If a Canadian corporation does a significant amount of
business ex-Canada it may benefit from the formation of a foreign trading
corporation incorporated in a low/no tax jurisdiction.
Assuming that the Canadian corporation’s net income is taxed
at about 25% it is possible to structure both Canadian and offshore
corporations so that the tax load on foreign sourced net income falls to 2.5%
or lower. An added benefit to this kind
of structure is that offshore net after tax profits, if earned in a country
that has a tax treaty (and not in some jurisdictions a tax information
agreement) with Canada, can be repatriated to Canada tax free in the form of
inter corporate dividends.
We will examine three kinds of examples.
The first example is that of a Canadian company that
manufactures products in Canada and sells
significant amounts of product ex-Canada. These ex-Canada sales can be to the United
States[1]. Under these circumstances the Canadian
corporation can establish an offshore world-wide distributor in a no/low tax
jurisdiction. We prefer to use Barbados
where the tax rate of net income does not exceed 2.5%. In this example the Canadian company would
sell its products to the Barbados company at such a price so that a significant
portion of the profit would be earned in Barbados. The inter-corporate pricing is called
“transfer pricing” and would require a study to insure that the pricing is fair
between the companies.
The second example is a Canadian company that produces
nothing in Canada but owns intellectual property such as patents or copyrights
that it sells to an offshore trading company to be resold to others ex-Canada. The price at which the intellectual property
is sold to the offshore trading company should be supported by a third party
valuation.
The third example is a Canadian company that purchases
products produced by an independent third party either in Canada or elsewhere
and resells it ex-Canada. In such a case
transfer pricing is not required and all of the profit can be accumulated in
the offshore trading company.
For any of these programs to be effective the “management
mind and control” of the offshore trading corporation must reside
offshore. Whiel the foreign trading
corporation could be a wholly owned subsidiary of the Canadian company there
must be sufficient operational and decision-making control offshore so that the
separate legal existence of the offshore company can be justified. What kind of control that constitutes depends
on the facts of each case. However,
suffice to say, this is significant issue that cannot be downplayed.
The formation of an offshore trading corporation goes well
beyond the creation of the offshore corporation. Each transaction must be designed so that the
business relationship between parent and subsidiary is set out by agreement (or
agreements) and substantiated by the practice between them. No matter how well intentioned, if the
parties disregard their business arrangement then the program will fail. Matters of who pays what bills, who fields
telephone calls, what address is printed in invoices, what is disclosed on
websites are just a few that must be dealt with by advisors and
professionals. Matters relating to what
entity should receive dividends from the offshore corporation also form part of
the plan.
Lastly, mention should be made of a strategy for asset
protection. While this is true of any
business venture, it is particularly true for a business structure that may be
open to capricious and arbitrary behavior by taxing authorities. This kind of planning may be difficult to
businesses where profits are reinvested in hard assets or accounts receivable
or inventory. But where the business
produces mainly cash the question of asset protection should be paramount in
planning the venture.
The right kind of advisor.
Of course we are prejudiced and think that we give our clients superior
advice and service. But ask our
clients. Before we advise on an offshore
trading plan we spend many unpaid hours in determining if such a plan would be
beneficial to our potential client. If a
plan is recommended, we work as a team to put the plan in place. First there are schematics. Then there are consultations with our
offshore legal and management providers.
Drafting notes are prepared for our legal team so that precious (and
expensive) professional time is not wasted.
Documents implementing the plan are drafted and reviewed by our
team. Accountants on our team will
advise on Canadian tax aspects of the plan including splitting income and
capital gains exemptions through the use of trust and holding companies. We stay wit the transaction until it is
operating smoothly. We operate on a
pre-negotiated fee structure and create a budget for the implementation of the
plan.
[1] Note that this example does not apply where a Canadian
company has sufficient presence in the US or other foreign country so as to
render that presence a “permanent establishment” under the Canada – US tax
treaty.
