As a general rule, any corporation formed in Canada is deemed to be resident in Canada for the purposes of the Income Tax Act (“the Act”)[1]. This is true even if the “central management and control” (“CMC”) of that corporation is located outside of Canada.
But is the converse true? Certainly not! Unlike our neighbors to the South, the Act does not restrict the corporations that are treated as being tax residents to those formed under domestic law. Rather, a corporation may be considered resident in Canada, even if formed outside of Canada, if its CMC is in Canada. This is precisely why it is important for Canadians using offshore corporations, particularly in non-treaty jurisdictions, to be particularly careful about CMC in order to avoid Canadian taxation.
Given that, if a foreign corporation (“Forco”) is resident in Canada, will the tax treatment for that corporation and its shareholders be the same as if it were incorporated in Canada?
One would think so, but in many respects, that is not the case.
In both cases, the corporation will be subject to Canadian tax on worldwide income, but there are important differences. Very few accountants or lawyer in Canada are aware of these distinctions, unless they focus on these areas. Particularly:
CCPC Status
Even if Forco is legally a private corporation, controlled by Canadian resident individuals, and resident in Canada, it will generally not be classified as a “Canadian-controlled private corporation” (“CCPC”).
This is because of the fact that the CCPC definition[2] requires the corporation to be a “Canadian corporation”, which in turn, generally requires it to have been “incorporated in Canada”[3].
Since it will not be a CCPC, the taxable income of Forco will all generally be taxable at the general corporate tax rate, regardless of the type of income. This equates to a rate of 15% for federal tax purposes, plus applicable provincial tax (e.g. 11.5% in Ontario) for income taxable in a province, or an additional 10% federal tax in other cases. Generally, a total tax rate of around 25%.
Forco would not be eligible for any “small business deduction” on income from an active business carried on in Canada.
Conversely, if Forco has investment income or taxable capital gains, that same general tax rate will apply-no additional federal tax or “refundable dividend tax on hand”.
Taxation of Dividends
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Taxable dividends paid by Forco to Canadian resident individuals will be taxed as ordinary income-no “gross-up and credit”[5]. This is because it will not qualify as a “taxable Canadian corporation”[6].
However, it would appear that Canadian resident individuals who control Forco could effectively obtain a “gross-up and credit” by rolling over their shares in Forco to a holding company incorporated in Canada, and using that holding corporation as a conduit through which to pass the dividends.
[1] Paragraph 250(4)(a), and subject to certain “grandfathering” provisions applicable to corporations formed before April 27, 1965, as well as the application of “tie-breaker” rules in tax treaties.
[2] Subsection 125(7)
[3] Subsection 89(1)-subject to certain exceptions for corporations resident in Canada on June 18, 1971.
[4] Paragraph 112(1)(b)
[5] Paragraphs 82(1)(b) and 82(1)(d)
[6] As defined in subsection 89(1)
ABOUT THE AUTHOR OF THIS ARTICLE
Michael I. Atlas, CPA,CA,CPA(ILL),TEP
Michael Atlas is one of the most prominent international tax experts in Canada. He advises accounting and law firms all across Canada, as well as select private clients (corporate and personal) worldwide. He can be reached by phone (416.860.9175) or email (matlas@TaxCA.com).
