The Canadian Tax Advantage: Seven Things You Need To Know!

Sunday, October 4, 2009 - 01:00

As countries continue to struggle with the recession, companies seek to reduce costs and increase efficiency. Canada has quietly been working to become a very attractive jurisdiction in which to do business. Tax advantages are one of the driving factors that are attracting businesses from around the world. Here are some of the things that you need to know to understand why Canada has become so popular.

Corporate Income Tax Rate Reductions

Canada has made great progress in reducing general corporate income tax rates over the past decade. Further Canadian corporate income tax reductions are scheduled to come into effect over the course of the next several years.

Table 1 provides the substantively enacted combined federal and provincial general corporate income tax rates for select Canadian provinces.

Businesses operating in Canada will usually be subject to income tax levied by both the federal and provincial governments. When an enterprise conducts business in more than one Canadian province, the taxable income will be proportionally attributed to the different provinces in which the business has a permanent establishment.

In Ontario, a reduced corporate income tax rate is available for manufacturing, processing, mining, logging, farming or fishing activities. This rate is not reflected in the chart. The two Ontario corporate income tax rates are scheduled to be harmonized in 2013.

Elimination Of Capital Tax

Capital tax constitutes an important obstacle to investment. While the federal government and many Canadian provinces have traditionally levied a tax on the capital of a corporation, the focus has been on the elimination of this tax over the past few years.

The federal government eliminated the capital tax as of 2006. Many provinces are following suit. For example, neither British Columbia nor Alberta has capital tax. In Ontario, capital tax has already been eliminated for Ontario companies primarily engaged in manufacturing and resource activities. The capital tax will be eliminated for all corporations on July 1, 2010.In the province of Quebec, capital tax has been eliminated for corporations active in the manufacturing sector. Capital tax will be abolished for all corporations in Quebec on January 1, 2011.Tax Incentives For Scientific Research And Experimental Development

Canada is a hotbed for scientific research and experimental development ("R&D") because it offers among the most generous tax incentives in the world for these types of activities. In the face of the difficult recession, both the federal government and certain provincial governments have increased the tax incentives that are available for R&D activities.

Tax incentives are offered by both the federal government and provincial governments. When combined, the incentives offered in the province of Quebec are the most generous. As the Table 2 shows, for every dollar of R&D undertaken in the province of Quebec, the net cost to the corporation is 38.6 cents.

The three main components of the federal incentives in Canada relating to SR&ED can be summarized as follows:

a. The ability to claim a deduction in computing income for current and capital expenditures incurred in the year;

b. The ability to claim, in addition to the deduction in computing income, a tax credit in respect of most R&D expenditures;

c. The ability to include, as part of one's R&D expenditures for the purposes of the R&D tax credit, 65% of R&D salaries on account of overhead and similar expenditures.

The third component is interesting because it constitutes a simpler method for taxpayers to determine what amounts can be attributed to R&D.

R&D expenses generally include, with certain exceptions, all expenses directly related to the research and development (such as salaries and equipment). A taxpayer doing business in Canada may deduct expenses of the following nature:

a. for R&D conducted by the taxpayer or on its account, with regard to that taxpayer or business;

b. payments to a corporation resident in Canada or other entity (universities, etc.) that conduct R&D in Canada related to the business of the taxpayer and to the extent that the taxpayer is entitled to exploit the results of such R&D.

A taxpayer can also deduct certain capital expenses (other than land or leasehold interest in land) for SR&ED carried on in Canada related to the business of the taxpayer.

R&D generally refers to a systematic investigation or research carried out in a field of science or technology through experiment or analysis, and includes pure research, applied research and experimental development. Examples of experimental development include (i) work undertaken to achieve technological advances for the purposes of creating or improving materials, devices, products, or processes, including incremental improvements thereto and (ii) work with respect to engineering, design, operational research, mathematical analyses, computer programming, data collection, testing, and psychological research.

Refundable Tax Credit For The Development Of E-Business

The province of Quebec has introduced a refundable tax credit for the development of e-business in information technologies ("IT"). This tax credit is designed to consolidate the development of IT throughout the province. The tax assistance consists of a refundable tax credit equal to 30% of the eligible salaries paid by an eligible corporation. Eligible corporations may claim this tax credit until December 31, 2015. To be eligible, at least 75% of the corporation's activities must be in the IT sector. The amount of the tax credit may not exceed $20,000 per eligible employee.

