1. SPEAKER: GLEN MACMILLAN; ADAMS & MILES LLP
CASE STUDY - CANADA
SPEAKER:
GLEN MACMILLAN; ADAMS & MILES LLP

2. Withholding tax on license fee
Withholding tax issues on cross border payments should always be considered before the structure is established
Licence fees usually meet treaty definition of a “royalty”
No withholding tax under treaty if “payment is for information concerning industrial, commercial or scientific experience...” (i.e., business know how)
10% withholding tax if payment is in connection with a franchise agreement or for use of a trademark
Review wording of the license agreement when agreement is being drafted and consider carving out payments for business know how from payments for use of trademark

3. What is a franchise? Not defined in the treaty
Under common law principles, a franchise payment is made for the right to sell a product or service, use the franchisor's business model and do business under the franchisor's name.
Generally requires some degree of oversight by the franchisor of the franchisee’s business

4. Branch of US “S” Corporation
ADVANTAGES:
Can avoid need to address withholding tax on licence fee
Flow through of foreign tax to US shareholder
5% branch profits tax rate and $500,000 branch profits tax exemption
No requirement to report transactions, charges or cost allocations between branch and home office to CRA

5. Branch of US “S” Corporation
DISADVANTAGES:
Need to annually determine CDN$ profit “reasonably attributable” to Canadian branch
Often difficult to convince CRA auditors of reasonableness of “home office” charges to the Canadian branch
Non-tax commercial issues often arise, such as difficulties obtaining insurance and opening Canadian bank accounts

6. Branch of US LLC ADVANTAGES:
Can avoid need to address withholding tax on licence fee
Flow through of foreign tax paid to US shareholder
No requirement to report non-arm’s length transactions between branch and home office to CRA

7. Branch of US LLC DISADVANTAGES:
25% branch profits tax rate and no $500,000 branch profits exemption
Need to annually determine CDN$ profit “reasonably attributable” to Canadian branch
Various non-tax commercial issues often arise, such as difficulties obtaining insurance and opening Canadian bank accounts

8. Limited Partnership ADVANTAGES:
Flow through of foreign tax paid to US shareholder

9. Limited Partnership DISADVANTAGES:
Need to annually determine CDN$ profit “reasonably attributable” to Canadian branch
Need to address withholding tax on licence fee
Each partner required to obtain Canadian tax ID numbers and file annual Canadian tax return
Annual partnership information return must be filed
Various non-tax commercial issues often arise, such as difficulties obtaining insurance and opening business bank accounts

10. Canadian Corporation (non-ULC)
ADVANTAGES:
Generally considered the safest of entities for ensuring full treaty benefits
5% withholding tax on dividends if owned by S corporation, 15% if owned by US individual
Dividends treated as qualified dividends for US purposes - will dividends paid after 2012 still be treated as qualified dividends?
Generally easy to set up tax registrations, business licences and bank accounts.
Only need to prepare Canadian company trial balance, tax returns, etc. No need to maintain separate Canadian and US trial balances, Canadian and US tax calculations for depreciation, taxable income, etc.

11. Canadian Corporation (non-ULC)
DISADVANTAGES:
Need to address withholding on licence fee
No flow through of foreign tax to US shareholder (this issue may be less significant than in prior years due to substantial reductions in Canadian corporate tax rates in the past decade)
May need Canadian directors depending on jurisdiction of incorporation

12. Canadian ULC [owned by “S” corporation]
ADVANTAGES:
Flow through of foreign tax to US shareholder
Combines benefits of flow through of foreign tax to shareholder with compliance ease of a domestic Canadian corporation
5% withholding tax on dividends

13. Canadian ULC [owned by “S” corporation]
DISADVANTAGES:
Need to address withholding tax on licence fee
No treaty benefits for royalties, non-arm’s length interest and management fees
Need additional legal steps to obtain 5% dividend withholding tax rate; convert retained earnings into paid up capital followed by distribution of paid up capital to shareholder

14. Canadian ULC [owned by LLC]
ADVANTAGES:
Flow through of foreign tax to US shareholder
Combines benefits of flow through of foreign tax to shareholder with compliance ease of a domestic Canadian corporation

15. Canadian ULC [owned by LLC]
DISADVANTAGES:
No treaty benefits for dividends, royalties, non-arm’s length interest and management fees
25% withholding tax on these payments

16. Canadian ULC [owned by US Limited Partnership]
ADVANTAGES:
Flow through of foreign tax to US shareholder
Combines benefits of pass-through of foreign tax to shareholder with compliance ease of a domestic Canadian corporation
Full treaty benefits available if partners are “S” corporations or individuals

17. Canadian ULC [owned by US Limited Partnership]
DISADVANTAGES:
Need to address withholding tax on licence fee
Treaty benefits denied if partner is an LLC
Risk that treaty benefits will be denied on dividends, royalties, non-arm’s length interest and management fees if substance of the structure is challenged by CRA
In a current case, CRA is apparently asserting that a US partnership of two “S” corporations owned by the same individual is not a bona fide partnership

18. Recommended Structure
Carry on business through a branch of US “S” corporation because:
Avoids withholding tax exposure on licence fees (ensure the intellectual property is owned by the S corporation)
Full treaty benefits available and flow through of all Canadian tax paid to US shareholder
Combined Canadian income tax and branch tax will be about 30%; US shareholder should obtain full foreign tax credit
If withholding tax on royalties were not an issue, ULC owned by S corporation may be a preferable structure