International expansion is first done for economic and financial reasons and can be done in a variety of ways as sending an employee abroad to solicit orders or acquiring a foreign corporation. Regardless of the size of the expansion, it is always important to understand the tax implications and obligations that may arise. Thus, the Income Tax Act (ITA) of Canada and the foreign tax regimes, as well as the different tax treaties should be among the elements to analyze before starting any activity abroad.
3 tax considerations to take into account before starting an international expansion
At the tax level, several questions must be answered, or at least raised, before starting any expansion abroad.
- Does the country targeted for the expansion have a tax treaty with Canada?
- What is the tax treatment in this country in relation to the type of income my corporation will generate there?
- How can I repatriate back to Canada my foreign profits and limit my tax impact?
It is by raising and answering these kind of questions that you will be able to establish an optimal international structure to operate abroad.
4 tax elements to know
Here is some important information for any corporation wishing to expand its activities abroad:
The tax treaties signed by Canada are of great importance to commercial trade and allow our corporations to improve the efficiency of their international expansion. A tax treaty signed between Canada and another jurisdiction will prevent such corporation from double taxation on the same income and will generally allow to obtain lower withholding tax rates when remitting funds from abroad to Canada.
It should also be noted that these tax treaties only apply to certain types of taxes, including income taxes, and may not apply to certain states/provinces. This situation occurs in some territories of the United-States and in Québec.
Foreign tax and foreign tax credit
Canada allows Canadian corporations operating abroad through a branch to benefit from a foreign tax credit. This credit usually allows corporations to reduce their overall tax rate to a level comparable to what it would have been had the income been earned in Canada. However, if the foreign tax rates are higher than those in Canada, the foreign tax credit will be limited to the Canadian income tax payable.
Type of income earned abroad
Canada wants to encourage corporations to expand their commercial activities abroad. However, Canada does not allow property income earned abroad, such as interest or rental income, to be taxed at lower rates than in Canada. Therefore, the ITA includes some rules regarding the Foreign Accrual Property Income. In a simplified way, if a controlled foreign affiliate corporation generates property income abroad, this income will be immediately taxable in Canada even if the income is earned by the foreign corporation and is not repatriated to Canada.
Moreover, it is important to note that certain incomes are not taxed in a similar way than in Canada. For example, in Canada, 50% of capital gains are taxable, whereas in certain countries capital gains are either non-taxable or fully taxable.
The notion of transfer pricing can be of great importance if a Canadian corporation has a foreign subsidiary with which it has commercial transactions. Why? Very briefly, a person that does transactions with a person with whom it does not deal at arm’s length must trade at fair market value and must be able to demonstrate it in the event of an audit. Contemporary documentationmust generally be kept up to date in order to provide the CRA with the necessary information in the event of an audit.
All these elements constitute a good starting point for preparing any international development project, in terms of tax planning. However, it should be noted that tax laws are constantly evolving. Thus, it is always recommended to communicate with a tax professional.
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