Harmonization Of Retail Sales Taxes

The Canadian goods and services tax ("GST") is generally considered to be "business friendly" when compared with other retail or manufacturing sales taxes. Although the GST is imposed on purchasers of taxable property or services at all levels of trade, it is intended to be borne entirely by the final purchaser or consumer. To achieve this result, businesses throughout the production and distribution chain are generally entitled to claim a refund of GST expenses that they have paid. As a result, businesses are not subject to multiple layers of hidden sales or manufacturing taxes that otherwise increase production costs.

With the exception of Alberta, all Canadian provinces also levy some form of retail sales tax. The federal government has been working to encourage each of the provinces to harmonize their retail tax system with the GST. The province of Quebec has long since adopted a retail tax system that operates using the same principles as the GST.

The British Columbia government announced on July 23, 2009 that it will harmonize its provincial sales tax with the GST effective July 1, 2010. Ontario has also announced that it would be doing the same, effective July 1, 2010. While the HST will follow many of the underlying concepts of the GST, both Ontario and British Columbia have announced that they intend to retain certain provincial particularities.

For businesses, it is important to note that both Ontario and British Columbia intend to temporarily restrict the ability of large businesses (those with GST-taxable revenues in excess of $10 million) to claim input tax credits ("ITCs") in respect of the provincial component of the sales tax on certain business inputs. Details regarding the British Columbia restrictions were not available at the time of writing, but it is anticipated the restrictions will be similar to Ontario.

Ontario announced for the first five years following harmonization, large businesses and financial institutions would not be able to claim ITCs on:

a. energy, except where purchased by farms or used to produce goods for sale;

b. telecommunication services other than internet access or toll-free numbers;

c. road vehicles weighing less than 3,000 kilograms (and parts and certain services) and fuel to power those vehicles; and

d. food, beverages and entertainment.

Dawn Of The Tax Information Exchange Agreement Era!

On August 29, 2009, the Canadian government signed a Tax Information Exchange Agreement ("TIEA") with the Netherland Antilles. Negotiations to conclude TIEAs are ongoing between Canada and 14 other "tax haven" countries.

This announcement is significant, as dividends paid out of active business income (or on income that is deemed to be active business income) by foreign affiliates of a Canadian corporation that are resident in a country having a TIEA with Canada will generally be excluded from corporate income tax upon repatriation to Canada.

Prior to the introduction of the TIEA regime, only foreign affiliates resident in a country with which Canada had a tax treaty could pay a dividend to its Canadian parent that could benefit from this exemption from Canadian income tax.

The introduction of the TIEA regime also has a significant effect on countries that do not have either a comprehensive income tax treaty or a TIEA with Canada. Recent Canadian legislation establishes that income earned by foreign affiliates in countries that do not have either a comprehensive income tax treaty or a TIEA would become taxable in Canada on an accrual basis even if no amount is ever paid back to the Canadian parent where, more than 60 months before that time, one of the following two conditions were fulfilled: (i) Canada began negotiations to enter into a TIEA, or (ii) Canada sought, by written invitation, to enter into negotiations for a TIEA with the particular country. For countries that were in the process of negotiating a TIEA with Canada at the time that the program was publicly announced, negotiations must be successfully completed before 2014.

Under the TIEA, Canadian officials may require that countries who have signed a TIEA with Canada exchange information pertinent to the application of Canadian tax law. The exchange will only occur upon request and is subject to restrictions.

Thomas Copeland is a Partner in the Montreal office of Fasken Martineau, practicing in all areas of taxation law as well as general corporate law. Claude E. Jodain is a Partner, also in the Montreal office, specializing in tax law with expertise in business financing, financial instruments, cross-border acquisition transactions, corporate reorganizations and the like. Fasken Martineau is a leading Canadian full service law firm with offices across Canada as well as in London, Paris and Johannesburg.

Please email the authors at tcopeland@fasken.com or cjodoin@fasken.com with questions about this article.