Corporate Taxation & Structuring in Canada and Canadian Scientific Research & Experimental Development Program Overview (SR&ED)

Transcription

1 Corporate Taxation & Structuring in Canada and Canadian Scientific Research & Experimental Development Program Overview (SR&ED) Claude E. Jodoin, M.Fisc. Maximize your R&D $...Look North of the border! - Huntsville - March 15, 2011 Maximize your R&D $...Look North of the border!- Birmingham March 15, 2011

2 A Canadian Perspective on Canada-US Cross Border Tax Issues I. Corporate Taxation in Canada Applicable Income Tax Rates Applicable Sales Tax Rates Withholding Tax Recent changes and opportunities Changes to Domestic Rules: Disposition of TCP II. Choice of Entity III. Review of SR&ED Review of SR&ED Incentives: Federal Tax Incentives Québec Tax Incentives Ontario Tax Incentives Alberta Tax Incentives British Columbia Tax Incentives IV. General and Eligibility Requirements Structuring Ideas and Issues: a) Structures for SR&ED: USCo carries out SR&ED Directly USCo contracts with Canadian Subsidiary USCo contracts with a CCPC b) Acquisition Structures: Exchangeable Share Structure 2

3 I. CORPORATE TAXATION IN CANADA

4 2011 Corporate Tax Rates Québec Ontario Alberta British Columbia Federal General Business (non-ccpc) 11.9% 12% 10% 10% 16.5% Small Corporations (CCPC only) 8% 4.5% 3% 2.5% 11% Investment Income (non-ccpc) 11.9% 12% 10% 10% 16.5% Capital Tax 0% 0% 0% 0% 0% 4

5 Sales Taxes in Canada Federal: Québec: Ontario: Alberta: British Columbia: Goods and services tax ( GST ) Sales tax Sales tax includes GST No sales tax Sales tax includes GST 5% 8.5% 13% 0% 12% 5

6 Withholding Tax Dividends: 25% Interest: Royalties: Capital gains: 25% or 0% 25% See comments on Taxable Canadian Property 6

7 Withholding Tax - Interest Zero withholding on arm s length interest as of January 1 st, 2008 under domestic law Arm s length non-resident can be resident anywhere No longer need the 5/25 loan exemptions Borrower need not be a corporation Loan can be on resolving and short term basis Domestic exemption does not apply to a participation debt interest Generally defined as Interest that is paid or payable on an obligation, all or any portion of which interest is contingent or dependent on the use of or production from property in Canada or is computed by reference to revenue, profit, cash flow, commodity price or any other similar criterion or by reference to dividends paid or payable to shareholders of any class of shares of the capital stock of a corporation 7

8 Withholding Taxes Canada US Tax Treaty reduces the applicable rates: Dividends: If corporation holds more than 10% of payor: 5% Others: 15% Interests: reduces withholding rate to 0% Royalties: 10% Capital gains: no tax on most property (except real property) 8

9 Changes to Domestic Rules: Disposition of TCP When a non-resident sells or disposes of a property that is taxable Canadian property ( TCP ): Need to get a clearance certificate To get the tax clearance certificate: Must either pay an amount (25%) of the gain; or Establish entitlement to treaty exemption 9

10 Changes to Domestic Rules: Disposition of TCP (cont d) Changes to domestic rules: Section 116 Definition of taxable Canadian property (TCP) was very broad and included shares of Canadian private corporations and substantial interest (more than 25%) of publicly traded shares Disposing of TCP required obtaining tax clearance certificate (under section 116 ITA) even if no income tax was payable Most treaties with Canada exempted tax on gain of TCP (except where value is derived from real property) (Problem for US is LLC) Delays in processing: If not obtained on time: buyer must withhold and remit 25% of price (not just gain) Non-resident must file tax return even if no tax is payable 10

11 Changes to TCP Definition Federal budget on March 4th, 2010 proposed to restrict the definition of TCP to: Real property in Canada; Property used in a Canadian business; Designated insurance property of insurers; and Shares (interests in trusts or partnerships) where more than 50% of value (at any time in 60 month window) is derived from Canadian real property, timber or resource properties; Options in respect of such TCP is also TCP New definition means that third country blockers are no longer needed when structuring investments into Canada (Quid: dividends, etc.) No longer need treaty exemption Non-treaty corporation can be used Key is to not be in the definition of TCP 11

12 Where seller is a LLC (fiscally transparent) protection under Canada-US Treaty is now available to the extent its members are qualifying US treaty residents (See later) 12

