Characterization issues arise for tax purposes when a non-resident uses a Canadian professional employer organization

A professional employer organization (PEO) is an unrelated entity that is used to outsource a foreign entity’s human resource (HR) function. The contract between the foreign entity and the PEO might provide that: the PEO acts as the employer of the individuals in Canada for the purposes of servicing the foreign entity’s needs in Canada, and is responsible for all payroll compliance and reporting provided that it is first paid in full by the foreign entity and receives related indemnities; and the PEO is an independent contractor, and not an agent of the foreign entity.

Canadian tax considerations include:

• Leaving aside the PEO relationship, the foreign entity will often in fact be carrying on business in Canada, under Canadian common-law principles or under ITA s. 253 (which includes reference to orders solicited or anything offered for sale through an agent or servant).
• Although many non-resident companies claim that they have no employees in Canada because their arrangement with the PEO is instead a contract for services, this position may be less tenable where stock options and other equity consideration are provided as part of the compensation package.
• Even if the relationship is a contract for services, the dependent agent provisions of the applicable treaty should be analyzed to determine if the foreign entity is thereby carrying on business through a Canadian permanent establishment.
• If the foreign entity provides stock options to a person hired by the PEO, a resulting provision of “remuneration” to the individual may force the foreign entity to register for Canadian payroll purposes, which would create uncertainty regarding whether the s. 110(1)(d) deduction (which requires an agreement of the individuals concerned with their employer or another qualifying person) would be available.

Neal Armstrong. Summary of Hetal Kotecha, “Canadian Tax Concerns Arising from the Use of Professional Employer Organizations,” International Tax Highlights (IFA), Vol. 3, No. 3, August 2024, p. 9 under Treaties – Income Tax Conventions – Art. 5.