Tax Treaties & Canadian Business Expansion

Today I’m continuing the series on cross-border expansion for Canadian businesses. This week it’s a quick commentary on tax treaties. Captain Obvious says: Tax treaties matter! This is especially true for companies considering expansion into the United States. The nuances of these treaties can significantly influence your decisions around entity choice, tax obligations, and overall expansion strategy.

Understanding the Impact of Treaties

Tax treaties are agreements between two countries that dictate how a resident of one country is taxed on income derived from the other. For businesses expanding to the U.S., the treaty between Canada and the United States serves as a critical guidepost. This treaty plays a pivotal role in dictating the type of entity or non-entity you may choose for your business operations in the U.S. If you want to read the Treaty in its entirety, go HERE. It’s thrilling stuff.

Active vs. Passive Income and Treaty Implications

The classification of income as active or passive can lead to different treatments under the treaty. Active business income, such as revenue from sales or services provided in the U.S., is generally considered U.S. “effectively connected income.” This classification brings the business under the U.S. reporting regime, even if the treaty protects the business from tax. On the other hand, passive income like dividends or interest may fall under different treaty provisions, influencing withholding tax rates and reporting requirements.

Choosing the Right Legal Entity

Choosing the appropriate legal entity when expanding to the U.S. is crucial. Each entity type, from corporations to partnerships, comes with its own set of implications under the U.S.-Canada Tax Treaty. Caution: US advisors will default to telling Canadians that a US LLC should used for a startup business. And while this can be done, it has a nasty, nasty, nasty little side-effect for Canadians. Make sure you do your research here. (Remember, “Surprise” is a bad word.)

Navigating State-Specific Considerations

It’s important to remember that state tax laws in the U.S. can differ from federal laws. Each state has its own rules, referred to as ‘Nexus,’ which determine tax obligations based on the level of business activity within that state. So not only do you need to consider US Federal tax filings, there may also be individual US State filings as well.


Tax treaties matter. They will dictate what paperwork needs to be done (And there will likely be a ton of paperwork if you’re thinking of getting into the cross-border world.) Be prepared, be organized, and like you always hear me say, set up your tax life so you never have the problem in the first place.