There are several aspects to consider when determining whether it is advantageous to create an American entity separate from your Canadian business.
As a matter of fact, in addition to taxation, which has become more competitive in the United States since the December 2017 tax reform, other various considerations can considerably influence your decision.
First, your decision depends on your company’s situation, its development stage and your projects. As a general rule, it is important to consider incorporating a U.S. entity when your company has certain activities in the United States. For example:
- if you export a lot of products or services to the United States;
- if you have a certain physical presence in the United States (representatives, American employees, warehouses, etc.);
- if a good proportion of your clients are American.
Each case is unique. For a manufacturing company, it’s usually best to wait until it has made a breakthrough in the U.S. market, while a high-tech company may find it advantageous to quickly set up an entity in the United States.
If you think it makes sense to set up a U.S. entity, you should then consider whether there are more advantages than disadvantages to setting up a U.S. entity. There are various considerations.
U.S. corporations can take advantage of tax consolidation, a benefit that does not exist in Canada. In summary, a corporation with one or more subsidiaries can file a single tax return for all of its entities. This allows it to offset the losses of some entities against the profits of others, thereby reducing its total tax bill.
Furthermore, it’s currently possible to deduct 100% of the value of capital investments for several types of tangible assets, such as machinery and computer equipment, but not buildings. All sectors of activity can benefit from this measure. However, the capital cost allowance will be reduced to 80% in 2023, and will gradually decrease thereafter until it reaches 20% in 2026, the last year of the measure.
In some cases, where U.S. operations become relatively large in relation to those in Canada, incorporating an entity with operations in the U.S. has the additional benefit of ensuring that Canadian shareholders will continue to be entitled to Canadian capital gains relief on the sale of their shares.
Incorporation in the United States ensures shareholders’ limited legal liability with respect to U.S. operations. It can also make it easier to obtain work visas.
This can make you more attractive to U.S. clients, as most of them prefer to purchase their goods and services from a U.S. company.
You should also be aware of restrictive measures such as the Buy America provision which requires, in certain areas such as transportation, that goods sold to government agencies contain a certain percentage of U.S. content.
U.S. incorporation facilitates access to capital from U.S. investors. They prefer to acquire an interest in a U.S. company because it makes their lives easier, particularly in terms of taxes. Opening a bank account in the United States is simpler, making it easier to do business with your U.S. partners.
Incorporating a U.S. company creates additional administrative costs, particularly for the production of financial statements and tax documents. However, the costs of incorporating a company are low.
This factor has less weight since the U.S. tax reform of December 2017, which lowered the federal corporate tax rate from 35% to 21%. Adding the tax levied by the states (from 2.5% to 12% depending on the state), the combined U.S. rate is about 25% on average in 2020, considering that state tax is deductible from federal tax.
This is still higher than the combined tax rate of 15% (federal and Quebec in 2019) for Canadian-controlled private corporations (CCPCs) eligible for the small business deduction (SBD).
Without the SBD, the combined rate was 26.6% in 2019, which is comparable to that of the United States.
In addition, the United States is less generous than our governments in terms of tax credits, particularly those for research and development (R&D), which are never refundable at the U.S. federal level. Few U.S. states have R&D credits: they mainly offer tax credits related to job creation and to areas that are being revitalized.
Finally, developing a new market and starting up new activities usually generates high expenses and even losses at the beginning of operations. By keeping the losses related to the American business in your Canadian company, you will be able to deduct them against your other Canadian income and thus increase your financial flexibility.
Do you have tax questions about your business? Contact our experts.
This article has been written by Annie Poitras and Jean-François Poulin.