Foreign Trading Corporations for Canadian Corporations

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.

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[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.

FATCA is a little less fat.

The recent signing of a Canada-US agreement on how FATCA is to be enforced in Canada is a half a loaf at best.  The Canadian Banker's Association (CBA) has stated that the agreement is an improvement of what was to be an intolerable situation but only an improvement.  "Canada is not a tax haven for US citizens", it said.  (Consider the US citizen that wins a Canadian lottery--taxable in the US and not taxable in Canada.  I am certain that the funds would be safely invested in Canada--but that's another story).

So, information on bank accounts (with the now exception of many tax free accounts such as RRSPs and TFSAs) owned by US citizens or those who were born in the US will be collected (at a huge cost) and sent to our friendly CRA where the information will be shared with the IRS.  An improvement?  This changes the role of the CRA from tax collector to inquisitor or agent of the IRS.  Still, in my view, an attack on our sovereignty.

What the Finance Minister should have said was that the IRS should take a hike with respect to Canadian enforcement.  But how could it do so in the face of impending approval/non approval of the Keystone pipeline.  Not a change.  Uncle Sam says "jump" and Canada says "how high".

Privacy and What It Means to You

Just consider what the current means of surveillance would have meant in the hands of Joe McCarthy.  Then it was just people snooping on people.  I suppose the occasional envelope was steamed open and mail was intercepted.  Investigative techniques are not to be used by either the Canadian or US investigators on domestic citizens.  Oh yeah! We now have privacy commissioners and others who are mandated to insure our privacy but little is really done about the domestic snooping that appears to be going on constantly.  How are we to respond?

On a level of personal security we all know that we are to use complex passwords that can't be easily hacked.  However,  a determined hacker will inevitably breach our firewalls and well- meant complex passwords.  Given that most banking transactions are now done over the Internet or some kind of safe network we can only hope that banks and other financial institutions are doing their stuff.  My inside information is that banks are bleeding like the rest of us.  However, banks and other financial institutions do pay up when your account is raided.  This adds to the cost of banking but I am not sure how much it impacts the average consumer.  And then there are credit cards and debit cards (another aspect of the banking business).  The US refused to accept the chip technology (on the grounds that it was too expensive) that we take for granted in Canada and they are now paying the price. We a just a bit more secure with out chip technology but only a bit.  And then there is Facebook and Twitter where we place our lives on display for the public to see (latest dumb post: going to bed now...").

There is a tort doctrine in common law called "contributory negligence".  This doctrine applies where one of the parties, usually the plaintiff, has done something that contributes to his harm.  Riding over the centre of the road, attending a hockey game where he is likely to be hit by a puck are just two examples.  When we place ourselves in harm's way we cannot squeal too loudly when harm occurs.  I believe that this principle applies to privacy.  We have consented to put our lives out in public and we can hardly complain when those who are malevolent take advantage of our exposure.  If you leave your wallet on the street can you complain when someone takes it?  Even the common law states that a "finder" has good title against everyone except the rightful owners.  Don't do dumb things.

We have allowed all of this to happen to ourselves and when bad things happen we can hardly complain.  If we are to be catalogued and carded for the delivery of health care can we really, really, expect that some day some bureaucrat will have that information on his/her laptop and then leave that very laptop in the mall.  Life happens.  Is there really a firewall that can't be breached?  By anyone?  When we set up state-of-the-art spying agencies can we really, really expect that they won't spy? On us? As they say on Monday Night Football, "C'mon man!".

I am all for Snowdon and everyone else who is a whistleblower on spying (with the exception of exposing agents whose lives might be in danger).  This is because people like Snowdon turn the tables on those who would keep spying on us a secret.  If "they" can spy on us why can't we spy on "them"?  Therefore, if we are contemplating criminal behaviour why can't one of the deterrents be the fear that we are being spied on and that our criminal behaviour will be found out.   A bit Big Brother? It's already here.  So we must all comport ourselves in a manner that assumes that we are being spied upon.  If we don't like it we have to turn the clock back 40 years and no one wants to do that.

