Canadian international tax rules adhere to the tax models promoted by the Organisation for Economic Co-operation and Development (OECD). They follow the international norm of giving priority to the country where taxable income is generated (i.e., the source country).
Broad Principles of Tax Rules
Canadian residents are liable for taxes on their income worldwide. A corporation is considered a resident of Canada for tax purposes if its central management is located in Canada or if it is incorporated in Canada.
Eliminating Double Taxation
To avoid the double taxation that would result from having the same income taxed in both the source and residence country, Canadian residents are entitled to relief in the form of a credit or exemption.
A foreign entity operating in Canada through a permanent establishment (i.e., an entity not legally separate from its parent corporation) is liable for tax only on income generated in Canada.
Taxation of Foreign Investment in Canada
Foreign investors doing business in Canada through a separate legal entity (such as a subsidiary) are considered to be Canadian residents and are taxed as such. Income tax is applied to these investors’ worldwide income, and appropriate relief is provided for taxes paid in other countries if the subsidiary also carries out business abroad. Payments made to non-residents are subject to withholding taxes. The statutory withholding tax rate is 25%. However, this rate is usually reduced through Canada’s extensive network of tax treaties with other countries.
Non-residents doing business in Canada through permanent establishments (such as a branches) rather than as separate legal entities pay income taxes on the income attributed to the business they conduct in Canada. In addition, a branch tax is imposed on non-resident corporations’ after-tax source income that has not been reinvested in Canada. The statutory branch tax rate is 25%, but it can be reduced by tax treaties. The branch tax is a proxy for the withholding tax that would have been on dividends if the branch’s business had been carried out through a subsidiary.
Non-resident corporations incorporated as principal-business corporations (PBC) in Canada have access to special tax incentives, such as flow-through shares and the Canadian Exploration Expense and Canadian Development Expense. PBCs are corporations whose principal business is directly related to one or more mining or oil and gas activities.
Taxation of Canadian Investment Abroad
When a Canadian resident’s foreign operations are conducted through a branch, the branch's income is included in the resident's taxable income in Canada. However, a tax credit can be claimed for foreign taxes levied on income attributable to the branch. This credit is limited to the tax payable to Canada on the foreign-source income and is computed on a country-by-country basis. Canadian taxes cannot be deferred when a branch structure is elected, but foreign losses are deductible against Canadian-source income.
When foreign operations are conducted through a subsidiary, the income earned by the subsidiary is generally not subject to taxation in Canada until profits are remitted to Canadian shareholders in the form of dividends or until the Canadian corporation disposes of its foreign subsidiary. The tax treatment of foreign subsidiaries depends on ownership:
- If Canadian ownership is less than 10% of common shares, then the income is “portfolio income.”
- If ownership is equal to or greater than 10%, but less than 50%, the foreign corporation is a “foreign affiliate.”
- If ownership is greater than 50%, the corporation is a “controlled foreign affiliate.”