Structuring United State Business Expansion into Canada
An Outline of Basic Concepts
Prepared by:
Lawrence J. Stordy
Stewart McKelvey Stirling Scales
1959 Upper Water Street
Halifax, Nova Scotia B3J 2X2
I. Sales Representative based in Canada – The “Permanent Establishment” Concept

[Note: the Canadian rules in this section are essentially identical to the US rules, since both are
based on the same Treaty provisions.]

Will not be subject to Canadian income tax on business profits so long as activities are sufficiently
limited. Pursuant to tax treaty, U.S. businesses only pay Canadian tax if they carry on business in
Canada through a “permanent establishment”.

Permanent establishment does not extend to operations of a sales representative so long as he or
she does not have the authority to conclude contracts on behalf of the U.S. entity or if
representative is independent acting in the ordinary course of his or her business (broker).

There is no permanent establishment solely because: the U.S. entity maintains facilities for
purpose of storage, display or delivery; maintains stock of goods for storage display or delivery or
processing; or advertises.

However, care must be taken in the event that the U.S. entity contemplates some kind of Canadian
operations center, as it could easily be a permanent establishment subject to Canadian taxation.

A U.S. business relying on the Canada-US Treaty rules to avoid taxation in Canada must file
a return with the Canadian tax authorities disclosing its reliance on the Treaty rules, to
afford the Canadian authorities an opportunity to audit whether the business qualifies for
Treaty relief – this is a relatively new Canadian rule.

Note: Canada’s tax authorities do not recognize a United States “Limited Liability
Corporation” or “LLC” as an entity that qualifies for the Treaty benefits noted above or in
the rest of this outline, so to take advantage of the Treaty rules, US expansion into Canada
should be carried out through an entity other than an LLC.

Note Canada’s goods and services tax must be considered in structuring expansion into
Canada, along with the following provincial and local taxes: property taxes, business
occupancy taxes, deed transfer taxes, payroll taxes, workers’ compensation levies. These
are not addressed in this outline.
II. Establishment of a Branch Office

[Note: The Canadian rules in this section are similar to the U.S. rules, because both have similar
branch tax systems.]

A U.S. business’ Canadian branch office is subject to general Canadian income tax (at flat rates for
corporations - about 40% combined federal and provincial taxes) to the extent that it carries on
business in Canada through a permanent establishment
Only income attributable to the U.S. business’ Canadian operations is taxable in Canada
Overhead of the U.S. corporation attributable to the Canadian operation may be allocated
to reduce taxable income

Also subject to a Canadian “branch tax” (Income Tax Act S. 219)
The Income Tax Act imposes a 25% tax on after tax profit not reinvested in the Canada
but the U.S.-Canada Tax Treaty limits the rate of tax to 5%
Comparable to the withholding tax levied on dividends paid by a Canadian subsidiary of a
U.S. parent
The tax is payable to the extent the Canadian net assets of the U.S. corporation are
reduced over the year – ie. to the extent of profits repatriated to the U.S.
The tax treaty also provides an exemption so that the branch profits tax may only be
levied against earnings to the extent they exceed $500,000 CDN or its equivalent

Must register as a foreign corporation doing business in the province or provinces in which it is
located. (Provincial law governs the registration requirements.)

Advantages:
Might be a good choice if substantial initial losses are foreseen. This type of organization
may allow losses to be included in the consolidated return of the parent corporation and
deducted against income from other sources (but see ULC advantages outlined below).
Can easily be converted into a subsidiary if it becomes profitable.
U.S. entity might consider financing branch operation with debt so that the debt can be
repaid in lieu of a repatriation of profits that would attract the branch profits tax.

Disadvantages:
Because the branch is not a legal entity separate from the U.S. business, the U.S.
business remains fully responsible for all liabilities arising out of the Canadian branch
operations.
Although the U.S. entity will likely receive credit in the U.S. for Canadian taxes paid,
because somewhat different rules apply in each country to certain items, such as
depreciation, the credit received may not match perfectly with the tax liabilities owed.
Allocation rules also result in additional complexity for the taxpayer calculating income
tax in both jurisdictions.
III. Formation of a Separate Canadian Subsidiary

Subject to general Canadian income tax (at flat rates for corporations) on its worldwide income

Additionally, dividends paid to U.S. parent are subject to a 5% withholding tax (Tax Treaty).

