Where Non-Residents Acquire Control of a Canadian Corporation, Using a Canadian Holding Corporation is Usually Advantageous.

Many Canadian professional advisors will encounter situations in which they are acting for a foreign corporation ("Forco") that is buying control of a Canadian business. In situations where the assets of the business (as opposed to the shares of the corporation) are being acquired, Forco will likely form a Canadian subsidiary to operate the business. Usually, foreign corporations do not operate in Canada as a branch, for a variety of reasons. But what about situations where Forco will be acquiring the shares of the Canadian corporation ("Canco")? Is there any reason for Forco to form a Canadian holding company ("Holdco")?

Some of you may say "Why should they?-they will have a Canadian company anyway after the purchase is completed! "Well, guess again- where significant dollars are involved, there can often be tax advantages to forming Holdco to acquire the shares of Canco. The three most commonly cited ones are as follows:

(1) REPATRIATION OF COST
If Forco acquires the shares of Canco directly, the only portion of its cost that it may withdraw from Canco free of Canadian tax is the paid-up capital of those shares. Usually, this is only a small amount. The balance, representing the value of Canco's retained earnings, goodwill, etc., will have to be extracted as an actual or deemed dividend, subject to non-resident withholding tax under Part XIII. Although in certain cases the rate of Part XIII tax on inter-corporate dividends is as low as 5%, where multi-million dollar purchases are involved, this cost can still be significant enough to plan to avoid. If a Holdco is used to purchase the Canco shares, Forco could contribute the cost to Holdco as a loan. This would allow dividends to be paid by Canco to Holdco tax-free, and then used by Holdco to repay its loan to Forco, also tax-free. If you are thinking that you can create this structure after Forco buys the Canco shares (i.e. by transferring the Canco shares to Holdco for a note) take a good look at section 212.1 of the Income Tax Act-anything that Forco takes from Holdco in excess PAID-UP CAPITAL will be deemed to be a dividend! You have got to set this up initially!

(2) CHARGING INTEREST TO CANCO
Canada's corporate tax rates are fairly high by world standards (e.g. over 44% for non-manufacturing income in Ontario). As such, it is usually advantageous for multi-national corporations to shift profits from Canada to the head-office jurisdiction (or one that is even friendlier). That is why Revenue Canada has beefed-up its "transfer pricing audits". The use of Holdco will allow Forco to effectively reduce the profits that are subject to Part I corporate tax by interest charges that are usually subject to tax under Part XIII at 15% or less. That is, if Forco contributes 75% of the purchase price as a loan to Holdco and 25% as share capital (in order to avoid bumping-up against our "thin capitalization" rules) Holdco and Canco can be amalgamated after the share acquisition, and interest paid by the amalgamated corporation on its debt to Forco may be deducted from its profits that are subject to corporate tax.

(3) ABILITY TO STEP-UP THE TAX COST OF CERTAIN PROPERTY
If Canco owns non-depreciable capital property (e.g. land, shares in other corporations, interests in partnerships) it will not be possible to "step-up" the cost, for Canadian tax purposes, of those assets if Forco acquires Canco. However, this may be possible if Holdco acquires Canco, followed by an amalgamation of the two corporations. Accordingly, for these and other reasons, it is generally a good idea to consider the possibility of forming Holdco to acquire the Canco shares.

Michael I. Atlas is a Chartered Accountant specializing in tax planning for over 27 years. He has published several books including: "Canadian Taxation of Nonresidents" and "Taxation of Real Estate in Canada." Michael is a regular contributor to businessmatch-maker.com.