13 PREVIOUS STRUCTURE ISSUES LLC LLC Canadian Private Corporation Other Treaty Corporation 13 (Prior to change to TCP, needed to interpose a blocker corporation) If LLC is treated as a partnership for US tax purposes: Not entitled to treaty benefits (prior to Protocol) Had to use a blocker corporation in a treaty jurisdiction (such as Luxemburg) to be able to get section 116 certificate without paying tax Since Protocol, must look at members to determine if treaty benefits are available Canadian Private Corporation

14 STRUCTURING LLC INVESTMENT IN CANADIAN CORPORATION - after March 4, 2010 OLD LLC NEW LLC Other Treaty Corporation Canadian Private Corporation Canadian Private Corporation Now can invest directly into Canadian corporation if not TCP 14

15 By virtue of new definition of TCP, most private equity investments will not be TCP, so it will not matter if investor is resident in US or entitled to treaty benefits If the property (shares of Canco) is not TCP, there is no need to go through a blocker/stepping stone jurisdiction, and can invest directly into Canco (no certificate to obtain and not tax return to file) 15

16 A blocker corporation in a treaty jurisdiction may be desirable for other reasons, such as where there is an expectation of income in dividend or royalty: The withholding tax is 25% subject to the provisions of the treaty Need to qualify for reaty reduction/exemption (treaty reduces to 5-15% on dividends, or 0-10% on royalties) In a nutshell, as concerns, the LLC issue: Canada treats LLC as a corporation in all cases If LLC is not subject to tax in the US, Canada considers that LLC is not resident in US for treaty purposes, so does not get benefits (partial solution is in Protocol) 16

17 II. Choice of Entity

18 Choice of Entity Corporations vs. Partnerships: Corporations have a separate legal personality, while partnerships do not. Certain entities are hybrids in that they are classified differently for US and Canadian tax purposes. For example: Nova Scotia Unlimited Liability Company (NSULC) (British Columbia and Alberta) is considered a corporation for Canadian tax purposes but may be treated as a partnership in the US; A US LLC is always treated as a corporation for Canadian tax purposes but is treated as either a corporation or partnership in the US. 18

19 Choice of Entity (cont d) Jurisdiction of incorporation (federal or provincial) Differences: Canadian resident directors (federal and Ontario) (need 25%) Québec does not require ULC (Alberta, British Columbia and Nova Scotia) Minority rights protection Unanimous Shareholders Agreement (restriction on directors powers, potential liability to shareholders) Written resolutions: unanimity 19

20 Choice of Entity (cont d) Canadian principles of entity classification Classification of domestic entities: Depends on the private law characteristics of the entity Classification of foreign entities: For Canadian tax law purposes classification of foreign entities is based on the criteria applied to domestic entities For tax treaty benefit purposes, the trend has been to consider the characterization of the entity in the state of fiscal residence (this was not always so) 20

21 Choice of Entity (cont d) ENTITY Canadian classification Default US classification (elective) Treaty benefit entitlement (if CTB) C Corporation Corporation Corporation YES S Corporation Corporation Flow Through YES (Canada) LLC (separate person) Corporation Partnership (Corporation) Possible LLP (separate person) Partnership Partnership (Corporation) NO (Subject to look through) (NO) Partnership Partnership Partnership NO (Subject to look through) 21

22 III. REVIEW OF SR&ED

23 SR&ED incentives are provided at two (2) levels of government: Federal Each provinces provides its own set of incentives The incentives generally have two (2) components: Deductibility of SR&ED expenses Tax credits for SR&ED expenses 23

24 Federal SR&ED Tax Incentives The main components of the federal incentives in Canada relating to SR&ED can be summarized as follows: the ability to claim a deduction in computing income for current and capital expenditures incurred in the year. Any remaining SR&ED expenditures can be carried forward indefinitely; the ability to claim, in addition to the deduction in computing income, a tax credit in respect of most SR&ED expenditures; the ability to include, as part of one s SR&ED expenditures for purposes of the SR&ED tax credit, 65% of SR&ED salaries on account of overhead and similar expenditures. 24

25 Federal SR&ED Tax Incentives Investment tax credit (ITC) of 20% or 35% may be earned on qualified SR&ED expenditures Can be used to reduce taxes payable or received as a cash refund Any remaining ITC may be carried back 3 years or forward 20 years ITCs are earned at: 35% on the first $3 million of expenditures for Canadian controlled private corporations (CCPC) 20% for other corporations (public or foreign), individuals, partnerships, or trusts ITCs may be used to reduce taxes payable ITCs earned at 35% rate may be refunded 25

