Canadian Corporation vs Canadian Branch Tax Implications

Non-residents wanting to do business in Canada need to carefully select the right structure as the structure would have different tax implications in Canada and in the home country jurisdiction. This article focuses on U.S. parent corporations wanting to do business in Canada through a Canadian branch or a Canadian corporation.

1. Canadian Branch

U.S. corporations can carry on business in Canada through a Canadian branch. It is important to note that a Canadian branch is not a separate legal entity.

Pros

Simplicity and low administrative cost.
Losses realized in Canada to be deducted in computing the U.S. corporate income, If losses are expected to be incurred in the near term.

Cons

Liability risk at the U.S. shareholder corporation level.
Preparation of financial statements that would need to segregate all the income/expenses earned/incurred in Canada to the Canadian branch.
If some Canadian assets are held by the U.S. corporation, the transfer of those assets into a new Canadian corporation might result in U.S. tax consequences, as well as Canadian tax consequences if assets are taxable Canadian property.

1.1 Taxation of Canadian Branch

A Canadian branch carrying on a business in Canada is subject to:

A combined Canadian income tax (federal and provincial) on its net income between 23% to 31% depending on the province where business is performed.
A 25% branch tax under Part XIV of the Act on the Canadian branch profits not reinvested in Canada (in the year the profit is earned), which may be reduced pursuant to the applicable Tax Treaty between Canada and the non-resident foreign country. For example, the 25% branch tax is reduced to 5% under the Canada-U.S. Tax Treaty. Note that some of Canada’s Tax Treaties exempt the first $500,000 of a non-resident corporation’s branch profits (e.g., under the Canada-U.S. Tax Treaty).

It should be noted that the U.S. entity doing business in Canada through a Canadian branch would include its income earned in Canada for U.S. tax purposes and would be entitled to a foreign tax credit for the Canadian taxes paid.

2. Canadian Corporations

2.1 Canadian Corporations other than Unlimited Liability Corporations (ULCs)

U.S. corporations can carry on business in Canada through a Canadian corporation instead of a Canadian branch. As opposed to a Canadian branch, a Canadian corporation is a separate legal entity. Canadian corporations that are formed under federal and provincial corporate laws would have limited liability exposure.

Pros

Liability risk at the Canadian corporation level only and not at the shareholder level.

Cons

Canadian losses cannot be transferred to the U.S. shareholder entity to be deducted against its income.
Additional legal, administrative and tax compliance costs.

2.2 ULCs incorporated under Nova Scotia, Alberta, and British Columbia Corporate Laws

Pros

ULCs formed in Nova Scotia, Alberta and British Columbia are treated as a fiscally transparent entities for U.S. tax purposes, which allow the income and losses to flow directly to the U.S. entity shareholder, while it is still regarded as a corporation for Canadian tax purposes and taxed in Canada accordingly.
A U.S. entity might, depending on the legal form chosen, benefit for a foreign tax credit in the U.S. for the Canadian income tax paid under Part I of the Act and the Canadian withholding tax applicable under Part XIII of the Act.
Although the ULC cannot have the Tax Treaty benefit under the Canada-U.S. Tax Treaty, the Canada Revenue Agency (CRA) accepted the so-called “two step approach” to have the same result regardless of whether a dividend is paid from a ULC or a regular Canadian corporation.
In most of the Canadian jurisdictions, there is no residency requirement for members of the board of directors.

Cons

Shareholders have unlimited liability risk (except if a “blocker” corporation is used).
Additional legal, administrative and tax compliance costs.

2.3 Taxation of a Canadian Corporation

A U.S. controlled Canadian corporation whether a regular corporation or a ULC is subject to:

A combined Canadian income tax (federal and provincial) on its worldwide income between 23% to 31%.
A 25% Canadian withholding tax under Part XIII of the Act on passive source payments, which may be reduced by the applicable Tax Treaty with Canada. For example, for a dividend payment made from a Canadian corporation to a US parent corporation, the rate would be reduced to 5% if Treaty Tax benefit is available (i.e., Limitation of Benefits clause does not apply to limit the benefit of the Canada-U.S. Tax Treaty).

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Bardia Afzali, B. Eng., LL. B., M. Tax

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