Foreign investors: 4 things to know before investing in Canada
Political instability, tumbling currency values, economic uncertainty—they’re common reasons why high net-worth foreign investors often try to extract funds from their home countries and search for financial refuge elsewhere. Many look to Canada as that safe-haven.
Why? Put simply, our $1.6 trillion economy is one of the largest and most stable in the world. The rule of law is strong and ethical business practices are de rigueur, creating a relatively level playing field for entrepreneurs of all stripes. The World Bank Group currently ranks Canada 16th in its annual ease-of-doing-business index. Part of the credit for that high placement goes to a workforce that is highly educated and entrepreneurial, as well as federal and provincial governments that maintain a steady hand on the economic tiller to help foster growth and ease market shocks in times of uncertainty.
For foreign investors, Canada is a smart bet. But not without understanding some of the unique characteristics of our business environment.
Indeed, while Canada maintains a welcoming approach to foreign investment, our economy is more regulated than other countries’—particularly in specific industries such as media, banking and energy. The rules that helped Canada navigate past the worst of the recessionary storms of 2008-09 can also pose challenges to investors used to operating in more laissez-faire environments.
With that in mind, here are four key points that every foreign investor should take into account before investing or doing business in Canada:
Incorporation—The rules that govern corporations vary by province. Most of Canada’s 10 provinces, require corporations to appoint a Canadian tax resident as a local director. But when incorporating in Ontario, for example, the law requires that at least 25 per cent of the directors of a corporation (with the exception of a non-resident corporation) be resident Canadians. Where a corporation has less than four directors, however, at least one director must be a resident Canadian. Foreign businesses unable or unwilling to appoint a local director might consider incorporating in British Columbia instead. That’s because B.C. doesn’t have the same residency requirement for directorship. Remember that once incorporated—even in a jurisdiction with local resident directorship requirements—your company may apply for extra-provincial registration to continue operations in another province with more attractive operating rules.
Of course, there are other options for foreign investors looking to establish businesses in Canada, such as a branch operation, partnership or joint venture. Each has its own rules for compliance, which we’ll explore in a future blog post.
Funding structure (investment loans vs. capital)—In many countries, individuals are required to make significant capital investments before they can form a company. Not so in Canada, where even a meagre $1 investment is enough to incorporate a business. After incorporation, companies can seek investment loans immediately—many of these come in the form of intercompany loans from a foreign parent company. These loans can be interest bearing, meaning that a foreign parent company can charge a reasonable rate of interest on any loan made to a Canadian subsidiary. However, for the purpose of tax deductibility, you’ll need to be aware of the Thin Capitalization Rule—specifically, when the level of debt is greater than its equity capital. In that case, certain interest expenses could be denied or deferred by the CRA if the debt-to-equity ratio is below a particular threshold, and certain other conditions.
Taxation Rates—If a foreign-owned company based in Canada is set up as a non-Canadian Controlled Private Corporation (CCPC), the corporate income tax rate is 26.5 per cent regardless of the source of income, which for certain forms of investments can be more advantageous than a CCPC. The tax rate on passive income earned by a non-CCPC is 26.5 per cent, compared to the 53 per cent tax rate that a CCPC pays before dividends are distributed.
Stability of law and regulations—Again, the overall investment environment is stable in Canada, particularly when compared to some other countries where taxation and business law systems are still in a state of development or subject to rapid and unexpected change, leaving many investors at a financial disadvantage. Take China, where a new inheritance tax will soon come into effect, prompting many investors to consider repositioning their wealth outside of the country. Currency depreciation is another challenge for high net-worth Chinese, prompting many to convert liquid assets to U.S. dollars or other, more predictable currencies. At the same time, uncertainty over shifting regulations remains a concern in China and other non-Western markets.
While stability reigns supreme in Canada, so do the (often steep) penalties for disobeying provincial and federal laws—think costly fines or even imprisonment. That’s why it pays to invest in the right legal, accounting, immigration and strategic business assistance to ensure that you remain on the right side of the law when doing business in the Great White North.
Jenny Lian, Partner
