It is too soon to tell what impact U.S. President Donald Trump’s recent efforts to ban nationals from seven Middle Eastern and African countries, or any of the other initiatives he is proposing, will have on the business sector in Canada. One possible outcome is that it may lead to increased interest, from companies in the U.S. and around the world, in Canada as a welcoming place to do business. For these companies who are turning an interested eye to Canada, no decision to establish or invest in a business in Canada should be made without a basic understanding of the legal framework in which the business operates or will operate.
The nature and extent of the factors to be considered may vary for each business and its products.
In Canada, one may incorporate federally or provincially. It is also possible to incorporate unlimited liability corporations in certain provinces or conduct business in Canada without incorporating by carrying on business through a branch operation, joint venture or franchise. Both structure and the ensuing tax implications of using such a structure should be preliminary considerations.
A number of issues should be considered in choosing whether to operate as a branch or subsidiary.
If the Canadian operation is expected to incur significant losses in its early years of operation, the foreign entity may wish to carry on business in Canada directly through a branch, in order to deduct those losses for foreign tax purposes, if possible.
Many foreign investors prefer to carry on business in Canada through a Canadian subsidiary. The use of a subsidiary is more convenient for administrative purposes. For example, it makes the process of executing documents much simpler. The use of a subsidiary generally limits the liability of the foreign parent to its capital investment in the subsidiary. In conducting business through a branch office, the foreign parent exposes itself directly to all of the liabilities of the Canadian operation.
Corporations may be created in Canada under either federal or provincial legislation. Accordingly, assuming a decision has been made to incorporate in Canada, a choice must be made regarding the jurisdiction under which the entity should be incorporated. Corporations established under federal or provincial legislation may carry on business anywhere in Canada as of right, but are required to register in each province in which it carries on business.
In most Canadian jurisdictions, governing legislation permits corporations to adopt a unanimous shareholders agreement. Such agreements have the effect of transferring certain of the directors’ powers to the shareholders. To the extent that these powers are transferred to the shareholders, the directors are generally relieved of liability and the shareholders are then subject to those duties and liabilities. This can be useful in the case of a foreign corporation that wishes to limit the powers of the Canadian subsidiary’s directors over the operation of the subsidiary, especially where the subsidiary and the parent have different directors. It is worth noting that a federally incorporated company must have Canadian directors (generally 25%).
As previously mentioned, another option is to incorporate an unlimited liability corporation (a “ULC”). A ULC may be formed under the laws of Alberta, British Columbia or Nova Scotia. A ULC can be similar to a general partnership and is different from the common form of corporation where the corporation’s shareholders are not, in general, liable for the liabilities, acts or omissions of the corporation. For U.S. tax purposes, a ULC is a flow-through entity. The IRS treats a ULC as a branch if there is only one shareholder or as a partnership if there is more than one shareholder. This is different than in Canada, where a ULC is treated and taxed like any other corporation. The end result is that a ULC is a hybrid entity. Certain transactions involving interest payments and deemed dividends paid by a ULC to a U.S. parent are usually still eligible for a reduced rate of withholding tax.
Other forms of carrying on business, such as partnerships, limited partnerships and joint ventures, are similar in nature to their U.S. equivalents. However there are different tax treatments involved and therefore tax experts should be consulted.
In regard to franchising, there are several business structures available to a foreign-based franchisor wishing to expand into Canada. The first is to operate the franchise directly from the franchisor’s existing foreign-based corporate structure. While direct franchising has the advantage of minimal start-up costs, it exposes the franchisor to liabilities incurred by Canadian operations and the lack of a local presence may detract from the effectiveness of the franchisor’s marketing in Canada. An alternative method is the establishment of a branch office to administer the granting of franchise rights in Canada. However, this approach may attract Canadian income tax liability and does nothing to insulate the franchisor from the operating losses and liabilities of its Canadian branch. Third, a foreign-based franchisor may opt to incorporate a Canadian subsidiary, which would serve to immunize the parent franchisor from Canadian liabilities and operating losses. Canada has no comprehensive federal franchise legislation equivalent to the U.S. Federal Trade Commission Franchise Rule, however some provinces, including Alberta, Manitoba, Ontario, Prince Edward Island and New Brunswick have their own franchise legislation. These laws are similar to the U.S. law in that they require specific disclosure documents, and contain rules on franchise agreements and the franchisor/franchisee relationships.
One final note regarding current trends which may continue and grow in the months and years to come. At the American Bar Association’s recent Business Law meetings that were held in Montreal, Quebec, two current trends were discussed at length:
(a) Acquisitions by way of “three-corner amalgamation”. This structure remains the preferable structure for acquisitions of Canadian companies by U.S. buyers. It involves the incorporation of a Canadian subsidiary and then a merger with the target.
(b) More and more U.S. companies are incorporating Canadian subsidiaries to carry on their research and development activities. The reasons for this are the large R&D credits available in Canada and also the immigration regulations relating to employees (it is sometimes easier to get entry into Canada for employees with certain expertise).
For more information on any of the topics discussed in this article, please do not hesitate to contact Dirk Bouwer by phone at (613) 566-2850 or by email at firstname.lastname@example.org.