CANADA BUSINESS

In so far as the attractiveness of a country's investment climate is determined by factors such as access to sizeable markets, labour force quality and availability, capital costs, regulatory environment, and business infrastructure, Canada could certainly be seen as one of the world's front runners. The country has a small but relatively affluent domestic market, and shares close economic ties with the US. A well developed and efficient transportation infrastructure and plenty of natural resources (including arable crops, timber, crude oil and natural gas, copper, zinc, iron ore, and fish!) offer support to the business community, and in annual Global Competitiveness Reports, Canada's information technology and communications infrastructure usually figures highly.

But there are other factors to be considered - how attractive is the taxation regime for foreign investors, both on a corporate and a personal level? What are the incentives on offer in terms of taxation and government assistance? In this article we will be looking at the ways in which foreign corporations can do business in Canada, and the taxation implications of each choice.

Corporate Taxation In Canada

Corporations resident in Canada are liable for taxation on their world-wide income, but a non-resident corporation is liable only on income from business carried out in Canada, and disposal of 'taxable Canadian property' (which includes but is not limited to: real and resource property situated in Canada, shares of a Canadian corporation other than a widely traded public corporation, shares of a resident private corporation, capital property used during the course of Canadian business, and certain interests in partnerships or trusts).

The rate of corporate tax in Canada is 38%, but after a 10% federal abatement and a 8.5% rate reduction are deducted, the gross corporate tax rate in 2008 is 19.5% (having been cut from 21% in 2007). The gross corporate tax rate is due to fall to 19% in 2009, 18% in 2010, 16.5% in 2011, and 15% in 2012.

Investment income (other than most dividends) is subject to tax at the federal rate of 29.1%, in addition to a refundable federal tax of 6.7%, for a total federal rate of 35.8%.

More comprehensive information on corporate tax rates is available from the Canada Revenue Agency website.

Provincial and territorial corporate tax rates are added to the basic rate, and vary between less than 2.5% and 16%. In some provinces (eg British Columbia) taxation rates are reduced for manufacturing or processing income earned by any corporation. A proportion of capital gains are added to income for tax purposes. Private corporations are subject to a 33 1/3 % tax on dividends received from a company in which they have less than a 10% holding (portfolio investment).

A tax on corporate capital which was particularly unpopular with Canadian corporations was dropped in the 2003 budget, being phased out over a period of 5 years.

In November 2004, the Canadian Council of Chief Executives urged the government to usher in a fresh round of corporate tax cuts to help insulate business against unfavorable underlying economic factors, and ensure that Canada maintains a competitive edge.

“The time has come for a second major round of tax reduction, this one with an initial focus on corporate taxation,” the CCCE argued in its pre-budget submission to the House of Commons Finance Committee.

“The choices that Canada makes on corporate tax policy will have a huge impact on how quickly Canadian enterprises adapt to a higher dollar, and on the extent to which their responses maintain and add to employment in Canadian communities,” the group warned at the time.

The Council noted that while Canada's headline corporate tax rate was slightly lower than that of the United States, the effective tax rate faced by Canadian firms was in actual fact much higher.

The executives also expressed concern that the tax gap between Canada and its neighbour will continue to grow as a re-elected George W. Bush seeks to push through further tax cuts and regulatory reform.

Citing data released by the IMD World Competitiveness Yearbook for that year, the Council observed that Canada had the fourth highest corporate tax rate of the 60 countries featured, yet ranked 33rd in terms of tax collected as a share of the economy. By comparison, Ireland, with a corporate tax rate of 12.5% is said to collect 25% more revenue than Canada.

“In today's world, high corporate taxes simply do not pay,” argued the CCCE.

“Smart corporate tax policy therefore should be front and centre in the next federal budget,” the Council concluded.

When budget time arrived, in February 2005, Finance Minister at the time, Ralph Goodale announced that some of the government's fiscal surplus was to be shared out in corporate and personal income tax cuts. Under the proposals contained in the budget, corporate income tax would be reduced by 2% to 19% by 2010. This would be done in steps, beginning with a cut to 20.5% in 2008, to 20% on 2009 and finally to 19% in 2010. The corporate surtax would also be eliminated in 2008, Goodale announced.

In June, 2005, Ralph Goodale said that the government would stick to its promise to cut corporate tax, despite being forced to abandon budget plans as a result of political pressure.

Jim Westlake, Chair of the Board of the Canadian Chamber of Commerce, said stated that his members were "deeply worried" that the extra spending forced on the government in order to get its plans through would leave little or no room for the promised tax cuts.

"Bill C-48, the budget amendment that fulfills the terms of the Liberal-NDP agreement at the expense of corporate tax rate cuts, was concluded quickly and with little effort to determine whether the new spending initiatives are effective in boosting productivity and fostering long-term economic growth," the Chamber noted in a letter issued to Goodale.

