One advantage Canadian entrepreneurs in the technology space have over those in other industries is mobility.  Whether from the demands of their business or a lifestyle choice, many choose to relocate from Canada to the United States. 

Canadian Departure Tax

An individual ceasing Canadian residency is subject to a deemed disposition of certain assets at their fair market value when they leave Canada.  These assets include shares in start-up corporations, whether formed in Canada or the United States. 

Valuation

The determination of fair market value is based on normal valuation principles which can include revenue generation, number of clients and employees, development of intellectual property and brand value.  In addition to these factors, the funding of start-up entities at all stages is also considered, though the value of certain shares owned by investors who funded the start-up often have rights and privileges that rank these shares ahead of common shares.

US companies often obtain valuation reports by arms’ length parties for US federal tax purposes to ensure the value of any stock options or shares issued to individuals are below the fair market value of the entity.  Referred to as “409A” valuations, these reports are produced to avoid the steep penalties and high taxation that would result where options or shares issued to individuals are already “in the money”. 

When determining the fair market value of private company shares for purposes of Canadian Departure Tax, Canada Revenue Agency will use all information available including fair market value reports, 409A valuations, and corporate activity.  Investor funding rounds can also indicate the value of a company.  Such value may or may not be tied to the shares issued to those that funded the corporation. 

Canadian entrepreneurs considering a move from Canada to the United States should consider not only Canadian departure taxes on their start up shares but other assets as well. 

Avoiding Departure Tax

Many entrepreneurs do not plan to sell their shares soon and would rather invest cash in their start-up than pay the Canadian Departure Tax liability.  This liability can be deferred so long as the individual provides security to Canada Revenue Agency. Where the shares meet the tests of being a Qualified Small Business Corporation, the deemed gain on departure may be exempt from Canadian tax.  Entrepreneurs that move from Canada to the United States before their shares appreciate significantly may avoid Canadian departure tax.

US Tax Implications

Consideration of the US tax implications of their move is also important and those include:

• The need to make an election under Internal Revenue Code Section 83(b) to ensure lower capital gains tax rates on the eventual sale of their shares;
• The type of entity to form to take advantage of the United States’ Qualified Small Business Stock (“QSBS”) rules to obtain tax free gains in amounts much higher than the Canadian equivalent.
• Elections to increase the fair market value of assets for US tax purposes.
• Consideration of the Canada-US Social Security Agreement on a transfer from a Canadian corporation to an affiliated US corporation to reduce overall payroll taxes
• US anti-deferral rules applicable and strategies to assist US residents of Canadian corporations.
• State income tax rules which may differ from US federal tax rules.

Next Steps

Andersen can assist entrepreneurs considering a move from Canada to the United States. 

Please contact Steven Flynn  Managing Director and Partner to learn more.