Canadian Business Investment in the US
The US is a natural market for Canadian businesses. While there are many similarities between doing business in Canada and the U.S., it is the differences that require your attention.
Canadian corporate tax rates are about a third lower than their equivalent in the U.S., about 25% versus 35%, plus state income tax. If you consider that Canadian corporate tax rates can be as low as 13½% on the first $500,000 of taxable income, the difference if is even greater. U.S. federal corporate tax rates hit 34% on taxable income in excess of $75,000.
If you can conduct your US business activities without being subject to U.S. tax, you will reduce your tax liability and your costs to comply with US tax law. The Canada-U.S. tax treaty exempts Canadians from US tax for certain activities conducted in the U.S., but it still requires those claiming tax treaty benefits to report their use or be exposed to a penalty of up to $10,000.
Even where a Canadian corporation or individual is exempt from U.S. federal income tax under the Canada-U.S. tax treaty, they may be liable for state and local income, sales and other taxes. Generally, Canadian persons with US business activities will be liable for state and local taxes where their personnel, including agents, or property is present in a state, even if only temporarily. In certain cases, Canadian persons may be subject to state and local taxes where they don’t have any physical connection to a state except that the benefit of their services is realized there.
If the primary objective of US business activity is realization of capital gains, such as those arising from real estate investment, careful consideration should be given to avoiding holding such investments through a corporation. Unlike Canada, the US has no preferential corporate capital gain tax rate. The US capital gain tax rate on individuals is generally 20% where the investment is held for 12 months or longer. The corporate capital gain tax rate for U.S. federal income tax purposes goes up to 35%, plus state income tax if applicable.
Depending on the business activity, it may be desirable to invest in the U.S. through a U.S. corporation. Generally, the U.S. corporation should be owned by a Canadian corporation(s) that has a 10% or greater interest in it. Doing so reduces the US withholding tax on distributions from the U.S. corporation from 15% to 5%. Where the U.S. corporation has an “active business” in the U.S., its earnings will not be subject to Canadian tax when they are distributed to it and the subsequent distribution to shareholders will be eligible to be taxed at a preferential tax rate in Canada. It also protects the Canadian shareholder from US estate tax.
Many U.S. persons invest in the U.S. through a limited liability company or “LLC”. An LLC is not to be confused with a regular corporation. While both have limited liability, an LLC is treated for U.S. tax purposes as a “pass-through” entity that subjects its owner(s) to U.S. tax. Conversely, Canadian tax law treats an LLC as a corporation that only taxes its owners when distributions are made. The difference in U.S. and Canadian characterization of LLCs can result in tax being assessed by both Canada and the U.S. without offsetting foreign tax credits. We do not generally recommend Canadian residents or corporations invest in the U.S. through an LLC.
You will be required to report your ownership of investments outside of Canada to the Canada Revenue Agency. In some cases the income earned in a U.S. corporation may be taxable in Canada before the earnings are distributed where the income is characterized as Foreign Accrual Property Income or “FAPI”. FAPI applies to most investment activities that do not constitute an “active business”, including real estate.