Where You Live--The Conrad Black Tax Case

An article today in the Financial Post by Vern Krishna (a venerable tax lawyer, professor and writer) points out how arbitrary the courts can be in dealing with tax issues.  As pointed out by Prof. Krishna tax treaties are negotiated and enacted so that a person or corporation is not taxed twice on the same income by the treaty partners.  That is, if a person lives in two places, or more, there are rules as to who will b e the main taxing authority.  In this case it was a question as to whether Canada or the UK was the main taxing authority.  We all know that residency usually is the hallmark of where taxes are levied.  Mr. Black stated that he was a resident of two countries--Canada and the UK.  By the terms of the treaty he claimed that he was a domiciled non resident of the UK.  He claimed that, while he was willing to pay tax on income earned in Canada he was not willing to pay tax on his non resident income--some $5.1.  A tidy sum.  Canada claimed tax on the $5.1 million and the tax court agreed.  Notwithstanding the treaty that has tie breaking rules and notwithstanding that most observers believe that Mr. Black withstood the test of being a non resident of Canada, the tax court disagreed.  The tax court took a very liberal view of the tie breaking rules of the treaty.  I trust that Mr. Black will appeal and be successful in that appeal.

The arbitrariness of the CRA and now some of the courts indicates that any tax planning on an international level needs a further component:  asset protection.  While many business cannot benefit from asset protection (that is they have assets such as land, buildings, physical plants and accounts receivable in Canada that is open to seizure), many individuals and businesses who operate internationally have assets that are mainly in cash or cash equivalents.   Those individuals might be wise to secure these assets in jurisdictions where tax authorities would have difficulty in collecting on a tax judgement.  We have heard about some of these jurisdictions.  Cook Islands, Belize, Nevis, etc.  They are usually mentioned in a pejorative way.  However, since the object of business or individuals is keep their savings and wealth intact, the use of these jurisdictions is not only not pejorative but fiscally responsible.  That is practical tax planning.

The Current Plight of the CRA

My recent experience with the CRA has left me with a kind of Alice in Wonderland make believe world.  In truth the CRA is underfunded.  The recent cuts and more cuts of the Harper government has left the CRA labour short, labour untrained and labour unsupervised.  Recently a client received an assessment that was patently wrong.  Not a matter of conjecture or interpretation.  Just wrong.  A supervisor confirmed the assessment.  Again wrong.  The matter was taken to appeals in Shawinigan. The appeals officer threw the assessment out.  Why?  Because it was patently wrong.  The client had spent $30,000 in legal and accounting fees and there was no redress.

In a recent expose by the CBC  went on a hunt for tax cheats.  This included hidden cameras and gotcha interviews in Canada and Barbados.  No one from CRA was interviewed but it was implied, with a wink and a nod, that CRA was on top of this.  Most of the information was bogus.  But what it did was to falsely implicate literally thousands of legitimate companies that are formed in Barbados by Canadian parent companies.   Of course this made the CRA and the government of the day look bad.  What were all of these tax cheats doing running around Bridgetown.  While as a direct result of this reporting or otherwise the CRA has created a newly formed group that deals with international trading transaction.  A recent run in with one of that group has left me gaping in disbelief.  After hundreds of hours of both the CRA official's time and time of company personnel and after the transfer of thousands of pieces of documentation, the CRA has taken the position that the transactions between the Canadian company and the Barbados company is a sham!   CRA has taken the position that it will disregard binding contracts between the companies.  I could have understood discussions regarding transfer pricing (that is the price at which goods are sold from the Canadian company to its Barbados subsidiary) or even a discussion about whether "management mind and control" existed in the Barbados (the Canadian company has employees in Barbados). However, the CRA took the lazy and intellectually dishonest way out.  In fact, counsel believes that this position taken by CRA is the strongest position for the company/taxpayer.  I believe that CRA will lose in court.  Tens of thousands will be spent on professional fees.  I wonder where all those highly trained persons in international trade/tax are hiding.