26 Illustration of Federal ITC on $5 Million of Current SR&ED Small Canadian-controlled Private Corporations Large Canadian or Foreign-controlled Corporations Credit Rate % Refund Refundable Tax Credit (Cash Back) Non-Refundable Tax Credit (Reduce Taxes) Credit Rate % Refund Refundable Tax Credit (Cash Back) Non- Refundable Tax Credit (Reduce Taxes) First $3 million in SR&ED expenditures 35% 100% $1,050,000 _ 20% $600,000 Remaining $2 million in SR&ED expenditures 20% 40% $160,000 $240,000 20% $400,000 TOTAL $1,210,000 $240,000 _ $1,000,000 26

27 Qualified SR&ED Expenditures Computation of qualified expenditures: Current SR&ED expenditures Capital SR&ED expenditures Overhead expenditures (proxy (65%) or traditional method) Shared use equipment (50% of costs over 2 years) Minus Contract revenue (from Canadian sources) Government/Non-government assistance Prescribed expenditures (used equipment) 27

28 Snapshot of Provincial Tax Incentives QUÉBEC: Deduction from income: same as federal Tax credit: always refundable CCPC (less than $75 million in assets): 37.5% of first $3 million of qualified expenditures 17.5% on excess Non-Canadian controlled: 17.5% Qualifying expenditures: Salaries and wages 50% of arm s length SR&ED contract cost [no limit] University Research: 28% of contract cost 28

29 Snapshot of Provincial Tax Incentives (cont d) QUÉBEC: Tax holiday for foreign researchers or experts 5 year provincial tax holiday on salary (100% year 1 and 2, then 75%, 50% and 25%) Other Incentives: E-Business; Refundable Tax Credit of 30% of salaries paid (annual limit of $20,000 per eligible employee); Need more than 5 employees throughout the year, and must devote more than 75% of activities to IT development. 29

30 Snapshot of Provincial Tax Incentives (cont d) ONTARIO: Harmonized with federal Tax credits: 10% refundable on first $3 million (same criteria as federal except that only 40% of capital expenditure qualify) 4.5% non-refundable on qualifying expenditures attributable to a permanent establishment in Ontario in respect of SR&ED in Ontario (same as federal i.e. salary, equipment, etc.) OBRITC: 20% refundable on first $20 million per year for SR&ED expenditure incurred by a qualifying corporation in Ontario under a research contract with an eligible research institute 30

31 Snapshot of Provincial Tax Incentives (cont d) ALBERTA Deduction from income: same as federal Tax credit: Available to corporations with a permanent establishment in Alberta and that carry on SR&ED activities in Alberta 10% refundable on first $4 million of qualifying Alberta expenditures (same criteria as federal) 31

32 Snapshot of Provincial Tax Incentives (cont d) BRITISH COLUMBIA Deduction from income: same as federal Tax credit: Available to corporations with a permanent establishment in British Columbia and that carry on SR&ED in British Columbia CCPC: 10% refundable on first $3 million of qualifying expenditures (same as federal) 10% non-refundable on balance Non-CCPC: 10% non-refundable on qualifying expenditures (same as federal) 32

33 Snapshot of SR&ED Incentives Fed. / Prov. deductions Federal Tax Quebec Tax SR&ED Expenses SR&ED Salaries and SR&ED Contract Capital SR&ED expenses and other current SR&ED expenses Y Y % (+ proxy) % ( 28% Research Center N/A Non SR&ED Expenses Current expenses Capital Y CCA N/A N/A N/A N/A SR&ED Pool (indefinite carry forward) 20 years carry forward 33

34 SR&ED: General and Eligibility Requirements SR&ED must take place in Canada (limited support work outside Canada qualifies federal budget 2008) Claimant must carry on a business in Canada Non-residents must have permanent establishment in Canada (e.g. subsidiary or branch) SR&ED must be related to the business Claimant must incur qualifying expenditures Salary and Wages Materials (consumed or transformed) SR&ED Contracts (payments to another party) Leases (machinery and equipment) Overhead (traditional method or proxy method (65%)) Third Party Payments (universities, approved entities) Capital Expenditures (machinery and equipment) 34

35 SR&ED: General and Eligibility Requirements (cont d) Basic Research: advancing scientific knowledge without a specific application Applied Research: advancing scientific knowledge with a specific application Experimental Development: Achieving technological advances in order to create or improve materials, devices, products, or processes 35

