This article was originally published on August 19 2019 by The Lawyer’s Daily (www.thelawyersdaily.ca), part of LexisNexis Canada Inc
If you’re a Canadian resident working for a U.S. company in Canada, there are a multitude of crossborder implications regarding employment law, payroll reporting, income taxes and Social security taxes. The evolution of the professional employer organization (PEO) since the 1980s has become a popular solution for U.S. and Canadian employers when employing remote workers.
PEOs make up a billion-dollar industry. What began as a provider of payroll services evolved to a provider of virtually all HR management functions and it could affect tax responsibilities. Many people, lawyers included, are not familiar with PEOs.
PEOs involve leased employment agreements with a company in which the PEO acts as the legal employer through a co-employment relationship and the PEO is responsible for hiring, firing, payroll, benefits administration, etc. In the U.S., there are more than 900 PEOs employing about 3.7 million people and the number is growing. In Canada, the concept is relatively new, with only 177 PEOs operating as of 2017.
While there are benefits in choosing the PEO route, the arrangement can lead to confusion about tax liabilities and determination of joint employment regarding who is liable for certain taxes, such as for unemployment and workers’ compensation. There may also be confusion about whether income paid to employees is exempt under a tax treaty.
The U.S. Department of Labor recently proposed a new standard to test the relationship between a PEO and its “client” in terms of joint-employer status. It is deemed to be joint employment if the
PEO meets any of these conditions:
- Hires or fires the employee.
- Supervises and controls the employee’s work schedules or conditions of employment.
- Determines the employee’s rate and method of payment.
- Maintains the employee’s employment records.
Here is how the Canadian PEO works for a U.S. company. The company enters into an agreement with the PEO to “lease” an employee. The PEO is the legal employer, responsible for payroll,
benefits, employment standards and other HR management functions, while the U.S. company retains daily oversight of the employee (i.e., common law employer). This allows the company to
hire the talent it needs and to manage the employer’s regulatory requirements at a reasonable cost with little disruption to the business.
Let’s say a U.S.-based company — we’ll call it ABC Inc. — employs a Canadian resident remotely in Canada; we’ll call him John. How does ABC Inc. manage John’s payroll and HR matters? Should
ABC Inc. hire a Canadian payroll expert or an employment lawyer to keep it out of trouble? It might because Canada has a different framework than the U.S. for employment law.
So ABC Inc. enters into an agreement with the Canadian PEO to effectively lease John. But what happens, in terms of taxation, if he travels to the U.S. to meet clients or attend meetings? Who is
the employer when it comes to determining if his remuneration is eligible for a treaty exemption under Article XV of the United States – Canada Income Tax Convention (1980)?
In this case John lives and works in Canada, but his “functional employer” is ABC Inc. even though a Canadian-based PEO administers his payroll and benefits. So when he travels south of the
border on business he is advised that he is covered under the treaty because his “legal employer” is in Canada. Therefore, John doesn’t have to pay income tax in the U.S.
John assumes he is exempt from U.S. taxation because his compensation earned while working on U.S. soil is paid by the Canadian PEO. Here’s what the treaty says according to subparagraph
XV(2)(b): If the compensation is not paid/borne by a U.S. resident and the employee doesn’t spend more than 182 days in the U.S. during any 12-month period beginning or ending in the
year, the compensation earned while on U.S. soil will be exclusively taxed in Canada, the employer’s country of residence.
That sounds straightforward. John gets paid in Canada. He pays tax in Canada. He does not meet any of the U.S. residency tests and continues to be a tax resident of Canada. Also, the PEO is
based in Canada and is not a U.S. resident.
Unfortunately for John, the relationship between ABC Inc. and the Canadian PEO constitutes a joint-employer relationship and ABC Inc. is a U.S. resident. That means the “borne by” test of the
treaty is met. So, despite being a Canadian resident who lives and works in Canada, John is still working for a U.S. company and any compensation allocated to time spent working on U.S. soil is
subject to taxation by Uncle Sam, assuming his compensation during the year exceeds the treaty threshold of US$10,000.
What is the upshot of all this? If you are a company in a cross-border PEO arrangement or an employee under this arrangement, understand what joint-employer status means and the possible
cross-border implications for income taxes and Social Security taxes. Will the PEO administer the U.S. payroll obligations in addition to the Canadian? What if a U.S. state does not follow the
This is where the advice of a cross-border tax expert is highly recommended.