A Canadian Tax Lawyer’s Analysis on Corporate Tax Residence

Starting Point of Tax Law and How it Relates to Corporate Tax

The starting point of tax tax law in Canada is section 2 of the Income Tax Act. Subsection 2(1) states that “an income tax shall be paid, as required by this Act, on the taxable income for each taxation year of every person resident in Canada at any time of the year”. It’s important to note that “person” in this subsection includes not only individuals, but also corporations.

On the other hand, subsection 2(3) speaks about non-resident tax in Canada. It states that income tax shall be paid by non-residence of Canada only on income that was derived from (a) employment, (b) business in Canada, and (c) disposition of taxable Canadian property.

Then, subsection 2(2) of the Income Tax Act states that “taxable income” is the “taxpayer’s income for the year plus the additions and minus the deductions permitted by Division C.”

Therefore, by implication, Canada imposes income tax since residence of a person and on the basis of type of income source. This is why tax residence is a crucial element of Canadian tax law. In this article, we will discuss in depth about tax residence of corporations.

Brief Overview of Corporations and Taxation

Under corporate law and tax law, a corporation is a distinct legal entity that is separate from its own owners (that is, shareholders), directors, officers, and employees. Therefore, it is important to understand that even if an individual owns 100% of the shares of a corporation, the assets belonging to the corporation specifically do not belong to the individual. In fact, the corporation owns the assets as it is a separate and distinct legal entity apart from the owner and each of the owner and the Corporation have separate and distinct tax obligations. This is a crucial point to understand to avoid tax issues.

As discussed, the word “person” in subsection 2(1) includes not only individual taxpayers, but also corporations. This means that a Canadian resident corporation is obligated to report is worldwide income to the Canada Revenue Agency. The after-tax dollars can only be distributed to its shareholders once the corporate taxes have been paid. Therefore, there are two levels of taxation with respect to corporate income that flows to a shareholder.

First, the corporation is required to pay taxes on its income, and then the individual is required to pay taxes on the corporate dividend he or she receives from the corporation. Despite this two-layered taxation system, through the principle of tax integration, total taxes levied on such structure is effectively equivalent to the amount of tax that an individual shareholder would pay if he or she earned the same amount of income on a personal level.

Corporate Residence – Statutory Rules

There are both statutory deeming rules as well as common law rules for determining the residence of a corporation for Canadian tax purposes. The most straight forward rules are the statutory deeming rules. Paragraph 250(4)(a) states that if a corporation is incorporated in Canada after April 26, 1965, then from that point forward, it will be a Canadian resident corporation. If a corporation was incorporated before April 27, 1965, then the corporation will be a Canadian resident corporation if the corporation is found to be a Canadian resident corporation under the common law rules or if it carried on business in Canada.

Corporate Residence – Common Law Rules

What if a corporation was not incorporated in Canada? It may still be a Canadian tax resident corporation under the common law rules. Common law rules state that a corporation is a resident in the location in which its central management and control is exercised because this is where the actual business of a corporation is carried on. This rule – commonly known as the central management and control test – was based upon Lord Loreburn’s decision in the House of Lords in the United Kingdom in De Beers Consolidated Mines Ltd. v. Howe. Therefore, even if a corporation is incorporated outside of Canada, if central management and control abides in Canada, then the company is a resident for Canadian tax purposes.

The central management and control test is a question of fact. One of the main factors that courts will look at to determine a corporation’s “central management and control” is the location in which the corporation’s board of directors make their decisions. The reason why the board of directors are important is because board of directors have the legal power to manage the affairs of the corporation. Thus, the residence of the board of directors will often decide the tax residence of a corporation.

On the other hand, the residence of shareholders of a corporation is not important for corporate residence purposes. The reason is because directors of a corporation do not have legal duties to follow the instructions of their shareholders. Therefore, it is generally presumed that shareholders will not affect the central management and control of a corporation.

However, in some cases, the residence of shareholders may be relevant for the central management and control test. This is the case if shareholders control the corporation by exerting influence over the directors of the corporation. If there is clear evidence that shareholders have effective management and control of a corporation, then the residence of shareholders may be the location in which the corporation’s central management and control is exercised.

Pro Tip: Carefully plan Which Jurisdiction to Incorporate and who will be the Directors

You should consider the implications to corporation’s residence status for income tax purposes when you decide in which jurisdiction to incorporate and who will be the directors of the corporation. Incorporating in Canada is a good idea if you want a Canadian resident corporation, and make sure that the directors of the corporation are Canadian residents. On the other hand, if you want a non-resident corporation, then you should consider incorporating in a jurisdiction outside of Canada and make sure that the directors of the corporation are not Canadian residents. If you would like to speak to a tax professional about your corporate tax residency, please contact our top Canadian tax law firm.

F.A.Q.

Are Canadian Tax Resident Corporations Taxed?

Absolutely. Subsections 2 and 3 of the Income Tax Act applies to “persons” and corporations are included in the definition. Thus, Canadian resident corporations are liable to Canadian tax on its worldwide income.

Are Corporations Separate Legal Entities?

Yes, for Canadian tax and corporate law purposes, corporations are considered separate and distinct legal entities apart from their owners.

Can a Corporation that was not Incorporated in Canada be a Canadian Resident Corporation for Income Tax Purposes?

Yes. It my still be a Canadian tax resident corporation under the common law rules. Common law rules state that a corporation is a resident in the location in which its central management and control is exercised because this is where the actual business of a corporation is carried on.