36 SR&ED: General and Eligibility Requirements (cont d) Technical Support Work: Includes work that is commensurate with the needs and in direct support of Basic and Applied Research or Experimental Development Engineering Design Operations Research Mathematical Analysis Computer Programming Data Collection Testing Psychological Research 36

37 SR&ED: General and Eligibility Requirements (cont d) Three (3) criteria must be fulfilled in order for a project to be eligible: SR&ED project must contain: Scientific or technological advancement Scientific or technological uncertainty Scientific and technical content 37

38 SR&ED: General and Eligibility Requirements (cont d) Certain activities are excluded from SR&ED: Market research or sales promotion Quality control or routine testing Social science or humanities research Prospecting, exploring, producing, or drilling Commercial production or commercial use Style changes Routine data collection 38

39 IV. STRUCTURING IDEAS AND ISSUES: a) Structures for SR&ED:

40 1. USCo Carries Out SR&ED Directly USCO US CDA SR&ED activities: - Employees 40

41 USCo Carries Out SR&ED Directly (cont d) USCo must carry on business in Canada Gets 20% federal credit on all SR&ED expenses in Canada Gets provincial credit of 17.5% on SR&ED salaries in Québec Since USCo is not Canadian controlled, the federal credits are not refundable (Québec credit is refundable) Example of benefit: SR&ED expenses: $1,000,000 ($800,000 salaries/$200,000 equipment) 41

42 The Canadian Tax Advantage Net Cost of SR&ED in 2010 Federal Québec Federal Ontario Federal BC A. Expenditures for SR&ED materials $200,000 $200,000 $200,000 $200,000 $200,000 $200,000 B. SR&ED salaries $800,000 $800,000 $800,000 $800,000 $800,000 $800,000 C. Proxy Amount (65% of B) (overhead): $520, $520,000 $520,000 $520,000 $520,000 D. Tax credit $276,000 $140,000 $290,320 $68,400 $273,600 $152,000 E. Tax savings $96,360 $86,156 $105,811 $76,954 $94,776 $57,440 F. Net cost to the corporation $401,484 $458,515 $422,184 NOTE: Need income and income tax to access the benefits, except for the Québec tax credits of $140,000 which is paid to USCo. 42

43 2. USCo Has a Canadian Subsidiary to Carry Out SR&ED USCO US CDA 100% CANCO 43 Canco is a subsidiary of USCo Canco carries out SR&ED in Canada (either itself or under contract for USCo) COMMENT: If Canco carries out SR&ED for USCo: USCo owns the IP from the SR&ED Canco gets federal 20% tax credit (and provincial tax credit) If Canco carries out SR&ED for itself: owns the IP (may be licensed from/to USCo) This is an application of the taxable supplier/contract payment rules: the first Canadian taxpayer gets the credit The net cost is the same as described in previous slide

44 3. USCo / Canco Carry Out SR&ED USCO US CDA 100% CANCO SR&ED Contract SR&ED Research Center USCo / Canco carries out SR&ED either directly or through a research entity 44

45 The Canadian Tax Advantage Net Cost of SR&ED in 2010 QUÉBEC ONTARIO BC Direct Research Center Direct Research Center Direct Research Center A. Expenditures for R&D materials or contract $200,000 $1,000,000 $200,000 $1,000,000 $200,000 $1,000,000 B. SR&ED salaries $800,000 N/A $800,000 N/A $800,000 N/A C. Proxy Amount (65% of B) (overhead): $520,000 N/A $520,000 N/A $520,000 N/A D. Federal tax credit $276,000 $144,000 $290,320 $152,800 $273,600 $180,000 E. Provincial tax credit $140,000 $280,000 $68,400 $236,000 $152,000 $100,000 F. Tax savings $182,516 $196,904 $105,811 $174,192 $152,216 $190, G. Net cost to the corporation $401,484 $379,096 $458,515 $437,008 $422,184 NOTE: Need income and income tax to access the benefits, except for the Québec tax credits which are paid to Canco. $529,200

46 4. USCo Contracts for SR&ED with a CCPC USCO US CDA SR&ED Contract SR&ED CO US Opco does not carry on business in Canada SR&ED Co is a CCPC that carries out SR&ED for US Opco at a price (cost plus) less tax incentives (and thus passes on the incentives) 46