In the event, the government lost a confidence vote in November, and lost the subsequent election in early 2006, leaving the plans for further corporate tax cuts in tatters.

In November, 2006, the Canadian Supreme Court struck a blow against the government's General Anti-Avoidance Rule (GAAR) by ruling that transactions structured to legitimately minimise tax payments do not constitute a breach of the law.

In the case of the Queen v. Canada Trustco Mortgage Company , the transaction at issue was a leveraged sale-leaseback which resulted in the taxpayer having minimal economic risk.

Finding in favour of the taxpayer, the Supreme Court decided that the transaction in question was not structured illegally and, therefore, found that it did not fall outside the "object, spirit or purpose" of the capital cost allowance provisions of the Tax Act.

Crucially, the Court also stated that the Tax Act continues to "permit legitimate tax minimization" and that the GAAR should be applied in a "consistent, predictable, and fair" manner to provide certainty for the taxpayer.

Introduced in 1988, the GAAR was intended to act as a catch-all anti-tax avoidance measure which compelled taxpayers to comply not just with the letter of the law, but with the spirit of the tax legislation.

"It's an extremely important case,” observed Alan Wheable, senior vice-president of taxation for Toronto-Dominion Bank, the parent company of Canada Trustco Mortgage Company.

“I think it's reassuring to both regular taxpayers and the government, because I think it indicates that the government can't do whatever it wants [even though] there are definite limits on taxpayers," he added.

In his March 2007 budget, Finance Minister Jim Flaherty announced that that he would eliminate the deductibility of interest on debt taken on by companies to finance foreign affiliates to stop companies claiming deductions both in Canada and the country where they are making acquisitions.

However, the proposal provoked an outcry from businesses and tax experts, who warned that the move could severely hamper Canadian firms' ability to compete in both the international and domestic market place.

As a result of this outcry, Mr Flaherty was obliged to clarify his proposal, insisting that the plan was aimed only at firms exploiting offshore structures to 'double dip.'

"If one looks at what I've said, every time I've spoken on this topic, I've said the focus and target is on double-dipping, that is double interest deductions by corporations using tax havens," Flaherty told reporters.

He also added that: "We are going to make illegal the use of double deductions and tax havens. They will have the benefit of a single deduction."

"It's about tax fairness. This is a continuing issue in Canada that if we're going to lower taxes overall for individuals and for corporations then we must have tax fairness - that is everybody must pay their fair share and you don't pay your fair share if you're using a tax haven and taking a double dip."

The 2008 budget provided further assistance for Canada’s manufacturing and processing sector by extending accelerated capital cost allowance (CCA) treatment for investment in machinery and equipment for three years. Specifically, the 50% straight-line accelerated CCA treatment will apply for one additional year, and the accelerated treatment will then be provided on a declining basis over a two-year period.

The government also announced measures to support the small and medium-sized businesses by improving the scientific research and experimental development tax incentive program and easing the tax compliance burden by reducing the record-keeping requirements for automobile expense deductions and taxable benefits.

In addition, the 2008 budget enhanced the cross-border business and investment environment by streamlining cross-border tax-withholding and return-filing rules.

In May 2008, the Advisory Panel on Canada’s System of International Taxation issued a consultation paper, 'Enhancing Canada’s International Tax Advantage.'

The creation of the Advisory Panel was announced by the government in November 2007. Its goal is to help guide the establishment of an international tax policy framework respecting foreign investment by Canadian businesses and investment into Canada by foreign businesses.

“With increasing globalization comes more competition from foreign businesses,” noted Peter C. Godsoe, the Panel’s chair. “Our panel’s goal is to ensure Canada’s system of international taxation maintains its support for Canadian businesses as they compete abroad, while continuing to attract new foreign investment to Canada.”

The paper poses a series of questions about Canada’s international taxation system, sets out some of the Panel’s initial views and invites public comments on how to improve the competitiveness, efficiency and fairness of Canada’s international taxation system.

Registration Without 'Permanent Establishment'

There are several ways in which foreign corporations can do business in Canada (excluding Canadian Controlled Private Corporations or CCPCs, which are not really of interest to foreign companies). Each involves various degrees of residence and establishment, and has very specific advantages and disadvantages. The first of these is registration in Canada without a 'permanent establishment' (such as a branch, office, or place of management) there. Any company wishing to do business in Canada must first be incorporated, under Canadian federal or provincial legislation, or in a foreign country. A company wishing to do business in the country without setting up a permanent establishment should, for the purposes of registration, be classified as an 'extra provincial corporation': this term is used to describe a company registered in a Canadian province other than the one in which it is doing business, but it can equally apply to a corporation registered in a jurisdiction outside Canada.

If applicable to the kind of business or service being provided by the non-resident entity, this structure can sometimes prove advantageous from a taxation point of view if the non-resident's country of origin has a double taxation agreement with Canada. Many treaties provide that the profits of the foreign corporation doing business in Canada will only be subject to Canadian income tax if the activity takes place through a 'permanent establishment'; thus, no Canadian tax will be payable. With this type of structure, start-up costs can also sometimes be utilised against income tax in the foreign entity's home country.

