Tax and business implications of opening a branch office
When a firm decides it’s time to expand into a new province or even into the U.S. or overseas, what are the must-know tax risks and implications?
From the August-September 2016 print issue, p. 38
Expanding your engineering firm’s operations with a new branch in a different province or country can be a significant step in your growth trajectory, but the process itself can be overwhelming.
New province, new rules
From an income tax perspective, you first need to establish whether your firm — in this case a corporation — will have what’s referred to as a “permanent establishment” in the new province, because this will determine which province you will be taxed in. Taxable income is allocated among all provinces in which you have a permanent establishment on the basis of revenue earned and wages paid in each province.
The provinces generally follow the federal definition of permanent establishment. Essentially it means the presence of a physical location, but the term can also apply if you have an employee or agent in the province, if you’re holding and distributing inventory there, or if you bring significant amounts of equipment into a province.
From an income tax rate perspective, the implications of where your permanent establishments are located in Canada are not particularly severe because corporate tax rates don’t differ greatly from province to province. Consider the January 1, 2016 federal/provincial combined general corporate tax rates for B.C. and Ontario — 26.0 and 26.5 per cent, respectively. Further, there are relatively few differences between provincial and federal income tax calculations, minimizing the burden of filing corporate income tax returns in different provinces (though Alberta and Quebec do have separate provincial corporate tax returns that must be filed directly with provincial authorities).
One of the biggest practical tax issues your firm is likely to face when opening a new branch is provincial sales tax (PST). Rules for provinces like B.C., which has both PST and GST, can be convoluted and different from provinces that have HST (harmonized sales tax), or only GST (goods and services tax). You’ll need to determine what services and activities are subject to PST; you could even end up in a situation where you need to remit PST on equipment you bring into the province on a temporary basis.
And before making the move, familiarize yourself with the legal regulations associated with operating in the new province.
Be structure savvy — branch
Opening a “branch” normally suggests you will operate under the same legal entity, just in a new jurisdiction. In this structure, the same entity has tax filing and payment obligations in multiple jurisdictions.
The common alternative structure, in which a new legal entity is created to operate in a new jurisdiction, is commonly referred to as incorporating a “subsidiary.” A subsidiary determines its own tax filing and payment obligations depending on where it operates. Each option has advantages and disadvantages.
Within Canada, creating a new subsidiary may not offer significant tax advantages but could still be the best course of action in cases where there are specific ownership or other legal requirements in a province — or if there are concerns about potential liabilities that need to be compartmentalized.
For example, consider an Ontario corporation opening an office and commencing operations in B.C. The minimal tax rate differential means overall corporate income taxes paid in a branch structure will be similar regardless of the split in taxable income between provinces. However, if there are other reasons that a corporate subsidiary is desirable, generally one could be incorporated to operate in B.C. without creating an inefficient tax scenario. Taxable income in a B.C. subsidiary would be subject to tax in B.C. at the same rates as taxable income allocated to B.C. in a branch structure. Further, earnings from a Canadian resident subsidiary can usually be distributed to a Canadian resident parent corporation, without incurring additional tax.
Opening a U.S. branch may be woven into your growth strategy, but Canadian and U.S. taxes don’t always integrate well. In particular, at the state level you could face complex issues, as each state has its own tax regulations. For example, you could end up required to remit sales taxes to the state, even if you aren’t required to file income tax returns in the same state.
Expanding into the U.S. (or other foreign jurisdictions) is significantly more challenging to structure on a tax effective basis and requires specialized assistance. Often companies that expand into the U.S. enlist a U.S. resident advisor to help them, but tax inefficiencies can arise when advisors don’t understand taxation on both sides of the border. Some structures that are commonly used in the U.S., such as LLCs, can be particularly problematic for Canadian residents.
At a basic level, U.S. corporate tax rates are higher than those in Canada and there are usually additional taxes incurred when funds are repatriated to Canada, whether from a branch or subsidiary.
The Canadian compliance costs of a foreign subsidiary or branch operation can also be significant, as can penalties associated with non-compliance. For example, additional tax information returns (to report the existence of, and transactions with, foreign affiliates) must often be completed. In addition, the allocation of income and expenses cross-border is subject to a high level of scrutiny under transfer pricing rules. It is a requirement under these rules to maintain detailed documentation about cross-border charges.
If your firm is considering cross-border expansion, ensure you consult an advisor who understands both Canadian and U.S. tax. And even if your growth is closer to home, it’s advisable to involve your accountant early on in the process to ensure success.cce
Marlin Miller, CPA, CA, is a partner at Collins Barrow Calgary LLP, where he develops and implements tax planning strategies for partnerships and corporations. firstname.lastname@example.org