U.S. businesses expanding into Canada face a handful of business and tax challenges. The first decision that must be made is whether to operate a branch or form a Canadian subsidiary.
Operating a Branch
Operating a branch in Canada simply means that the U.S. business starts conducting business directly in Canada, with the necessary registrations. There are several drawbacks associated with a branch operation:
- First, the U.S. business will be a non-resident of Canada. As such, all services it provides in Canada as well as Canadian source passive income, such as interest, rents and royalties, earned by the U.S. business will be subject to a number of withholding tax rules. Also any taxable Canadian property, which includes land and buildings, will be subject to withholding tax.
- Second, a U.S. business carrying on business in Canada will be required to file a Canadian income tax return and generally be exposed to Canadian tax obligations.
- Third, the U.S. business may also be required to register for and comply with the goods and services tax/harmonized sales tax (GST/HST) and, in the case of British Columbia, provincial sales tax (PST).
U.S. businesses most often form a Canadian corporate subsidiary in order to avoid the above consequences of operating a branch. The Canadian corporation will be a resident of Canada, which will prevent the withholding tax rules referred to above from applying. Another advantage of a Canadian subsidiary is that the subsidiary will bear the Canadian tax obligations rather than the U.S. parent. It will be the Canadian subsidiary that must file a Canadian income tax return and comply with GST and PST requirements.
There are two main choices when incorporating a subsidiary in Canada:
1. The “Ordinary” Corporation
The “ordinary” corporation is the most common business structure in Canada. As a separate legal entity, the assets and liabilities of a corporation belong to the corporation, not to its shareholders. Shareholders may receive dividends from the corporation and are entitled to receive the assets of the corporation upon liquidation once the corporation’s debts and other obligations have been discharged.
Corporations in Canada can be incorporated federally or provincially under comparable legislation with slight variations. The subsidiary can be an ordinary corporation incorporated under the Canada Business Corporations Act (the CBCA) or an ordinary corporation incorporated under the Business Corporations Act (British Columbia) (the BCBCA). A provincially incorporated corporation must first register or obtain an extra-provincial license to conduct business in another province, and a federal corporation must obtain an extra-provincial license to conduct business in any province. If the subsidiary is only going to carry on business in BC, then a BC corporation would be the likely choice.
A corporation is a legal entity with the rights, powers and privileges given to it by its constating documents and governing statute. Corporations created under the CBCA (or corresponding provincial statutes) have the powers of a natural person, with some exceptions. Consequently, a corporation may hold property, enter into contracts and sue and be sued in its own name.
A corporation is managed by its directors. The CBCA requires that at least 25 percent of the directors of a corporation incorporated under the CBCA be Canadian residents. Boards with fewer than four directors must have at least one resident director. The BCBCA does not contain a similar requirement and provides that there need not be any BC resident directors. This is most desirable from a U.S. parent perspective.
The directors may appoint officers (who are not subject to residency requirements) to manage the daily affairs of the corporation. Both directors and officers can incur personal liability if they cause the corporation to act in breach of applicable laws and in some other circumstances.
2. Unlimited Liability Subsidiary Companies
The province of British Columbia allows the Canadian subsidiary of a foreign-owned corporation to incorporate as an unlimited liability company (ULC) under the BCBCA. A ULC operates much like a partnership and, as the name implies, a ULC’s shareholders may face unlimited liability. The shareholders of a ULC incorporated under British Columbia law will be liable for the ULC’s debts and liabilities if the ULC liquidates or dissolves and cannot pay such debts and liabilities. Former shareholders can also be liable in specific circumstances.
Despite the lack of limited liability, U.S. businesses have for years used ULCs as Canadian subsidiaries and to hold Canadian assets. The reason being that ULCs offer favourable tax outcomes for their U.S. shareholders. For Canadian tax purposes, ULCs are treated as taxable Canadian corporations. Under “check the box” rules in the U.S. Internal Revenue Code, however, ULCs may be treated either as a disregarded entity (if it has a single owner) or as a partnership (if it has multiple owners). This treatment provides certain tax benefits for U.S. shareholders.
Although a corporation for Canadian income tax purposes, a ULC may elect to be treated instead as a flow-through entity for U.S. income tax purposes. For this reason, ULCs have been used frequently by U.S. taxpayers for investments in Canada as well as by Canadian taxpayers in U.S. transactions.
British Columbia ULCs, with its potential tax advantages and no resident director requirement, are an attractive structure for U.S. businesses expanding North into Canada. Given the complexities involved, U.S. businesses thinking of expanding into Canada should consult with both Canadian and U.S. tax and legal advisors as to how to structure their Canadian operations. U.S. businesses should consult a U.S. tax advisor to confirm that the U.S. tax benefits associated with a ULC discussed above are available in their particular circumstances and under the latest version of the Canada-U.S. Tax Convention.
What Else to Consider
It is important to note that with the establishment of any business in Canada, including the acquisition of a business, a notification under the Investment Canada Act is required. This is a notice of investment and, provided the business is not of a cultural nature and within the applicable monetary limits, there is, subject to potential national security issues, no further review required.
Starting April 24, 2015 there will be new regulations regarding the notification as much more information than currently is required. The new information sought out by Investment Canada covers the investor (i.e. the new BC company), but more importantly, the owners, officers and directors of the investor.
Tags: Hugh Claxton, Business, Article