Introduction
In my blog that was posted on November 12, 2015, Canadian Corporations Can Repatriate Profits of Offshore Subsidiaries Tax-free, I explained that Canadian-based corporations, unlike their U.S. counterparts, can usually repatriate the earnings of offshore subsidiaries, free of Canadian tax. This is usually true even if those earnings have borne little or no tax at all in the offshore jurisdictions.
In response to that posting, I received many emails from Canadian corporations and their professional advisers asking for more information about what is required and entailed to successfully set-up an offshore corporate structure.
This ten (10) part series of articles is intended to be a primer that will explain, in relatively basic terms, the key issues and considerations that are involved in such planning.
Corporate Residency
Under Canada’s Income Tax Act (“the Act”) [1], a corporation that is resident in Canada is subject to Canadian tax on its worldwide income from all sources. This is true regardless of whether or not such income is remitted to Canada.
Accordingly, it is essential that any foreign subsidiary (“Forco”) that is formed by a Canadian corporation (“Canco”) should not be resident in Canada for the purposes of the Act.
As a general rule, any corporation formed in Canada is deemed resident in Canada [2] However, avoiding Canadian residency status for Forco is not as simple as just forming it in a foreign jurisdiction. A corporation that is formed outside of Canada can still be resident in Canada based on common law rules.
These common law rules are, for the most part, derived from old UK tax cases [3] which the Canadian courts [4] and the Canada Revenue Agency [5] seem to have accepted [6].
Under those rules, a corporation is resident at the place of its “mind and management” or “central management and control”.
As a general rule, that place is where the majority of its Directors reside, assuming that they meet and make decisions there [7).
Therefore, the majority of Directors of Forco should be non-residents of Canada [8] and all meeting of Directors should be held outside of Canada.
However, with the increased focus by the CRA on corporate residency issues, those facts alone may not always be sufficient to establish residency for Forco offshore. Rather, there should be evidence that, not only are the Directors meetings held outside of Canada, but that the key strategic decisions are actually made there. Although the representatives of Canco can certainly make suggestions to the Directors of Forco regarding the actions they would like taken, the Directors should not relinquish their decision making powers to the representatives of Canco. Ideally, evidence should be maintained that the Directors carefully reviewed and considered all relevant facts before making their decisions, and did not just automatically “rubber-stamp” decisions that had already been made in Canada [9].
In the next article in this series, I will discuss the concept of carrying on business in Canada, and why Forco needs to avoid that.
Footnotes:
[1] Unless indicated otherwise, all statutory references in this series are to the Act
[2]Paragraph 250(4)(a)-limited exceptions are applicable to corporations formed before April 27, 1965
[3] See, in particular, DeBeers Consolidated Mines Limited v. Howe [1906] A.C. 455.].
[4] See R.A. Hewitt & Sons Limited v. The Queen 2000 DTC 2441 (TCC) for a (relatively) recent example of the application of this general principal in a Canadian context (Bahamian corporation held to be resident in Canada).
[5] In this series referred to as “the CRA”
[6] Paragraph 5 of Interpretation Bulletin IT-451R, published by the CRA, states “Subject to the provisions of subsection 250(4) which deems residency in Canada throughout a particular taxation year, a corporation is normally resident in the country where its central management and control are located.”
[7] Probably, the most significant UK tax case on corporate residency in recent years is the UK Court of Appeal’s decision in Wood v. Holden (Inspector of Taxes), 27[2006] EWHC Civ. 26 (CA), leave to appeal to the House of Lords denied June 14, 2006, which clearly affirmed this general proposition.
[8] My personal preference, in typical situations, when I am advising clients, is to avoid having any Canadian Directors at all.
[9] For a good example of what not to do in order to maintain residency offshore, see the decision of the Supreme Court of Canada in St. Michael’s Trust Corp. as Trustee of the Fundy Settlement v. The Queen (2012 DTC 5063), as well as the earlier decisions in that case of both the Tax Court of Canada and the Federal Court of Appeal. Although this case actually dealt with the issue of trust residency, rather than corporate residency, the court explicitly stated that the same principles should apply to both.
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