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Opportunities for growth and expansion into the U.S. are exciting, but the unknown can hold costly tax consequences. With rigorous enforcement by the U.S. federal and state tax bureaus, avoiding potential pitfalls and capitalizing on the numerous possibilities requires careful planning. If you decide it's time to expand south of the border, here are some things to be aware of so you can effectively manage your Canadian and U.S. tax liability.
Monitor your cross-border activity and structure your business accordingly: If your business presence exceeds a certain threshold or level of activity within the U.S., your corporate taxes could be affected. With so many ways of doing business across the border, monitoring your activity is key to determining which approach is best for you. Your options range from operating a Canadian corporation that isn't taxable in the U.S. to developing a branch that is taxable, to establishing a full-fledged U.S. subsidiary.
Each of these alternatives brings with it different tax consequences. If your organization has a substantial commitment to doing business in the U.S., setting up a branch or subsidiary company might be an effective strategy. In most cases, the subsidiary will be subject to state income tax in one or more states, at rates that vary from 0% to about 10%. Also, setting up a subsidiary will allow you to better manage immigration and bookkeeping relating to state and federal tax compliance. A visible presence will also help boost consumer confidence and offer entrepreneurs important liability protection.
Beware of varying state income tax rules: In the U.S., 47 out of 50 states impose some form of corporate income tax. In fact, it is not uncommon for a Canadian company to become subject to state income tax even if it isn't taxable at the federal level, since most states do not follow the Canada-U.S. Tax Treaty.
There is a tremendous variety in corporate income taxation rates and approaches from one state to the next. Initially, many Canadian business owners are blindsided because they assume the federal treaty applies at the state level when, in fact, the difference can be dramatic among jurisdictions. Most states impose tax on net income or taxable income. However, some states tax gross income, while others will have a capital or franchise tax. Some states require companies to file a separate income tax return. All of these factors must be considered to manage your tax posture effectively.
Track the movement of employees: Many Canadians don't consider the U.S. a foreign market because of proximity, similar time zones and language. But, tracking the movement of your workforce across the border is especially critical for companies operating as a branch or a subsidiary.
If you have established a U.S. branch, you are required to withhold tax on the payroll of Canadian employees working across the border. If you are set up as a subsidiary, there will invariably be a mix, especially if employees of the Canadian company are providing specialized services in the U.S. In this case, transfer pricing would come into effect.
Ultimately, any managerial or technical services that the Canadian company provides to the U.S. subsidiary will need to be documented. It is also likely that the U.S. subsidiary would have to pay a management fee to the Canadian company. Generally speaking, to the extent that U.S. corporate tax rates are higher than Canada's, there can be a tax benefit for the tax deduction that the U.S. subsidiary will receive.
Use debt capital to fuel expansion in the U.S.: Depending on the amount of capital required to set up the branch or subsidiary, there are advantages to using debt capital to fund your expansion across the border. But, there are important limitations on the amount of debt allowed to finance such activities, so make sure you are aware of them before you proceed.
The best time to develop a U.S. tax strategy is before your company expands into the market. With numerous factors to consider, drawing on the skills of an experienced international tax professional will help ensure your U.S. tax strategy is tailored to your unique situation. This advisor can guide you through the requirements so your strategy meets your specific business needs, and can help you manage your overall U.S. and Canadian tax liability and enhance after-tax cash flow.
Related Topics:U.S. Tax; Corporate Tax
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