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In this article, we discuss two common structures that a foreign corporation (“ForeignCo”) can use in carrying on a business in Canada. Each structure has its pros and cons and whether one structure is better suited than the other will depend on a variety of factors such as legal, tax, and business strategy. In addition to the federal Canada Business Corporations Act, Canada has 10 provinces and three territories and each has its own statute governing corporations.
Opening up a branch in Canada can be considered as an extension of a ForeignCo’s existence. It is done by registering your ForeignCo as an extra-provincial corporation in the provincial or territorial jurisdiction in which you want to establish your head office and in every other jurisdiction in which you propose to carry on a business, and by having an agent for service as a point of contact in each jurisdiction in Canada. Unlike creating a subsidiary, opening a branch can be less time-consuming and may initially involve less paperwork. Also, if the business is expected to incur significant losses early on, operating a branch may be preferable, as a ForeignCo may be able to deduct such losses in their own domestic jurisdiction. However, since registration in Canada does not lead to the creation of a separate legal entity, a ForeignCo may be directly exposed to liability for its Canadian activities.
Aside from the question of legal liability, there are tax issues that a ForeignCo should consider when opening a branch in Canada. Ultimately, the degree of tax exposure for a ForeignCo operating a branch will depend on the tax treaty, if any, between Canada and the ForeignCo’s country of domicile. A business operating through a branch having a so-called “permanent establishment” will be subject to 15% general federal corporate tax as well as provincial corporate tax that varies depending on the province in which the permanent establishment is located. The term “permanent establishment” is complex in its definition but it generally refers to a fixed place of business of the corporation such as an office. In addition, a ForeignCo may need to pay a 25% branch tax on profit from the branch that is repatriated to the ForeignCo and not reinvested in Canadian property, subject to any applicable tax treaties which may provide a rate reduction. Generally speaking, the purpose behind the branch tax is to put a ForeignCo that operates through a branch in the same position as a ForeignCo having established a Canadian subsidiary.
A Canadian subsidiary can be established by incorporating a company in Canada that will be owned by the ForeignCo. In Canada, a company can be incorporated federally, provincially, or territorially. It should be noted that a federally-incorporated company does not, by virtue of its federal status, necessarily offer any advantage over provincial or territorial incorporation.[i] Thus, even if you incorporate federally, you will still need to register the corporation in the province or territory in which the subsidiary establishes its head office and in each province and territory where it carries on business. Also, a federal corporation will need to comply with provincial laws and obtain any permits and licenses that may be required in its line of business. Another important point to note is that the residency requirements for directors vary from one jurisdiction to the other, ranging from none to a majority of the directors having to be Canadian residents. In this context, a resident Canadian generally refers to a Canadian citizen or a permanent resident of Canada.
A Canadian subsidiary of a ForeignCo will be considered a resident of Canada for tax purposes and will accordingly be subject to tax on its worldwide income. As with operating a branch, the subsidiary will need to pay federal corporate tax as well as provincial corporate tax depending on in which province it operates. Furthermore, the subsidiary may need to pay withholding tax (which is essentially an equivalent of a branch tax) on payments such as dividends to non-residents (i.e. a foreign parent company), again subject to reduction by any applicable tax treaties.
Although it might seem simple enough to just open up a branch or incorporate in Canada, there are many more issues that a ForeignCo must consider. A ForeignCo looking to carry on a business in Canada should speak to a professional for advice specific to their circumstances.
Martin Aquilina is an international business lawyer. He has extensive experience in advising Canadians doing business overseas as well as foreign companies wishing to expand their business into Canada.
[i] See Supreme Court of Canada case, Reference re Upper Churchill Water Rights Reversion Act.
This article is for informational purposes only and does not constitute legal advice. If you wish to discuss your issue with a lawyer, contact Martin today. 613-747-2459 ext.308, [email protected]