In our latest Tax Alert, we take a look at repatriation planning. Specifically, we examine the most effective tax strategies for a Canadian subsidiary (“CanCo”) to repatriate profits to its U.S. parent corporation (“USCo”).

Cash distribution – Dividends vs. return of capital

CanCo may distribute profits to USCo via dividend payment or return of capital. Profits distributed by CanCo to USCo would be subject to a 25 per cent dividend withholding tax under Part XIII of the Canadian Income Tax Act (the “Act”). The 25 per cent withholding rate may be reduced under the Canada‑U.S. Treaty (the “Treaty”) to 5 per cent.¹ Note that relief under the Treaty is denied if the beneficial owner of the dividends either carries on or has carried on business in Canada through a permanent establishment (“PE”) situated in Canada, and the holding in respect of which the dividends are paid is effectively connected to the PE.

CanCo can distribute profits as a return of capital on a tax‑free basis provided there is adequate paid‑up capital (“PUC”).² The starting point for computation of PUC of a class of shares is the stated capital of the class for corporate law purposes. The PUC of a class of shares is equal to its stated capital, plus or minus certain adjustments specified in the Act. Adjustments are generally designed to prevent a corporation from using tax‑deferred transactions to increase the stated capital of the corporation, thereby obtaining an increased PUC.

Inter‑company payments

Cross‑border interest payments

Subject to certain exceptions, recent amendments to Canadian domestic law and the Treaty have largely eliminated Part XIII withholding tax in respect of interest paid by a resident of Canada to a resident of the U.S. Therefore, interest payments made by CanCo to USCo can be an effective means of repatriating profits back to the U.S. However, consideration must be given to the Thin Capitalization rules. Very generally, these rules limit deductibility of interest to the extent such interest is attributable to debts owing to specified non‑residents of the corporation in excess of a prescribed threshold.

Intercompany charges/management fees

Depending on business type, USCo may enter into arrangements with CanCo to earn other kinds of income, such as management fees, rents and royalties. Generally, management fees, rents and royalties are also subject to a 25 per cent withholding tax under Part XIII, and the applicable rates may be reduced under the Treaty.

Often, a non‑resident with a controlling stake in a Canadian company will charge management fees to the Canadian company in exchange for provision of management consulting‑type services. Depending on the residency and Treaty eligibility of the recipient entity, Part XIII withholding tax on the management fees can be eliminated entirely to the extent such fees are treated as business profit under the Treaty, and the recipient does not carry on business in Canada through a permanent establishment. 

Canada’s transfer pricing rules are set out in section 247 of the Act. The rules include a provision for the Canada Revenue Agency (“CRA”) to make an adjustment to a transaction or series of transactions between related parties in the event the transactions are found to reflect non‑arm’s‑length terms and conditions. Under subsection 247(4), a corporate taxpayer who engages in cross‑border related‑party transactions is required to determine arm’s‑length prices for those transactions and document those transactions and the prices paid or received. If it is found a taxpayer failed to make reasonable efforts to determine and use arm’s‑length prices and allocations, the legislation imposes a severe penalty, applicable regardless of whether or not a Canadian tax liability results from the transfer pricing adjustment.

Inter‑company loans

Loans to USCo

Shareholder loans are a common business practice allowing shareholders to extract funds from their corporation while incentivizing shareholders for investing in the corporation. However, shareholder loans from CanCo to USCo could result in negative Canadian tax consequences if they are interest‑free or have low interest rates, and/or remain outstanding for a long period of time.

Generally, unless an exception applies, the shareholder loan rule in subsection 15(2) of the Act, combined with paragraph 214(3)(a), provide that the amount of a loan received by USCo (the parent), or any person connected with USCo, from CanCo (the subsidiary) is deemed to be a dividend for withholding tax purposes. The two most commonly relied upon exceptions to the application of subsection 15(2) are (i) where an election is made for the loan to be a pertinent loan or indebtedness (PLOI Exception), and (ii) where the loan is repaid within one year after the end of the tax year of the lender in which the loan was made (other than as part of a series of loans or other transactions and repayments). 

Loans from USCo

Repayment of existing loans from USCo is another way of repatriating profits to the U.S., however foreign exchange implications of loan repayment should be considered. Subsection 39(2) applies to debts and similar obligations denominated in a foreign currency. The provision deems the amount of all such gains and losses to be a capital gain or loss for the year from a disposition of currency of a country other than Canada. 

Drawing on our deep experience and expertise in cross‑border tax planning, we can guide you through the intricacies of repatriating profits and related matters. Simply contact your Baker Tilly advisor today to get started.

1. ¹ In the case of a shareholder resident in the U.S. and qualifying for benefits under the Treaty, the applicable rates are as follows:
   • Five per cent of the gross amount of the dividends if the beneficial owner is a company owning at least 10 per cent of the voting stock of the company paying the dividends; and
   • 15 per cent of the gross amount of the dividends in all other cases.
2. ² Note that reduction of PUC can be made prior to payment of dividends

Meet the Author

Mandeep Gaheer
Windsor, Ontario
D (226) 774-5356

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