No additional U.S. tax where income earned directly by U.S. citizen/Cdn resident (p. 898)
…US taxable income will typically be lower than Canadian taxable income. Since Canadian personal income tax rates (including provincial taxes) are higher -at all income levels than US rates, an American in Canada with only Canadian-source income will almost always have little or no US tax.
Potential non-creditability of CFC tax (pp. 903-904)
Where US shareholders collectively own shares with more than 50 percent of the votes or value of a non-US corporation, that corporation is a CFC. [fn 48: IRC section 957(a).] In this context, a "US shareholder" is a US person who owns at least 10 percent of all of the corporation's shares, measured by voting power. [fn 49: IRC section 951(b).]…
[T]he CFC regime can have an impact on a US professional's decision to incorporate in Canada. The inclusion of corporate income in personal income could cause the individual's personal US income to exceed his or her personal Canadian income. As a result, the overall US tax could exceed the overall Canadian tax. The foreign tax credit would then fail to eliminate the US tax, and there would be net US tax in addition to the Canadian tax. This additional US tax would not be effectively creditable in Canada because there would be no US-source income against which the credit could be claimed. [fn: 59: ITA subparagraph 126(l)(b)(i); the definition of "qualifying incomes," in ITA subsection 126(7); and ITA paragraph 4(l)(a).]
Harsh treatment of PFIC distributions (pp. 912-913)
A Canadian corporation is a PFIC to an American owner if [fn 106: IRC section 1297(a).]
- 75 percent or more of the corporation's revenue is passive, or
- 50 percent or more of its assets are held to produce passive income.
This rule does not apply to a corporation that is also a CFC, provided that it was incorporated after 1997 [fn 107: IRC section 1297(d)(s).] …
An ordinary distribution is taxed in the year of distribution as ordinary income. … An excess distribution … is treated as though it were earned evenly over the period of ownership of the PFICC interest.
Frequent qualification of medical and legal corporations as PFICs (p. 917)
Medical and legal corporations often qualify as PFICs because they rarely hold much in the way of active business assets. The investment assets can quickly reach 75 percent of the total assets, In this case, distributions from the PC can be taxed in a very adverse manner,…
Potential for U.S. tax to exceed Cdn tax where a professional-corp. ULC retains income (p. 926)
The different challenge that is created with a ULC is that because it is fiscally transparent, all of the entity's income is included in the individual's US personal income. For Canadian purposes, only the portion distributed is subject to personal tax. The corporate tax is eligible for credit, since it is considered to have been paid by the individual. The corporate tax is applied at a low rate.
Thus, if some income is retained within the ULC, there is a potential for the US tax to exceed the Canadian tax. Such US tax would be levied on Canadian-source income and therefore would not be eligible for a foreign tax credit. [fn 183: Paragraph (d) of … "non-business income tax" in … 126(7).] Close attention must be paid to salary and dividend planning to ensure that double taxation is avoided.
Managing a professional corp that is a CFC so that the Cdn effective tax rate exceeds 31.5% (pp. 928-929)
Scenario 1: All Family Members are US Persons
Where all family members are US persons, the company will be a CFC and thus cannot be a PFIC. With a CFC, the problem is the imputation of corporate income to the shareholders….
… Investment in an RRSP is generally effective. While contributions are not deductible for US purposes, given the limited contribution room and the differences in Canadian and US tax exemptions, deductions, and rates, that limitation does not usually create net tax. US tax on income earned inside an RRSP is deferred until the income is withdrawn. [fn 185: Article XVIII(&) of the Canada-US tax treaty,…]
Once the investment income passes the 5 percent threshold … it is usually possible to manage the portfolio so that the Canadian effective tax rate exceeds 31.5 percent. Focusing the corporate portfolio on income-yielding securities will meet this goal. Many professionals will have portfolios inside and outside their PCs (including in their RRSPs). The "outside" portfolios can be focused on growth-oriented stocks….
Having the Cdn family members set up an investment company (sidecar) to which PC lends funds (pp. 929-930)
Scenario 2: Not All Family Members Are US Persons
[T]he substantial majority of practical scenarios involve "mixed marriages"—that is, a marriage between a person who is a US citizen and one who is not. If the professional is the American, the PC is a CFC. If a family member (other than the professional) is an American, the PC may be (or become) a PFIC.
The challenge with a CFC … is that the corporate investment income is imputed to the professional. Since the income is not distributed out of the corporation, there is no related Canadian personal tax, and consequently the foreign tax credit can be insufficient to eliminate the US tax.
