Canadian
Corporations Operating in the U.S. as a Branch
For tax purposes, a branch is generally defined as a fixed
place of business (e.g., an office or factory) in a foreign
jurisdiction in which a corporation carries on its business.
A branch is not a separate legal entity of the corporation.
A Canadian
company that conducts its US business operations through
a branch in the US may create a “permanent
establishment” as defined under the US-Canada tax treaty.
Transacting business in the US through a permanent establishment
will create US tax filing requirements and potential US federal
and state income tax liabilities for the Canadian company
on business profits derived from the branch.
A Canadian company that decides to expand its business operations
into the US through a branch should consider the pros and
cons before doing so.
Advantages of a Branch
One advantage of transacting business in the US via a branch
includes the ease of set up. The Canadian company would be
required to obtain a business license in the state in which
the branch will operate, but it does not need to incorporate
a new company in the US The Canadian company is also required
to obtain a US tax identification number, or federal employer
identification number. Both are relatively simple to do.
If the Canadian company expects to incur losses while it
is expanding into the US, conducting business through a branch
would enable the company to deduct such US branch losses
for Canadian tax purposes against current Canadian taxable
income. Such losses could offset any Canadian tax otherwise
payable.
If the US branch is profitable and is liable for US corporate
income taxes, the company could generally claim a foreign
tax credit on its Canadian corporate income tax return for
income taxes paid to the US The foreign tax credit calculation
in Canada ensures that double tax should not occur on the
same income. The allowable foreign tax credit for Canadian
tax purposes is limited to the lesser of the actual foreign
taxes paid or the Canadian tax otherwise payable on such
income.
In addition
to federal and state income taxes, some states impose minimum
and/or franchise taxes. These taxes are not
eligible for foreign tax credit in Canada and may only be
claimed as a deduction as they are generally computed based
on the corporation’s capital, similar to provincial
capital taxes.
In addition to US corporate taxes, the company may be liable
for branch profits tax (BPT) at a rate of 5% under the treaty
for profits ultimately repatriated from the US branch. The
BPT eliminates the withholding tax inequity that would otherwise
result if profits were earned by a US subsidiary of the Canadian
company.
A US subsidiary that pays a dividend to its Canadian parent
is required to withhold and remit tax at a rate of 5% under
the treaty on the amount of the dividend. The BPT eliminates
the advantage a branch would otherwise have. The treaty does
provide an exemption from BPT on the first C$500,000 of after-tax
branch profits not reinvested within the US. Accordingly,
the first C$500,000 can be withdrawn from the US without
incurring BPT. There is no such exemption for dividend distributions
from a US corporation.
Disadvantages of a Branch
When the branch becomes profitable, its profits are taxed
both in the US and in Canada. While the company may claim
a foreign tax credit against its Canadian tax for US taxes
paid, the foreign tax credit may not completely offset the
Canadian tax on the income due to potentially higher effective
tax rates rate in Canada. In effect, the US income of the
branch is taxed at the higher of the US and the Canadian
tax rates.
Further difficulties may arise due to differences in the
computation of taxable income in the US vs. Canada in areas
such as inventory valuation, depreciation, retirement plans,
salary expense deductions for owner/managers, and interest.
These differences may result in some level of double taxation
of US branch income.
There are tax compliance aspects of branch operations that
may also be difficult. The US tax calculations required in
determining the appropriate allocations of costs and revenues
to a branch are complex. The amount of documentation required
regarding such costs and allocations may be significantly
greater than a company is likely to prepare in the ordinary
course of its business. The US branch tax rules are more
difficult to comply with than general corporate income tax
rules and may result in additional compliance costs.
A Canadian corporation with interest expense could be subject
to an additional layer of US tax known as branch level interest
tax. US rules require an allocation of overall corporate
interest expense to the US Branch in the determination of
US taxable income, regardless of whether the branch itself
borrowed any funds. The branch level interest tax is assessed
at a rate of 10%, and it cannot be claimed as a foreign tax
credit for Canadian tax purposes.
A significant non-tax consideration is the fact that the
US branch is not legally separated from the Canadian corporation.
Consequently, the Canadian assets of the corporation are
not shielded from potential US liabilities, and vice versa.
Before a Canadian company decides on a US business expansion,
the company should consult with their cross-border tax advisers
so a thorough analysis of the particular situation can be
undertaken.
Disclaimer
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"The
information contained herein is of a general nature and
is not intended to address the circumstances of any particular individual
or entity. Although we endeavor to provide accurate and
timely information, there can be no guarantee that such information
is accurate as of the date it is received or that it
will continue to be accurate in the future. No one should act on such information
without appropriate professional advice after a thorough
examination
of the particular situation.
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© 2006 KPMG LLP, the
Canadian member firm of KPMG International,
a Swiss cooperative. All rights
reserved."
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