only. For reference, here are the IRS’s full instructions on how to complete the W-8BEN-E form.
- Part I 1 Enter your corporation’s name
- Part I 2 – Enter the country of incorporation (“Canada”)
- Part I 4 – Check “Corporation”
- Part I 5 – Check “Active NFFE. Complete Part XXV” See Definition of Active & Passive NFFEs.
- Part I 6 – Enter corporation’s address
- Part I 9b – Enter 9 digit CRA business number (XXXXXXXXXRC0001)
- Part III 14a – Enter “Canada”
- Part III 14b – Check “Company with an item of income that meets active trade or business test”.
- Part XXV 39 – Check to certify that the corporation is an active NFFE. See Definition of Active & Passive NFFEs.
- Part XXX – Sign, print name & date form.
How Canadian companies can avoid the 30% tax
These requirements do not drastically impact private Canadian businesses that transparently and ethically provide services to American customers. In order to remain in compliance with FATCA, businesses engaged with clients across the U.S.-Canada border should file the proper paperwork in order to avoid this flat tax.
1. Have a permanent establishment in Canada, but not in the US
Article VII, Business Profits, of the Canada-U.S. tax treaty provides that:
1. The business profits of a resident of a Contracting State (Canada or US) shall be taxable only in that State (country) unless the resident carries on business in the other Contracting State through a permanent establishment situated therein. If the resident carries on, or has carried on, business as aforesaid, the business profits of the resident may be taxed in the other State (country) but only so much of them as are attributable to that permanent establishment.
According to Article V, examples of a permanent establishment (fixed place of business) are (but not limited to): place of management, office, branch, factory, workshop, mine/quarry. This provision allows some individuals and businesses operating wholly or in part in the jurisdiction of the other party to the treaty to avoid the 30% withholding tax by establishing permanent establishment.
So for a Small Canadian Corporation which actively operates a business in Canada, only has a permanent establishment(s) in Canada and provides services to U.S. customers as part of ordinary operations is therefore exempt from all U.S. government filings, tax payments and withholdings. They only have to report income and pay the respective taxes in Canada.
2. Be classified as an Active NFFE
Company with an item of income that meets active trade or business test
Form W-8BEN-E distinguishes an Active versus Passive NFFE to determine appropriate tax treatment. In order to qualify as an active NFFE, the entity must satisfy the conditions below as outlined by the form:
- The entity must not operate in substance or form as a financial institution;
- Less than 50% of gross income from the preceding calendar year may arise from passive income; and
- Less than 50% of the assets generate or are held for the production of passive income.
Under the current interpretation of Chapter 4 of the Internal Revenue Code, entities meeting all of the above conditions avoid the 30% withholding requirement. Most active businesses operating from Canada and providing services to American clients will satisfy the above conditions and avoid the respective withholding requirements.
Over to you
We’re interested to know, what kind of business do you do with US companies? Is your business exempt from the withholding tax? Let us know in the comments!