doing business in canada - Davies Ward Phillips & Vineberg LLP

Canadian Branch vs. Canadian SubsidiaryIn general, from a Canadian income tax perspective, there is little difference between carrying on businessthrough a Canadian branch of a non-resident entity and carrying on business through a wholly-owned Canadiansubsidiary.A Canadian incorporated subsidiary of a non-resident corporation is a Canadian resident for Canadian incometax purposes and is therefore subject to tax in Canada on its worldwide income. Certain types of payments(including dividends, rent and royalties) made by a subsidiary to its non-resident parent are subject towithholding tax as discussed above.Similarly, Canadian tax will apply to the profits attributable to an unincorporated branch of a non-residentcarrying on business in Canada. The allocation of items of income and expense between head office and theCanadian branch may be unclear and can result in ambiguity in the computation of branch income for purposesof the Tax Act. In addition, the Tax Act imposes a branch profits tax on the profits of the Canadian branch notreinvested in Canada. The branch profits tax is intended to parallel the dividend withholding tax.Hybrid EntitiesNova Scotia, Alberta and British Columbia corporate law permits the establishment of unlimited liabilitycompanies or "ULCs". These entities are treated like regular Canadian resident corporations for Canadian taxpurposes; however, in the U.S., they are eligible to be treated as flow-through entities for U.S. tax purposes. Thisdual or "hybrid" tax characterization can be a useful planning feature. However, as a result of the amendedCanada-U.S. tax treaty, the use of a ULC after 2010 by U.S. residents should be carefully considered and mayrequire additional steps or intermediate entities in order to be beneficial.The amended Canada-U.S. tax treaty treats U.S. limited liability companies as a look-through for the purposes ofapplying the provisions of such treaty.Capitalization of a Canadian CorporationA Canadian corporation may be capitalized with equity or with a combination of debt and equity.As noted above, share capital of a Canadian private corporation can generally be returned to shareholders freefrom Canadian tax, including Canadian withholding tax applicable to non-resident shareholders.A distribution to a shareholder in excess of such share capital will be deemed to be a dividend for purposes ofthe Tax Act. Deemed dividends to non-resident shareholders are subject to withholding tax in the same mannerand at the same rate (including any reduced treaty rate) as regular dividends.Repayment of principal loaned to a Canadian corporation by a non-resident shareholder is not subject towithholding tax, but, where applicable, tax must be withheld in respect of interest paid or credited on the loan.Subject to the thin capitalization rule discussed below and the general limitations on interest expense and lossesdescribed above, a Canadian subsidiary may deduct interest paid or credited by it to a non-resident in computingits income.Thin Capitalization and Interest ImputationThe "thin capitalization rule" is intended to prevent a Canadian-incorporated subsidiary from excessivelyreducing its taxable Canadian profits, and hence its liability for Canadian tax, by maximizing its interest expenseto related non-resident creditors. In very general terms, the subsidiary is denied an interest deduction to theextent that its "relevant debt" exceeds two times its "relevant equity". Under current rules, the thincapitalization restrictions apply only to corporate borrowers.Tax Considerations 87