Foreign Entities Acting as Shareholders in Ontario
In general, foreign entities enjoy much of the freedom that Canadians do in terms of investing in corporations as shareholders in Ontario. However, there are certain situations in which investors may be restricted or limited.
Non-Residents can invest as shareholders in Ontario
An individual meets the definition of a non-resident if they: (1) normally, customarily, or routinely live in another country and are not considered a resident of Canada; and (2) do not have significant residential ties in Canada, meaning they live outside Canada throughout the tax year or they stay in Canada for less than 183 days in the tax year.[1]
According to the Government of Canada, “Any ‘person’ can hold shares in a corporation. In addition to an individual, a ‘person’ can include a legal entity such as trust, a mutual fund or another corporation.”[2] Because non-residents fall under this definition, they may become shareholders in a Canadian corporation. However, they may be subject to special tax laws, not to mention that foreign entities will likely be subject to special tax treatments and that the number of non-resident investors in a corporation and the control of shares may impact that company’s classification.
The number of non-resident investors in a corporation may change its classification
A Canadian-controlled private corporation (CCPC) is a particular type of private corporation and is subject to lower income tax rates. A CCPC is a private corporation that is not controlled, directly or indirectly, by non-residents, public corporations, or any combination of the two.[3] Notably, for a corporation to qualify as a CCPC, it does not need to be controlled by Canadian residents; rather, a lack of control by non-residents of Canada is required.[4] Therefore, a private corporation whose ownership is divided, such that 50% of the company is owned by non-residents of Canada and 50% is owned by residents of Canada, qualifies as a CCPC.[5] However, if 51% of the voting shares belongs to non-residents and/or public corporations, the corporation no longer qualifies as a CCPC and therefore may be subject to increased taxes.
Conditions & Restrictions for Foreign Entities
In some instances, there may be a concern that a foreign shareholder of a Canadian corporation or the non-resident corporate parent of a Canadian subsidiary may be carrying on business in Canada. However, this is not usually a concern in normal circumstances as the legal form and relationship between a Canadian subsidiary and its shareholders is one that would not result in the shareholders being considered to be carrying on business in Canada. In other words, a foreign shareholder of a Canadian corporation can not be found to be carrying on business in Canada solely by virtue of being a shareholder of that Canadian corporation.
Even when a foreign shareholder has significant or even complete control of a corporation, this is usually not sufficient to draw the conclusion that the corporation’s business was actually the shareholders. However, a significant exception to this rule is where the Canadian corporation is essentially a sham or façade. As seen in Gurd’s Products Co, the court found that a US corporation was essentially operating all aspects of a business except the production, and thus, the US corporation was found to be carrying on business in Canada.[6] Such a determination has various restrictive implications, thereby making it critical to determine whether a foreign shareholder of a company is essentially carrying on their business in Ontario.
Tax Implications for Foreign Entities
Non-residents of Canada are subject to Canadian tax on certain sources of income. These sources include employment income performed in Canada, income from a business carried on in Canada, and taxable capital gains from the disposition of “taxable Canadian property.”[7] The Income Tax Act imposes withholding tax at a rate of 25% on the gross amount of dividends paid by a Canadian-resident corporation to a non-resident shareholder. However, this rate may be reduced by a treaty. For example, under the Canada-U.S. Tax Treaty, the withholding tax rate dividends is generally reduced to 15% for dividends. Generally, Canadian withholding tax is not imposed on payments made by a Canadian resident to a non-resident for arm’s length interest payments unless the payment qualifies as a “participating debt interest”, which is determined by factors such as dividend rates, revenues, profits, and cash flow.[8]
Non-residents who intend to acquire control, directly or indirectly, of an existing Canadian business will be subject to the Investment Canada Act (ICA). Under the ICA, certain investments are subject to review if they meet one of two thresholds: the Financial Threshold, or the Acquisition of Control Threshold. The Financial Threshold is met if the enterprise value of the Canadian business exceeds $1.613 billion for U.S. and other non-resident investors from countries with trade agreements with Canada, and $1.075 billion for non-resident investors from other World Trade Organization members.[9] If an investment meets this threshold, it will be subject to review by the Minister of Innovation, Science, and Economic Development to ensure it produces a “net benefit to Canada.” The Acquisition of Control Threshold is met if the non-resident proposes to acquire one-third or more of the voting shares of a corporation. This happens when a non-Canadian resident acquires a majority of the voting shares of a corporation or the majority of the voting interests of a partnership, trust or joint venture.
Additionally, investments that raise national security concerns are subject to government approval, regardless of transaction size or value. The ICA also creates particular, more restrictive rules for investments involving “cultural businesses.” Cultural businesses include businesses related to publication, the distribution or sale of books, newspapers, magazines, music, video or film.
There are also certain tax implications for situations involving a “specified non-resident shareholder” that should be highlighted. A “specified non-resident shareholder” is a “specified shareholder” who is a non-resident person (or a non-resident-owned investment corporation), and a “specified shareholder” is a person who, either alone or together with non-arm’s length persons, owns shares representing 25% or more of the votes or Fair Market Value (FMV) attaching to all shares in the corporation.
In situations involving specified non-resident shareholders, the thin capitalization rule comes into play. In fact, when a specified non-resident shareholder finances a Canadian corporation through debt, the thin capitalization rules found in ss.18(4) through ss.18(8) of the ICA restrict the deductibility of interest to a 1.5:1 debt-equity ratio.
Furthermore, there can also be further tax implications if a corporation becomes a Non-Resident Owned (NRO) corporation once foreign investment takes place. To qualify as an NRO, several criteria must be met such as: all shares and funded debt of the NRO are to be beneficially owned by non-residents of Canada and the NRO can only derive its income from specified sources. Essentially, an NRO is a Canadian corporation owned by non-residents that, effectively, is taxed as if it were a non-resident of Canada. An NRO’s total tax burden is reduced as it pays a refundable federal tax of 25% on its taxable income (excluding certain capital gains).
Contact Cactus Law to learn more about investing in Ontario.
Disclaimer: The purpose of this article is to serve as an informative piece and is not intended to provide legal advice.
About the Authors:
Kanwar Gujral is entering his third year at Osgoode Hall Law School in Toronto, Ontario. He has a dedicated interest in business and corporate law.
Emily Manka is a law student at the University of Ottawa Faculty of Law. She will be entering her third year in September 2021 where she will continue to pursue a career in civil litigation.
[1] Government of Canada, “Non-residents of Canada”, (18 January 2021), online: Government of Canada https://www.canada.ca/en/revenue-agency/services/tax/international-non-residents/individuals-leaving-entering-canada-non-residents/non-residents-canada.html.
[2] Government of Canada, “Share structure and shareholders”, (5 July 2016), online: Government of Canada https://www.ic.gc.ca/eic/site/cd-dgc.nsf/eng/cs06644.html.
[3] Kevin McGuinness, Canadian Business Corporations Law (Toronto, Ontario: LexisNexis Canada Inc., 2017) at §1.16.
[4] Ibid.
[5] Ibid.
[6] Gurd’s Products Co. v. MNR, (1985) 60 N.R. 184 (FCA)
[7] Elizabeth Breen et al, “Investing in Canada”, online: Thomson Reuters Practical Law https://uk.practicallaw.thomsonreuters.com/w-021-4471?transitionType=Default&contextData=(sc.Default)&firstPage=true#co_anchor_a517478 [Thomson Reuters].
[8] Ibid.
[9] Ibid.
