My name is Mark Goodfield. Welcome to The Blunt Bean Counter ™, a blog that shares my thoughts on income taxes, finance and the psychology of money. I am a Chartered Professional Accountant and a partner with a National Accounting Firm in Toronto. This blog is meant for everyone, but in particular for high net worth individuals and owners of private corporations. The views and opinions expressed in this blog are written solely in my personal capacity and cannot be attributed to the accounting firm with which I am affiliated. My posts are blunt, opinionated and even have a twist of humor/sarcasm. You've been warned.

Monday, December 7, 2015

Inbound and Outbound International Taxation Issues for Corporations Doing Business in Canada

In today’s economy, businesses look outside their borders for expansion and growth. There are many factors to consider when expanding internationally. In my experience, the income tax considerations are typically an afterthought. Often the people ‘steering the ship’ on the expansion project are not well versed or frankly don't give enough thought to the income tax aspects of any expansion project. However, if international taxation matters are not dealt with proactively or upfront, they can result in significant tax assessments and issues down the road.

Today, my guest poster, Harry Chana an International Tax Expert with BDO Canada LLP will review some high-level issues that need to be proactively considered when investing into Canada or when Canadian companies are looking to expand outside of Canada or dealing with their foreign parents.

As Harry says "I’m a firm believer that tax should not drive the business decisions but it is a critical input that should be considered part and parcel with any international expansion".

Inbound and Outbound International Taxation Issues for Corporations Doing Business in Canada 

By Harry Chana


Inbound Investment to Canada - Welcome to Canada


So you decided to expand your business into Canada. First of all welcome to Canada! Canada is a very good place to do business. However, as a non-resident coming to Canada, you may surprised by some of the tax rules around doing business in Canada. Here are some issues you should consider:

Trips and Traps Where You Have Canadian Customers


A couple of questions you should ask yourself if you are a non-resident of Canada and have Canadian customers:

1. How did you acquire that customer? For example, did you have a sales agent in Canada soliciting customers, did you send your employees to Canada to solicit, or did your employees attend a trade show or conference in Canada which resulted in a sale?

2. Are you required to be in Canada to service, support etc. that Canadian customer? For example, are you doing a supply and installation contract, onsite maintenance or warranty repairs, or customer site visits?

The above list is not exhaustive, but if any of the above apply, YOU, YOUR EMPLOYEES and YOUR COMPANY could be liable for Canadian tax and required to file Canadian tax returns.

You may be surprised to know that if you are sending your employees to Canada to work (such as on an installation contract, project management and /or client visitations), your non-Canadian employees are subject to Canadian source deductions. There is currently no de minimis number of days that exempt one from these deductions. Consequently, even if your non-resident employees are in Canada for only 1 day, they could be liable for Canadian tax. There is legislation that is proposed in the 2015 Federal budget to reduce this compliance requirement, where non-resident employees do not spend significant amounts of time in Canada.

In addition, there are penalties where a non-resident corporation fails to file a required Canadian income tax return. Luckily, if the non-resident is resident in a treaty jurisdiction (such as the U.S.), with proper planning, there are ways to possibly reduce or eliminate any Canadian tax that may arise.

Thin Capitalization Rules


The Thin Capitalization rules (also known as the Thin Cap rules) were brought in to prevent the erosion of the Canadian tax base by having foreign companies capitalize a Canadian company with nominal equity and large related party debt, to obtain an interest deduction in Canada and repatriate money outside of Canada. The rules around thin cap have expanded in scope greatly over the past couple of years and there are additional punitive measures if the rules are not respected. Canadian companies can be capitalized with debt, however certain related party debt-to-equity must not be exceeded (1:5:1). If this ratio is exceeded, a portion of the interest expense will be denied permanently and deemed to be a dividend back to the foreign parent, thereby attracting a withholding tax liability.

Outbound Tax Issues


Loans are used in tax planning quite often to finance operations outside of Canada. For example a foreign parent can loan money to its Canadian subsidiary and charge interest as a way to finance the Canadian subsidiary and repatriate money outside of Canada. Or vice versa, a Canadian company can lend money and charge interest to its foreign subsidiary as a way to finance it and repatriate money back to Canada. Of course, since we are talking tax, nothing is ever that simple and straightforward. A couple of things need to be considered with loans:

1) Shareholder Loans to foreign parent - Rather than declaring a dividend to a foreign parent (with withholding tax implications), you might think to just loan the money directly from the Canadian entity. However there are Canadian rules that if the loan remains outstanding for a certain period of time, the company is deemed to have paid a dividend to the foreign parent (and therefore is subject to withholding tax). This effectively puts the Canadian company in the same position as if it had paid a dividend in the first place. If you have a loan receivable from your foreign parent, you most likely need to consider these rules. However, there are some new planning strategies available to possibly reduce the withholding tax exposure.

2) Loans to foreign subsidiary - Similar to the comment above on loans to a foreign parent, there are tax implications if the Canadian company makes a loan(s) to a foreign subsidiary and doesn’t charge sufficient interest on the loan. There may be a deemed interest income pick-up on the loan which will result in additional income to the Canadian entity. There are exceptions to this rule, and sometimes the deemed income inclusion can be avoided.

Withholding taxes


I have mentioned withholding taxes a couple of times. They apply anytime interest, dividends and royalties are paid by a Canadian to a non-resident. The general withholding tax rate is 25%. There are some exceptions to this rate. For example certain interest paid to arms-length parties are not subject to withholding tax. Withholding tax can be reduced if there is a tax treaty between the two countries (ie. Canada and the foreign country). For example, under the Canada-US Tax Treaty withholding tax can be reduced to 0% if certain criteria are met. However a word of caution, a Canadian corporation paying interest, dividends or royalties to a US corporation is not automatically subject to reduced treaty rates, certain criteria must first be met. These tests are known as the Limitation of Benefit provisions.

The rules around international tax can be complex when dealing with foreign companies expanding into Canada or Canada companies with foreign subsidiaries. There are numerous pitfalls and traps for the unwary; the above are just a small glimpse into the tax implications that can result without proper planning. As I mentioned in the beginning, tax shouldn’t drive the business, but it is a critical input that you need to consider to avoid an unintended tax bill.

A final caveat. There are many other issues I have not touched on in this blog post. When dealing with international tax laws, a tax specialist is always required.

Harry Chana is a Partner in International Tax Services with BDO Canada LLP. He can be reached at 905-946-5457 or by email at hchana@bdo.ca

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.