47 Net Cost to Subcontract to a CCPC QUÉBEC Provincial Tax Credit $300,000 Federal Tax Credit $427,000 TOTAL CREDIT $727,000 Net Cost before income taxes $273,000 ONTARIO $213,560 $457,254 $670,814 $329,186 BC $152,000 $478,800 $630,800 $369,200 Contract cost: $1 million SR&ED Expenses: Salaries: $800,000 Materials: $200,000 Typically, USCo and SR&EDCo share the tax benefits in different proportions. 47

48 5. USCo Has a CCPC Carry Out SR&ED USCO US CDA 50% CANCO CANADIAN RESIDENTS OR CANADIAN VENTURE FUND 50% Canco carries out SR&ED in Canada Definition of CCPC: not controlled by non-resident and/or public company No control in law (more than 50% of votes, and must consider all rights to acquire shares, convertible debt, etc.) No control in fact: independent board, restricted use of vetos, avoid debt structures that can provide control in fact 48

49 Net Cost if USCo has a CCPC Carry Out SR&ED Federal Québec Federal Ontario Federal BC A. Expenditures for SR&ED materials $200,000 $200,000 $200,000 $200,000 $200,000 $200,000 B. SR&ED salaries $800,000 $800,000 $800,000 $800,000 $800,000 $800,000 C. Proxy Amount (65% of B) (overhead): $520, $520,000 $520,000 $520,000 $520,000 D. Tax credit $427,000 $300,000 $457,254 $213,560 $478,800 $152,000 E. Tax savings $30,030 $45,840 $36,210 $14,813 $40,612 $9,230 F. Net cost to the CCPC $197,130 $278,163 $319,358 NOTE: Need income and income tax to access the benefits, except for the Québec tax credits which are paid to Canco. 49

50 IV. STRUCTURING IDEAS AND ISSUES: b) Acquisition Structures:

51 6. Acquisition by USCo of Canadian Target US CDA USCO TARGETCO Classic Dilemma: USCo wants to acquire shares of TargetCo and pay in stock of USCo Canadian tax rules do not allow rollover/deferral treatment where transfers are made to non-resident companies: Canadian selling shareholders would realize immediate gain (and tax payable) Outright purchase will disqualify Target from retaining CCPC status for SR&ED incentives [thus loss of incentives] 51

52 7. Exchangeable Share Structure US funds Preferred voting shares Canadian funds Special voting shares US funds Special voting shares USCO 100% of non-voting common shares Canadian funds Exchangeable shares [Special voting share for CCPC status?] CANCO 52

53 BENEFITS OF EXCHANGEABLE SHARE STRUCTURE: Allows US funds to invest in US entity and Canadian funds to invest in Canadian entity Tax benefits are as described in Scenario 2 or, if CPCC status preserved, in Scenario 5 Shareholders realize gain only at time of exchange for shares of USCo 53

54 HOW IT WORKS: Special voting shares at USCo level provides Canadian shareholders of Canco with votes they would have upon an exchange Special voting shares of Canco provide voting rights for US funds at Canco level Exchangeable shares are shares that can be exchanged for shares of USCo at a fixed exchange ratio Possibility of preserving CCPC status by having Canadian residents hold at least 50% [use of special voting shares] 54

55 TAX IMPLICATION OF VARIOUS STRUCTURES ON SHAREHOLDERS: US Investors: Neutral (no Canadian taxes payable) Canadian Investors: Neutral (no US taxes payable) 55

56 Biography Claude E. Jodoin is a firm partner who specializes in tax law, and has developed an expertise in business financing, financial instruments, the purchase and sale of businesses, corporate reorganizations, including cross-border acquisition transactions involving the issuance of exchangeable shares. His vast experience is regularly sought in major files involving large public issues of securities on behalf of financial institutions, the establishment of complex financial structures and the reorganization of important national and international public and private corporations. Mr. Jodoin works closely with corporations involved in the high technology and biotechnology sectors, developing structures to benefit from scientific research and experimental development tax incentives. Within the course of his practice, he has also been called upon to represent clients before Revenue Québec, the Canada Revenue Agency and the Canada Border Services Agency. Some of his interventions have led to legislative or regulatory amendments. Finally, he has, since 1991, been actively involved in goods and services tax (and provincial retail sales tax) matters, having been both an author and presenter of numerous articles and conferences, and mentioned as an authority in these matters. He is also recognized as one of Canada's best Tax Law lawyers in The Best Lawyers in Canada (2008, 2009 and 2010 editions). Direct Line: (514) cjodoin@fasken.com Full Biography 56

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