We serve many clients that trade their products and services internationally. We find that most successful manufacturers are looking for new markets. Those new markets are often international markets.
And if you are doing business outside Canada, you may need help with:
- Transfer pricing
- 1120 (US form)
- Withholding tax
- Withholding tax refunds
Our clients are primarily manufacturers that are looking to export their products out of or into Canada, or distributors who are assisting manufacturers with importing and exporting. Both types of clients have international tax issues to consider.
Canadian Business – Doing Business Internationally
A surprising number of files we pick up with none of these filed. T1135 is familiar to most personal tax return filers. The thing is that this form is for all filers, not just personal tax return filers. So corporations may find that they have missed filing this form. T1134A and T1134B are for reporting interests in foreign affiliates. This includes an organization chart. We see this being missed when Canadians set up a subsidiary in a foreign jurisdiction. We see the confusion over what entails a foreign subsidiary. A common confusion is that the client thinks of it as a branch and the foreign accountant has set up an LLC for example. A couple of bizarre ones we have seen are LLCs set up to own motorhomes and rental properties. T106. Thankfully this has a De minimis rule. It discloses a lot of transactional information in multinationals. It can catch you off guard because its transactions are additive of both positive and negative amounts. There are also forms for trust transactions T1141 and T1142, but we try to avoid working with offshore trusts. They require a whole higher level of reporting and management.
We need to be cautious of Canadians moving money overseas in an effort to earn better returns. For example, interest rates in Australia are 5% or more compared to our Foreign Property Accrual Income (FAPI). Versus active income, we try to avoid structures with FAPI income and thus avoid the whole reporting and tax balances tracking issues. There are calculations of foreign surpluses etc. that need to be made in all foreign affiliate situations but they get considerably more complex with FAPI. So the general mantra is to try to have business income offshore and investment income offshore clear in your head so that you can review with your client the requirements for FAPI treatment. You also need to think about whether there really is an offshore relationship. With a foreign active business, it is easier to argue mind and management is there. With investment income, it is harder.
What are they and why do we hear about them? Think double deduction of expenses. CRA defines them on NR303 as “A hybrid entity is, in general, a foreign entity (other than a partnership) whose income is taxed at the beneficiary, member, or participant level. For example, the United States resident members/owners of a Limited Liability company (that is treated as a fiscally transparent entity under U.S. tax laws) may be entitled to treaty benefits if all the conditions in paragraph 6 of Article IV of the Canada – U.S. treaty are met. Under paragraph 6, an amount of income, profit or gain is considered to be derived by a resident of the United States if 1) the amount is derived by that person through an entity (other than an entity that is a resident of Canada), and 2) by reason of that entity being considered fiscally transparent under U.S. tax laws, the treatment of the amount under U.S. tax laws is the same as its treatment would be if that amount had been derived directly by that person. Paragraph 7 of Article IV contains additional restrictions on this look-through provision. Entities that are subject to tax, but whose tax may be relieved under an integrated system, are not considered hybrid entities.”
We also have then in Canada for example the Alberta Unlimited Liability corporations. The recent update to the US/Canada tax treaty had a lot of changes to try to eliminate a double deduction that could happen when you have two jurisdictions treating an entity two different ways. The general concept is that one country (non-resident) for example recognizes an expense but ignores the revenue and the other country (Canada) recognizes revenue and an expense. Thus revenue once and deduction twice.
Many think this is an inbound issue. We think of it as an outbound issue as the immigrant has assets outside of Canada that they have forgotten to report income on or have incorrectly or incompletely reported income on. These Immigrants could have lived in Canada for over forty years in some cases, so the main issues are catching up filings, considering what filings are required. Entity types can cause confusion. For example, foreign corporations held by immigrants or foreign trusts.
This is also a bit of an inbound and outbound issue. The issue is net tax rates. Building spreadsheets to analyze the tax so we have a Canadian taxpayer. What makes sense to reduce the overall tax cost? Think of three layers of tax.
- Foreign withholding tax on distributions (per the treaty)
- Canadian tax and potential foreign tax credits or flow-through without taxes
- Pay foreign tax of 30% and then have a withholding tax on the distribution and then get or don’t get a foreign tax credit or deduction.
The result is higher taxes than in Canada. This creates an incentive to transfer profits with before tax management fees as opposed to after-tax dividends. What about a foreign taxpayer about to pay branch tax in Canada? We have the same layers but in reverse and because Canadian tax is low when compared to other jurisdictions we try structures with direct exposure to Canadian tax and then direct exposure to the foreign tax. I.E. branch versus a corporation or in the case of US parent corporations they may “tick the box”. This is to allow better integration. Pay Canadian tax of 25% then perhaps some withholding tax let's say 5% and get a full credit in a foreign regime with a 30% tax rate. The result is the same tax as in foreign jurisdiction.
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Canadian and foreign tax laws are complex and have a tendency to change on a frequent basis. As such, the content published above is believed to be accurate as of the date of this post. Before implementing any tax planning, please seek professional advice from a qualified tax professional. EPR Maple Ridge Langley, Chartered Professional Accountants will not accept any liability for any tax ramifications that may result from acting based on the information contained above.