However, if there is no bilateral tax agreement between the two countries, then even if there is no permanent establishment in Canada, the corporation's taxable income will generally be subject to a combined federal and provincial tax. Also, legal liabilities may be greater, and must be borne by the non-resident company, and the lack of a permanent establishment in the country may severely prejudice the corporation's chances of receiving government assistance.

Canadian Subsidiary Corporation

Another, perhaps more usual way of doing business in Canada for a foreign corporation is to establish a Canadian subsidiary corporation. The subsidiary will be subject initially to a combined federal and provincial corporate income tax of up to 38% (as corporate taxation rates do vary from province to province), and then to withholding taxes (which vary according to applicable double tax treaties) on the repatriation of dividends to the home country. However, there is no obligation to repatriate Canadian after tax profits, and if left to accumulate in Canada, they may eventually be realised by the sale of shares in the subsidiary corporation. Although the shares sold in this eventuality would undoubtedly be classed as 'taxable Canadian property', and would thus fall under the Canadian capital gains net, tax treaties, if they exist between Canada, and the foreign entity's home country may again save the day.

The use of a subsidiary corporation is generally more convenient for registration, administration and compliance purposes, and the foreign parent company will be insulated to a certain extent, in that its liability will usually be limited to its investment in the subsidiary. A subsidiary also provides a greater degree of flexibility, in that Canadian corporate reorganisation rules can be utilised to permit reorganisation without immediate tax consequences. However, non-residents seeking to finance Canadian subsidiaries often prefer to do so through debt rather than equity in order to maximise interest deductions against Canadian income (called 'thin capitalisation'), and Canadian tax laws restrict the degree to which this device can be used. The thin capitalisation rules are sometimes a powerful reason for not incorporating in Canada.

Canadian Branch Office

Some international companies looking to set up operations in Canada choose to establish a Canadian branch office, for reasons that will be explained later. Branch offices are subject to the same level of combined federal and provincial corporate income tax as subsidiaries, and in order to equalise the Canadian tax consequences between these two major options, the branch's after tax profits are then subjected to a 'branch tax' (currently around 25%) unless reduced by a treaty. However, earnings reinvested in Canadian assets are not subject to the tax; also, certain organisations, including banks and those in the communications, mining, and transport industries, are exempt from branch tax, and so might find this a more attractive option.

Branch financing is not subject to the 'thin capitalisation' rules which apply to subsidiaries, and depending on the home country's tax rules, losses incurred by the Canadian branch , may be deductible by the foreign parent company for foreign tax purposes. The aforementioned investment allowance whereby profits reinvested in Canadian assets are free of branch tax may also free up the movement of cash between the Canadian branch and its foreign head office if a sufficient investment allowance is maintained.

However, a Canadian based branch office offers no liability cushion in terms of the assets of the foreign corporation. Administratively, and in terms of registration, branch offices can be more problematic, and unlike the withholding tax on subsidiary dividends, the payment of branch tax cannot be delayed, and must be paid annually. There is also the problem that a corporate reorganisation abroad may constitute a deemed disposition of Canadian assets, and give rise to Canadian tax consequences.

So Which Is Best…?

Ah, the $64,000 (that's $99,921 CAD!) question. Although taxation will obviously play a strong part in the decision about how and where to establish a Canadian based business, it shouldn't be your only consideration. Different types of business demand different treatment. Looking at it strictly from the point of view of Canadian taxation, it may seem preferable to carry out business through a branch office, especially in the start-up period where losses may occur. However, reasons unrelated to taxation such as liability limitation and cost often make a Canadian subsidiary the preferred choice. The decision, however, is yours to make, although obviously qualified professional advice is a must.

Federal and Provincial Investment Incentives

On a federal level, the Canadian government offers tax credits and incentives for manufacturing and research and development enterprises, duty relief on the manufacturing and processing of export, and assistance for various training programmes. In addition, each of the Canadian provinces levies different levels of corporate taxation, offers various investment incentives for foreign investors, and has diverse areas of expertise. In some provinces, although foreign investment is certainly encouraged, there are restrictions placed on the degree of permitted foreign ownership in certain sectors, such as financial services.

However, in British Columbia, there are tax incentives specifically designed to encourage international investment in the financial services sector - qualifying firms in Vancouver are currently refunded 100% of provincial income tax on their international operations. In Quebec, the accelerated depreciation rules for manufacturing enterprises are some of the most favourable in Canada, and Manitoba and Saskatchewan are lowering their income tax rates. Although there is not the time (or space) to detail all of the many and various incentives offered by the different Canadian provinces, you may be beginning to see that choosing where to locate your Canadian business may prove as hard, if not harder, than choosing an offshore jurisdiction in which to locate your assets!