1. Chapter Objectives Be able to: n Explain the alternatives available for domestic business expansion and the implications of each. n Explain the alternatives available for international business expansion and the implications of each. n Explain the different possible cash flows from a foreign subsidiary corporation and the tax treatment of each. n Explain cross-border transfer pricing and the implications for transactions with a foreign subsidiary corporation.

2. Domestic Business Expansion n The two fundamental structural alternatives are a division of the existing corporation or a new subsidiary corporation. n The factors to consider are: loss utilization, expansion failure, taxation of new profits, and repatriation of capital and accumulated profits. n If the expansion is organized as a division, the start-up losses can be used immediately to offset profits of other divisions; whereas with a separate corporation, the losses can only be used by that corporation. n If the expansion is organized as a separate corporation and the expansion failed, the losses could not be used until this subsidiary was amalgamated with the parent. n The expansion of profits will vary due to provincial differences and the formula for allocating profits amongst the provinces. n There are no significant tax implications for the repatriation of capital and accumulated profits.

3. Domestic Business Expansion (continued) n If there are to be new equity participants, several new issues arise in choosing the structure of the business expansion. For instance, will the new equity participants share in existing operations or just the newly expanded operations. n There is also the possibility of expanding the small business deduction since new corporations may be unrelated.

4. International Business Expansion n The two fundamental approaches to conducting foreign business operations are direct export sales to consumers and/or distributors or the use of a formal foreign structure that involves a physical presence in the foreign jurisdiction. The foreign structure could be via a foreign branch, a foreign subsidiary corporation, a foreign joint venture, and so on. n Since tax will be imposed in the foreign jurisdiction, it is important to consider the amount and timing of tax for each approach. n The factors to consider are: foreign taxes, Canadian taxes, loss utilization, and the tax treatment of different cross-border transactions. n Typically, foreign countries only tax non-residents who are carrying on a business from a permanent establishment. As a result, direct export sales will only be taxed once as world income of a Canadian corporation.

5. International Business Expansion (continued) n The foreign branch structure has one major advantage over the foreign subsidiary corporation structure. Losses incurred by the foreign branch can used to offset profits earned in Canadian operations. n Business profits of foreign subsidiaries are taxed in the foreign jurisdiction and not in Canada. Dividends from the foreign subsidiary are not taxed in Canada as long as it is a foreign affiliate. If these dividends are subject to a foreign withholding tax, there is no foreign tax credit in Canada since the dividend received is not taxable income. n Interest, rents, royalties and management fees may also be received from foreign subsidiary corporations. These payments shift foreign income to Canada and, as a result, foreign jurisdictions will usually have withholding taxes on such payments. There may also be limits on the deductibility of such expenses in the foreign jurisdictions.

6. International Business Expansion (continued) n Products sold to a foreign subsidiary are deemed to have been sold at a price that would reasonably have been expected in similar circumstances had the parties been dealing at arm’s length. This is referred to as the reasonableness test for cross-border transfer pricing. n When comparable arm’s length selling prices are unavailable, the two other accepted methods are cost plus a reasonable mark-up and resale price less a reasonable mark-up. n If a foreign branch is converted to a foreign subsidiary corporation, the election to transfer assets at an elected price, such as tax cost, is not available. As a result, there could be Canadian taxable income.