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There are several different structures available when setting up a business in Canada. Foreign companies operating in the country can do so through a branch or by setting up a separate business enterprise.
Often, tax considerations and liability determine the best business structure. The most common corporate structures used to establish operations in Canada are:
- Companies
- Sole proprietorships
- Partnerships
- joint ventures
- Franchises
- cooperatives
Companies
A corporation is a business entity with a legal status independent of its shareholders. Therefore, the debts, liabilities and obligations of the company are not the responsibility of its shareholders.
Companies used by foreign investors are generally created by incorporation under the Canada Business Corporations Act (LCSA) or similar provincial law. Certain types of corporations may be incorporated under other federal statutes, such as the Trust and Loan Companies Act, or under provincial equivalents. Provincial corporate legislation in some provinces allows for the creation of an unlimited liability company, which can be used for cross-border tax structuring.
Federal and provincial corporations are created by filing articles of incorporation with the appropriate government authorities and paying a nominal fee. The articles should include details of the rights, restrictions, privileges and conditions attached to each class of shares. Any number of shares of one or more classes can be created; however, at least one class must have full voting rights.
The articles of a federally registered corporation must name the first directors, and at least 25% of them must be Canadian residents. The corporate laws of some Canadian provinces do not require directors to reside and are sometimes used by foreign companies in Canada for this reason. While directors generally exercise management power on behalf of shareholders, their power may be limited by unanimous shareholder agreement. The company, its shareholders or third parties can hold directors personally responsible for certain aspects of their decisions.
For transactions or events occurring after February 26, 2018, the application of an existing anti-surplus stripping rule has generally been expanded to prevent a non-resident shareholder of a Canadian corporation from extracting (now or future), without withholding tax, retained earnings of the company that exceed the amount of capital that has been contributed to the company by the shareholder. The rule has been expanded to include a look-through rule where a partnership or trust is used to avoid the purposes of the anti-surplus stripping provision.
Provincial incorporation is often used when a corporation intends to restrict its activities to a single province. Provincial laws governing corporations vary somewhat, and while many of their provisions are similar to those of the CBCA, there are a number of differences between provinces, as outlined above.
While most foreign investors choose to do business in Canada through a Canadian company, there are two other options.
- Branches of foreign companies – A foreign entity may carry on business in Canada directly through a branch. A branch is an extension of the foreign parent company and must be licensed or registered in each of the provinces where it will operate. The taxation of branches and subsidiaries varies widely and there are also differences in the liability of parent companies. A non-resident corporation that carries on business in Canada through a Canadian branch is subject to tax on its Canadian source business income at the same rates applicable to Canadian residents.
- Unlimited liability company – Nova Scotia, British Columbia and Alberta allow the incorporation of an “unlimited liability company” as a Canadian subsidiary of a foreign company. These legal persons are treated as “intermediaries” for tax purposes and are often used, in combination with other entities, in foreign corporate structures for various purposes. A Canadian subsidiary of a non-resident corporation will be considered a resident of Canada for the purposes of income tax law and will be subject to Canadian income tax on its worldwide income. Under Canada’s domestic rules, there is no withholding tax on non-participating interest paid to arm’s length persons, and under the Canada-U.S. tax treaty, the withholding tax on non-arm’s length non-participating interest paid to United States persons is generally nil. This type of structure can be used as an alternative to a branch. Although it allows losses incurred by the corporation in Canada to be deductible by the foreign corporation, it still offers certain advantages of corporate status in Canada. It is important to note that shareholders can be held liable for corporate obligations. The advantages and disadvantages of forming an unlimited liability company in each province differ and should be considered when deciding whether or not to use this vehicle.
Sole proprietorships
A sole proprietorship is a business owned by one person. The owner is entitled to all profits and is personally liable for all debts and other obligations of the business. This liability may be limited by contract or covered by insurance.
There is no registration requirement for a sole proprietorship, which operates under the legal name of its owner. However, in some jurisdictions, a business license may be required to conduct certain types of business.
If the sole proprietorship will operate under a trade name other than the legal name of its owner or if multiple ownership is implied (for example by adding “and company”), a declaration must be filed in each province where the company operates.
Partnerships
A partnership is an association or relationship formed by a contract between two or more individuals, companies, trusts or partnerships. It is governed by provincial legislation and generally must be registered with provincial authorities. In addition, a partnership does not have a separate legal personality from its partners and is therefore considered a flow-through entity for tax purposes.
There are three types of partnerships.
- General
- Limit
- Limited Liability
In a general partnership, all partners are subject to unlimited liability. Unless otherwise agreed, the partners have an equal right to capital and profits and are equally liable for all losses, debts and liabilities of the partnership.
A limited partnership consists of both general partners and limited partners. One or more general partners are responsible for managing the business. Sponsors provide capital and can work for the company but do not participate in its management. Unlike general partners, limited partners are not exposed to unlimited liability – unless they participate in the control or management of the business.
In a limited liability partnership, a partner is generally not responsible for the actions of other partners who are not under his direct supervision or control. The laws of most provinces and territories provide for the creation of limited liability partnerships.
joint ventures
A joint venture is an association of two or more business entities for the purpose of carrying on a single business or a specific business. Joint ventures take many forms. They may be created through a separate corporation or a general or limited partnership, or the parties to a joint venture may jointly own business assets.
Joint ventures between Canadian and foreign companies are excellent vehicles for combining the strengths of participating companies while reducing the risk of entering new markets.
Franchises
A franchise is a business relationship in which a franchisee contracts the right to sell exclusive products or services using trade names and/or trademarks, styles and methods developed by the franchisor.
The franchisee generally agrees to comply with performance standards set by the franchisor and is granted a license to use the franchisor’s intellectual property and business methodology.
In return, the franchisee normally pays an initial fee and ongoing royalties.
For more information on franchising in Canada, see Chapter 15 of this guide.