International tax/trade is at the crux of the Canadian economy.  Canada has always been a trading country but that trade consisted largely of automobiles and resources.  In the current world no Canadian company of any size can exist without some aspect of international trade.  While this may consist mainly of north-south trade, trade worldwide is becoming the norm.  The Internet and etrade have had a huge effect on business.  If someone purchases intellectual property, where title to that property resides is a key factor in where income is earned.  If that income is earned in a low/no tax jurisdiction so much the better.

If CRA persists in its iron fisted approach to international tax/trade it will drive business offshore so that none of the profits will be repatriated to Canada.  Since Canada has a capital deficit that would be a shame.

I'm Back

After almost two years of being away I have decided to continue my blog.  While the content will be, mostly, professional stuff I will be commenting on world and other political economic and other matters.  I found that the blog was cathartic.  It was a way in letting off some emotional steam that tends to build up.  So, loo for entries.  Please give me some feedback.  In that way I know that I am writing to someone other than the ether.

Why They're Rioting in Quebec

The events of recent weeks belie a larger problem.  I'm not at all sure that the students in Quebec really know why they are marching.  It resembles  a tantrum by a toddler that escalates beyond an attempts at reason.  A total meltdown. The students have come off as big winners.  Tuition increases have been stretched out beyond the time when they are in school and bursaries have been increased so that most will not leave university with crippling debt.  They have claimed the scalp of a Quebec cabinet minister.  They only place they are not winners are with the public where only about 12% of whom support the students.  So, what's it all about?

A panelist on a recent CBC newscast may have put her finger right on the problem.  The protestors no longer trust parliament or any other elected body to act in their interests.  The protestors have been joined by anarchists, 1 percenters, occupy (fill in the blank) and other social malcontents to demonstrate that they believe that the whole system is rigged against them.  From corrupt politicians in Quebec (and I suspect elsewhere) to corrupt corporations in Quebec (Lavalin) to the inability of young people who do graduate to get any kind of meaningful job, the list of grievances are long and the list of answers are short.  While in previous generations the grievances may have been just as germane, the frustration with the establishment and recent successes in empowerment are relatively new.  Someone has suggested that these students have roots in the Arab spring.

I believe that it all goes back to empowerment. Even 10 years ago the average citizen had no easy venue to vent his or her anger or frustration.  The best one could do was write a letter to the editor. Today, a Facebook page can generate 100,000 signatures in days.  A flash mob can be generated in hours.  Everyone can have his or her say and each say is equal to every other say.  The ultimate in democratization.  When I was in university it was taken as a given the university students were going to be socially conscious or even radical but given time, a good job and a stake in society these same students would migrate to a more centrist political position.  The closest we came to the current demonstrations were in opposition to the Vietnam war where it was clear the politicians had lied to the electorate.  Flower children were a response to over materialism but the movement never went mainstream.  Today's social media allows the socially conscious young to have a platform and a kind of center of operations that will allow for serious social action.

There are two other curios observations.  Notwithstanding the social activism, young adults do not, generally, vote in any kind of election whether it be civic, provincial or federal.  Also, the social activism has not spread to other cities.  No one is marching in Ottawa, Toronto, Winnipeg, Calgary or Vancouver. The seed has not germinated in these other cities.  Students are generally stoic about their college tuition level.  The situation in Quebec is symbiotic.  Once the core objection took to the streets the others who believe that they have serious social issues piled on.  The others not associated with the student movement attracted most of the attention by breaking windows and torching cars.  It took some time before the student movement and the other malcontents joined forces.  What is to be learned is that time is the enemy of political inaction.

Today's political and social environment for young people is almost toxic.  Tens of thousands of civil servants are getting their pink slip, the unemployment rate among young adults is unacceptably high, older workers need to keep working to make ends meet thereby not creating any space for new hires and the world economy is generally in a mess.  Add to this a cadre of 25-30 year olds who are still living in his or her parent's basement and you have a pretty dismal picture of what it is to be a young adult.  Our granddaughter graduated near top of her class as a teacher and has no, repeat no, prospects of employment in her field.  It is not unreasonable to expect that these grievances and frustrations will not bubble to the top in the form of social action.  The only surprise is that it's not come sooner.

Berne.