Running a US-Based Business from Canadian Soil

However, early-stage investors and entrepreneurs occasionally worry that incorporating in Canada may negatively affect their company's perception in the US market and that tax implications will make it more difficult to get future cross-border funding or exits. Even if the creator is confident that a particular structure currently operates in a tax-efficient manner, regulations might (and frequently do) change, making an established structure useless or inefficient.

Although there are generally ways to overcome any potential

deal drag from an initial Canadian incorporation, such as establishing a U.S. subsidiary, forming sister companies on both sides of the border, or putting in place an exchangeable share structure, Canadian founders and shareholders, as well as U.S. investors and acquirers, may think that these solutions are too complicated, expensive, or likely to divert attention away from important tasks. The crucial query here is whether the Canadian government's substantial but probably transitory tax breaks will make it more difficult for a later-successful firm to raise the capital necessary for its longer-term expansion?

We talk about the advantages and disadvantages of these decisions. Is it ever in a founder's best advantage to pass up "free money" in the shape of Canadian refundable tax credits in the hopes of making it easier to enter and exit the U.S. capital markets? Is the tax structure in Canada for entrepreneurs in the technology sector simply too alluring to resist?

Positive aspects CCPCs

The primary benefit of incorporating in Canada is in the incentives provided by the government to corporations controlled by Canadians (CCPCs) for the purpose of scientific research and experimental development (SR&ED). As a result, the SR&ED income tax credit incentives may considerably lower the cost of continuing SR&ED activities in Canada.

For any entrepreneur, therefore, the key threshold questions would be, "Is my company a CCPC and does it qualify for the SR&ED credit?" A corporation that has been provincially or federally incorporated in Canada and is not "controlled" (either legally or practically) by one or more foreign nationals or publicly traded corporations is known as a CCPC. Generally speaking, startup technology businesses with a majority of its founders being Canadian residents will obtain CCPC status unless there are exceptional circumstances.

Basic and applied research expenses as well as experimental development costs for technological advancement toward the creation of new or improved materials, technologies, products, or processes are included in the qualifying SR&ED expenditures. These benefits can be extremely helpful in a company's viability, especially in its early stages, for eligible enterprises with low sales and R&D expenses.

Becoming a qualified CCPC also has additional advantages.

Reduced corporate tax rates for the first C$500,000 of revenue from an operating business

advantageous tax treatment for shareholders who are Canadian residents when selling shares of certain CCPCs, including (i) a one-time capital gains exemption (C$883,384 for 2020) and (ii) the deferral of realized capital gains if the proceeds of the sale are, in each case, reinvested in another CCPC, subject to certain requirements.

favorable tax treatment for certain arm's length employees who are residents of Canada when they exercise their options. This includes: (i) a tax deferral until the employee sells the underlying shares (as opposed to non-CCPC options where the taxable benefit is realized at the time of exercise); and (ii) a deduction on the sale of the underlying shares equal to 50% of the benefit derived from the options, even if the options were not granted at fair market value, as long as the employee holds the shares for a minimum of two years after the date of exercise (in contract to non-CCPC options which would only be eligible for the 50% deduction where the options were awarded with a fair market value exercise price).

Overseas funding

Because of these advantages, CCPC eligibility might be the deciding factor in choosing a location for the business. Indeed, U.S. investors who are aware of these advantages would anticipate that any Canadian tech business they fund will make use of and continue to be eligible for CCPCs for as long as feasible. Furthermore, it is common for companies whose founders are Canadian residents to consider reorganizing into a Canadian-based structure after initially deciding to incorporate in the United States but later realizing that many of their R&D activities would be eligible for "SR&ED." These cross-border reorganizations come with additional costs and complexity, which are discussed below.

With the removal of tax hurdles formerly imposed on non-resident investors, the tax efficiency of investments made in Canada has become even more significant. Before, the Canadian tax system posed serious barriers to U.S. investors selling a cross-border investment. These obstacles mostly took the form of requirements to apply for and receive clearance certificates from the Canadian tax authorities, in the event that buyers failed to meet the requirements, which resulted in sizable withholding obligations. Due to these obstacles, the majority of foreign investment was either made through tax-friendly jurisdictions or nations that had tax treaties with Canada to make it easier to obtain tax clearance certificates, or (ii) required the Canadian target to reorganize as a U.S. corporation or implement a share exchange structure, as will be covered in more detail below. These obstacles have been removed, primarily as a result of lobbying efforts by American investors, and this has greatly facilitated the ability of Canadian entrepreneurs to secure American funding. This has made it possible for the founders to concentrate on CCPC eligibility as the primary criterion for incorporation location.

NVCA records

Over the past ten years, the industry has changed to the point where young Canadian businesses are now frequently using National Venture Capital Association (NVCA)-style documents, which are recognizable to American investors but have been tailored to operate in Canadian legal systems. A legal distinction that has caused some U.S. investors to hesitate before investing in Canadian businesses has now been essentially abolished by this legislation.

As a starting point, the majority of Canadian jurisdictions—including the federal government and Ontario—have "modern" corporate legislation that are based on the ideas of Delaware corporate law.