Article by Jonathan Wright. Click here for homepage.
So your business is looking to Canada. Maybe your product is on every American desk and you’re in search of a new market. Perhaps you’re eyeing Canadian engineering talent, or you might simply want to take advantage of our lower corporate tax rates.
Whatever the reason, the structure you choose when entering into Canada matters from a tax perspective, and a little foresight can bring substantial benefits. In this note, my purpose is to provide some general ideas on how your northward expansion might best be accomplished from a tax perspective.
There are many options available, but I focus here on two: the Unlimited Liability Company (“ULC”) and the more typical limited company (a “Limited Company”). In Canada both are treated as their own company and are taxed on their own income or losses. The difference here is their treatment under US tax law.
See Through Me
In the United States, though tax will arise and be payable in a Limited Company, tax liability for a ULC (and, more importantly, tax losses incurred by the ULC) flows through to the parent.
Because of its flow-through nature, the ULC is popular for US businesses coming into Canada. Available for incorporation in British Columbia, Alberta and Nova Scotia, these corporations are treated as fiscally transparent under US tax law. In effect, they are treated like a branch of their US parent company.
The benefit here is the flow-through of losses. For a profitable US company expanding into Canada, the ability to use the losses incurred building its Canadian arm against its US corporate income can result in very significant tax savings. Then, once the Canadian business is profitable, the US parent is given foreign tax credits for tax paid in Canada.
Cash and Credits
Another option is the Limited Company. Neither Canadian nor US tax law permits the flow-through of income or losses from these entities. However, there are circumstances where this form is preferable to a ULC, the most common arising in circumstances where the new entity does not expect to incur any losses.
One structure where losses are unlikely to arise occurs when the US parent company sets up a Canadian business to develop its intellectual property. In this circumstance, the US parent would likely pay a service fee, resulting in income in the Canadian subsidiary greater than its expenses.
A Limited Company might be set up this way in order to take advantage of the Canadian Scientific Research and Experimental Development (“SRED”) credits. Broadly speaking, these are tax incentives available to Canadian businesses conducting research and development in Canada. Though more attractive credits are available for companies controlled by Canadians, these are available even for companies owned by foreign parents. And in these circumstances, the Limited Company would have income immediately against which it can use the SRED credits.
More to Consider
There are other factors which your tax professional will consider as you weigh your options. For example, the unlimited liability inherent to ULCs may be an issue. There will also be questions about the debt to capital ratio, and the best method of withdrawing funds from the Canadian subsidiary. Though relatively straightforward for a Limited Company, tax professionals in Canada have had to devise additional steps for withdrawing funds from a ULC in order to obtain the same tax benefits.
If you are considering whether coming to Canada makes sense for your business or are looking for tax advice on the ideal structure for doing so, please do not hesitate to contact the author at firstname.lastname@example.org or 604.678.4459, or visit our homepage at wrightlegal.ca.