Effective for tax years after December 31, 2017, as part of the Tax Cuts and Jobs Act, certain significant changes were made to profits recognition from sales derived from production activities in Canada and furnished to the US (and vice-versa). Previously, the sales were generally sourced based on a 50/50 method. For Canadian businesses that manufactured inventory (wholly or partially) in Canada and sold to the US, 50% of the sales were sourced to the production location and 50% were sourced to where the sale occurred (i.e., where the title to the inventory passed).
Going forward, the new rule requires that sales be sourced entirely based on location of the production, regardless of where the title shifts from the seller to the buyer.
One would think that under the new law gains, profits and income from the inventory produced in Canada and sold to the US will be all sourced back to Canada and none of it would taxed in the US? Wrong! When enacting the law, the Congress was focusing on US companies with domestic production and foreign sales. If there is no permanent establishment in the foreign country where sales happen the US manufacturer would completely escape foreign taxation. Furthermore, even if the US manufacturer has an office in the foreign country which materially participates in sales, the new provision prevents income to be resourced to the foreign country.
The rules applicable to foreign manufacturers with sales to the US happen to work quite differently. For foreign (e.g., Canadian) producers selling to the US, if they have a US office and actively solicit sales in the US, all the income from the sales will be treated as US source despite of the newly enacted source-of-production rule.
This discriminatory treatment is due to an existing overriding section which was in effect under the old method and which was likely not considered given the speed at which the new law was advanced. Hopefully, this oversight will soon be revised. Meanwhile, Canadian companies with productions in Canada and sales to the US must revisit their operating strategy to minimize what is brought under the US taxing jurisdiction.
Please consult your Hanson Crossborder tax professional to assist with your tax strategy.