By Robert Lee
For many Canadian businesses, the United States and other foreign markets represent unique opportunities for growth. Expanding into those markets could yield significant benefits over the long run.
Before taking steps to enter a foreign jurisdiction, one must consider the potential Canadian and foreign tax consequences of doing so. With the proper planning and implementation of a well-designed corporate structure, a Canadian business can position itself to achieve the best possible Canadian and foreign tax results while avoiding unpleasant surprises down the road.
When is tax planning essential for a cross-border transaction?
Below are some cross-border business activities that typically require Canadian businesses to obtain Canadian and/or foreign tax advice:
Entering a foreign market: A Canadian-resident corporation (we’ll call it Canco) may wish to grow its business by selling its products or services to customers in a foreign jurisdiction. Alternatively, Canco may seek to enter a foreign market by acquiring a competitor that has a presence in that jurisdiction. In either case, tax planning can assist Canco with achieving the desired commercial and tax objectives.
Attracting foreign investment: To expand its sources of capital beyond domestic investors, Canco could seek to raise capital by issuing shares to or borrowing money from foreign individuals, private equity funds, or pension funds. These investments must be properly structured so that they are optimal from a tax perspective for both Canco and the foreign investors. The nature of Canco’s business and the type of prospective investor (i.e., whether the investor is an individual, a corporation, or a partnership and whether it is taxable or tax-exempt) may affect how the investment is structured.
Transactions that are tax-efficient from a Canadian perspective may create foreign tax, commercial, or corporate law problems. However, many, if not most, of those concerns can be addressed in a practical manner.
Financing a foreign subsidiary’s operations: Canco’s corporate group may already have a presence in the target foreign market through a foreign-resident corporate subsidiary (we’ll call it Forco). Forco may require funds to undertake business activities, such as manufacturing goods, building a facility, or purchasing equipment. Although there are various ways to fund Forco’s activities, some financing options achieve better tax results (e.g., deductible interest payments).
Repatriating funds from a foreign subsidiary: If Forco has excess cash that Canco or another subsidiary in the corporate group could deploy in its business, steps may be available to
“repatriate” those funds tax efficiently.
Selling goods or services to a foreign subsidiary: If Canco sells a component or provides services to Forco (or vice versa), steps should be taken to ensure that the transaction is based on arm’s length prices and terms to defend against any “transfer pricing” dispute with the Canada Revenue Agency (CRA) or a foreign tax authority.
Moving employees across a border, through an employee secondment or similar arrangements: Canco may wish to temporarily “lend” one of its employees to Forco to assist with Forco’s business (or vice versa). Such an arrangement may give rise to Canadian and foreign tax considerations for the employee, Canco, and Forco. All three parties will also have to consider the potential Canada Pension Plan, Employment Insurance, foreign social security, and foreign unemployment benefit consequences of the arrangement.
Selling a foreign business: Canco’s corporate group may decide to exit a foreign jurisdiction by having Forco sell its business assets or by having Canco sell its shares of Forco. The sale should be
structured with a view to minimizing any applicable Canadian or foreign tax. In addition to business activities, Canadian-resident individuals also should obtain tax advice with respect to certain cross-border personal activities, such as the following:
Purchasing real estate in a foreign country: Foreign tax consequences can arise when an individual purchases real estate in another country. In particular, Canadians contemplating the purchase of real estate in the US should be aware of the potential application of the US federal estate tax and also of the number of days that a Canadian is permitted to be present in the US each year before being treated as a US resident for income tax purposes. Tax planning may avoid adverse results.
Permanently moving to a foreign country: An individual who emigrates from Canada may cease to be resident in Canada for income tax purposes. Ceasing to be resident in Canada may have
significant tax consequences and should not be undertaken without first obtaining Canadian tax advice.
Why cross-border transactions can be complex
International tax planning is one of the most complex areas of the law. It involves significant commercial, tax, accounting, and other considerations in multiple jurisdictions. To structure transactions that yield optimal tax results, the relevant provisions of the federal Income Tax Act and applicable provincial income tax legislation, tax treaties, CRA administrative pronouncements, and case law must be carefully examined. Moreover, entities like Canco and Forco will often need to engage a foreign tax advisor to conduct a similar review of the foreign tax implications of the
If a particular tax plan satisfies the relevant Canadian and foreign tax objectives, it must be properly implemented and the legal rights and obligations created must be strictly adhered to. The Canadian tax consequences of a set of transactions follow from the various legal relationships created by the transactions. If the relevant documents are inconsistent with the overall plan, the desired tax objectives may not be achieved. A tax plan is only as good as its execution.
Occasionally, transactions that are tax-efficient from a Canadian perspective may create foreign tax, commercial, or corporate law problems. However, many, if not most, of those concerns can be addressed in a practical manner when a team of Canadian and foreign advisors works collaboratively to overcome any legal or business constraints.
The takeaway : Plan properly for cross-border transactions
By undertaking proper tax planning before implementing cross-border transactions and by executing those transactions in a manner consistent with your intentions, you will position yourself to obtain the best possible tax result and to avoid any unpleasant surprises. Even if you have already implemented such transactions, it may be worthwhile to seek professional review of the structure resulting from those transactions to determine whether the tax costs can be minimized.
First published in the December 2018 edition of The Business Advisor.