Things to know
One of the most important considerations for a non-resident is whether to incorporate a Canadian subsidiary or to establish a branch operation.
A Canadian subsidiary of a non-resident corporation will be considered a resident of Canada for the purposes of the Income Tax Act and will be subject to Canadian income tax on its worldwide income. Under Canada’s domestic rules, there is no withholding tax on non-participating interest paid to arm’s length persons, and under the Canada-U.S. Income Tax Convention, withholding tax on arm’s length or non-arm’s length on-participating interest paid to U.S. persons is generally nil.
Since a Canadian subsidiary is a Canadian corporation, it is not subject to branch profits tax; however, upon the repatriation of funds by the Canadian subsidiary to the non-resident corporation by way of dividend, a 25% withholding tax is payable, subject to reduction by an applicable tax treaty.
The thin capitalization rules can disallow a deduction for interest payable by a Canadian subsidiary on debts owing to “specified non-resident persons” when such debts exceed the subsidiary’s equity by a ratio of 1.5:1. In addition, proposed legislation designed to ensure Canada’s compliance with Action 4 of the OECD’s BEPS project generally limits the Canadian subsidiary’s ability to deduct net interest and financing expenses in excess of 30% of EBITDA (for taxation years starting after October 1, 2023).
Subject to treaty relief, a Canadian subsidiary must withhold tax on several types of payments to non-residents, including dividends, interest paid to non-arm’s length parties, participating interest, certain management or administration fees and rentals, royalties and similar payments.
A non-resident corporation carrying on business in Canada through a Canadian branch is liable for income tax on its Canadian-source business income at the same rates that apply to Canadian residents.
In addition to federal and provincial income taxes, a non-resident corporation (NRC) carrying on business in Canada will be subject to the so-called “branch profits tax” which is intended to approximate the withholding tax that would have been paid on taxable dividends from a Canadian resident subsidiary if the non-resident corporation had incorporated a Canadian subsidiary to carry on business in Canada, rather than using a branch. Under the Income Tax Act, the branch profits tax is generally levied at a rate of 25% (which may be reduced under certain tax treaties) on the profits of the branch, after Canadian taxes and an allowance for investment in Canada.