The simplest way to solve this problem is to have the non-resident alien family members set up an investment company ("Investco"). The PC then lends excess funds to Investco. …
Investco is free to make investments without the potentially adverse impacts of US tax law, because all shareholders are non-resident aliens. Thus, Investco can invest in Canadian mutual funds without fear of the PFIC rules. …
For Canadian tax purposes, there is no need to charge interest on the loan from the PC to Investco, because intercompany loans are not subject to Canada's attribution rules. [fn 188: ITA subsection 74.4(2).] However, the loan should be made at a market rate of interest, in order to avoid adverse US tax effects.
Dealing with PFIC problem through giving voting control to US family member (pp. 931-933)
With a PFIC, the US-citizen family member is, by definition, a minority shareholder (at least by votes). Dividends paid to that individual are, in the best scenario, ordinary income for US tax purposes. Accordingly, the tax rate can be as high as 39.6 percent. While Canadian tax rates on ineligible dividends have risen significantly (from 31 percent in 2009 to 45 percent currently), it is possible for the Canadian tax to be less than the US tax….
One way to avoid the PFIC problem… [i]s to have the non-resident alien formally commit to voting the shares as directed by the US family members. This action would give the Americans control and turn the company into a CFC. This action may be precluded by a province's corporate legislation or the profession's regulatory body.
In 7 of Canada's 10 provinces (the exceptions being Alberta, Ontario, and Newfoundland and Labrador), the issue can often be dealt with by creating a holding company. The non-resident alien family member can set up a company to hold shares of the professional corporation. It is possible to avoid PFIC status by having the PC distribute its cash to the holding company. All investing is done by Holdco. Since the PC has little or no cash, it can avoid PFIC status….
This approach also works where the professional is a US person and the family members are non-resident aliens making the PC a CFC,…The non-tax issue that arises here is that the professional, who is substantially responsible for the generation of the assets, is not allowed to be a shareholder of Holdco. Otherwise, Holdco becomes a CFC or PFIC to the professional.
Dealing with PFIC problem through a gift of Neuman shares (pp.933-935)
…Alberta, Ontario, and Newfoundland and Labrador disallow corporate ownership of PCs….
For the CFC problem, the "sidecar-loan" strategy is generally the best option. However, where the US person is not the professional, the PC is at risk of becoming a PFIC. The sidecar-loan approach does not work; the loan is a passive asset.
One way of dealing with this problem is to issue Neuman shares to the US spouse (as is typically done) and then have the spouse gift the shares to the professional. That way, the professional ends up as the legal owner. From a US perspective, this is an effective transaction. Dividends paid on the shares are legally the property of the non-resident alien professional, and thus not subject to US tax….
At the time of the gift (which one would desire to have near commencement of the life of the corporation), the shares will have little value, so the quantum of the gift will be small and there will be little gift tax exposure….
For Canadian tax purposes, the gift will cause dividends on the shares to be subject to attribution….
There is a risk that the CRA would see this gifting strategy as abusive, and apply an anti-abuse rule that would void the attribution. [fn 204: ITA subsection 74.5(11).] [fn 205: 2014-0519661E5]
The provision contains a "principal purpose" test. It could be argued that in this case, the family ,member would retain the shares but for the US tax consequences of doing so. The attribution merely puts the family member in the same position as he or she would be absent the gift.
Although there may be significant advantages for a Canadian-resident professional to incorporate, challenges arise where the professional (or a spouse) is also an American citizen. Perhaps the most significant challenges arise where there is a “mixed” marriage between a US citizen and a (Canadian) non-resident “alien.” If the professional is the American, the professional corporation (PC) is a controlled foreign corporation (CFC). If a family member (other than the professional) is an American, the PC may be a passive foreign investment company (PFIC) given its control by the professional. (Medical and legal corporations often qualify as PFICs because they rarely hold much in the way of active business assets.)
Ontario, Alberta and Newfoundland generally prohibit corporate ownership (e.g., through a holding company set up by alien family members) of a PC. In this context, a possibility for dealing with the PFIC issues in the second situation is to issue Neuman (discretionary) shares, having a modest value, to the U.S. spouse, who then gifts them to the professional. From a U.S. perspective, dividends paid on the shares are legally the property of the non-resident alien professional, and thus not subject to U.S. tax.
For Canadian tax purposes, the gift will cause dividends on the shares to be subject to attribution under s. 74.5(1). However (p. 935):
There is a risk that the CRA would see this gifting strategy as abusive, and apply an anti-abuse rule [in s. 74.5(11) that would void the attribution.
…It could be argued [however] that in this case, the family ,member would retain the shares but for the US tax consequences of doing so. The attribution merely puts the family member in the same position as he or she would be absent the gift.