Fees for incorporation are payable at registration and on an annual basis (no different from any
other domestic corporation).

Advantages:
Preferable to a branch operation in some instances where branch tax is payable even if
earnings are not distributed whereas earnings of Canadian subsidiary are not subject to
withholding tax until actually distributed to the U.S. parent.
Provides a layer of insulation to the parent for the liabilities of the subsidiary but
subsidiary must carefully observe corporate formalities to ensure that a court will not
“pierce the corporate veil” to reach assets of the U.S. parent

Disadvantages:
Limitations on deductibility of interest under “thin capitalization rules” (ITA S. 18(4))
which, similar to the U.S. “Earnings Stripping Rules”, could result in the current taxation of
interest in the U.S. but deferred deduction of interest in Canada.
IV. Formation of a Separate Canadian Subsidiary as a Nova Scotia Unlimited Liability Company
(“NSULC”)


Unique to Nova Scotia, but can be used as a vehicle for US investment anywhere in Canada.
More expensive than a regular limited subsidiary, and the unlimited liability of the owners must be
shielded.
The following is a brief summary of the main United States income tax advantages available to a United
States taxpayer using a Nova Scotia Unlimited Liability Company (“NSULC”) to carry on business in
Canada. I am a Canadian lawyer and am not qualified to give United States income tax advice:
accordingly you should consult with a U.S. tax advisor to confirm the advantages outlined below.
1.
Losses of an ordinary Canadian corporation do not flow through to U.S. shareholders. Losses of an
NSULC flow through to its U.S. shareholders for U.S. tax purposes. Subject to U.S. loss restriction
rules, this enables the Canadian losses to be offset against profits of the U.S. shareholder.
2.
Using an NSULC can overcome rules which restrict the foreign tax credits a U.S. shareholder can claim
in respect of Canadian taxes paid by an ordinary Canadian corporation. With an NSULC, Canadian
taxes are treated as being paid by its shareholders for U.S. tax purposes and are therefore creditable
on a current basis.
3.
A U.S. individual shareholder, unlike a U.S. corporation, cannot generally claim a credit for the
underlying Canadian income tax paid by a Canadian corporation. Accordingly, if that individual wants
to claim the underlying Canadian income taxes as a foreign tax credit, an NSULC can be used.
4.
When a U.S. purchaser wishes to acquire a Canadian business, the owner will usually prefer to sell
shares of the corporation that owns the business, whereas the purchaser will usually prefer to buy the
corporation’s assets, in part to obtain a tax cost in the assets equal to the purchase price. If a
Canadian corporation that owns the business is an NSULC, and the U.S. investor purchases its shares,
the U.S. investor will be treated for U.S. tax purposes as having purchased the underlying assets. In
addition, the U.S. purchaser can incorporate a second NSULC to facilitate the deduction of interest on
money borrowed to fund the purchase price.
5.
An S corporation can acquire the shares of an NSULC, but cannot acquire shares of an ordinary
Canadian corporation.
6.
If there are significant transactions between the Canadian business and the U.S. shareholder, an
NSULC can ease transfer pricing concerns. Because the NSULC is disregarded by the U.S. tax
authorities, there are no U.S. transfer pricing issues. This allows the U.S. shareholder to focus on
satisfying the transfer pricing concerns of the Canadian tax authorities, without concern about
conflicting U.S. transfer pricing issues.
7.
A U.S. shareholder entering into a partnership or joint venture with a Canadian taxpayer can achieve
the advantages described above and also meet the tax objectives of the Canadian partner by
structuring the venture/partnership as an NSULC.
8.
A U.S. shareholder in a Canadian passive investment holding company can avoid U.S. passive income
taxes if the holding company is an NSULC.