Carrying on Business in Canada Series Part III: Canadian Subsidiary versus Branch

Once a non-resident corporation decides to expand and establish presence in Canada, they generally face two options for the expansion:

1. Establish a Canadian subsidiary (a separate Canadian corporation); or

2. Operate as a branch (i.e. the foreign company itself carries on business in Canada).

Each structure carries different tax and other consequences. This article generally provides a comparison of both options from tax perspective.

1. Understanding the Two Structures

What is a Canadian Subsidiary?

A subsidiary is a separate legal entity, typically incorporated under federal or under a provincial law (e.g., Ontario, British Columbia, Alberta). The foreign parent owns the shares of the Canadian corporation, but the corporation operates independently for legal and tax purposes.

Key features:

• Separate legal entity distinct from parent

• Pays Canadian corporate income tax on its own profits

• Generally provides legal limited liability protections

• Subject to corporate law requirements
  

What is a Canadian Branch?

A branch is not a separate legal entity. Instead, the foreign corporation itself registers to carry on business in Canada. Its Canadian operations are considered part of the parent corporation, and profits attributable to Canadian activity are taxable in Canada provided that the corporation carries on business in Canada (or has a permanent establishment in Canada if tax treaty applies).

Key features:

• Not a separate legal entity

• Parent company is directly exposed to Canadian legal liabilities

• Must evaluate whether it has a permanent establishment ("PE") under the applicable tax treaty

• Branch profits are subject to Canadian tax and potentially a branch tax (a rough proxy for dividend withholding tax)
  

2. Taxation: Subsidiary vs. Branch

Tax is often the driving factor behind structure choice. Canada taxes both subsidiaries and branches, but the mechanics differ significantly.

Subsidiary Taxation

Corporate Income Tax

A Canadian subsidiary pays tax on its worldwide income. Combined federal/provincial corporate tax rates range from 23–30% depending on the province of operations.

Withholding Tax on Dividends to Foreign Parent

When the Canadian subsidiary pays dividends to the foreign parent, a withholding tax of 25% applies. However, this rate may potentially be reduced to a lower amount (e.g. 5% - 15%) depending on the applicable tax treaty.

Interest, rent, royalties, and other similar type of payments may also be subject to the 25% withholding tax unless treaty relief applies.

Losses

Losses remain with the Canadian subsidiary and may be carried forward or back (subject to certain restrictions) to offset the profits of the subsidiary in the other years.

Ringfence of Canadian tax audit

One of the key advantages of operating through a Canadian subsidiary is that, in most cases, it ringfences CRA audit activity to the subsidiary’s own books and records. By contrast, when a foreign business operates through a Canadian branch, the CRA may request access to the foreign parent’s books and records, potentially broadening the audit scope and increasing compliance complexity for the parent company.

Branch Taxation

PE Considerations

If tax treaties apply between Canada and the foreign corporation's home country, it may be possible that the foreign corporation's Canadian branch is not taxable in Canada unless it has a PE in Canada. Refer to previous article here for detailed discussion on PE. For the remainder of the article, it'll be assumed that the Canadian branch would be subject to Canadian tax.

Corporate Income Tax on Canadian Profits

Canada taxes only the profits attributable to Canadian branch of a foreign corporation. Such profit must be determined based on transfer pricing arm's length principles.

Rules surrounding computation of income for tax purposes are broadly similar for Canadian subsidiary and branch. For example, rules such as thin-capitalization and excessive interest and financing expenses limitation ("EIFEL") rules must be considered in computing income of a Canadian subsidiary or a branch.

Branch Profits Tax

To approximate the withholding tax on dividends that a subsidiary would pay, Canada imposes a branch tax on branch profits not reinvested in Canada. The branch tax is 25% under domestic law although it is commonly reduced to a lower rate if tax treaty applies. Furthermore, a tax treaty may allow for certain amount of branch profits to be exempt from branch tax. For example, under the Canada - US tax treaty, there is branch tax exemption on the first CAD $500,000 of branch profits (lifetime).

Withholding Tax on Payments

When a Canadian person pays or credits certain type of payments such as rent, interest, royalties, etc., non-resident withholding tax of up to 25% applies on the payment. For this purpose, a Canadian branch of a non-resident corporation may be deemed to be a Canadian person if such payment is deductible in computing the income of the branch.

Branch Losses and Foreign Tax Credit

Subject to the rules in the foreign corporation's home country, it may be possible for the losses of the Canadian branch to be used by the foreign corporation to reduce its worldwide taxable income in its home country. Generally, this is one of the main tax advantages of operating as a branch in Canada, at least initially (i.e. if the branch is expected to generate losses in the near term).

If instead, the Canadian branch is profitable and liable for Canadian tax, it may be possible for the foreign corporation to claim foreign tax credit in its home country for the Canadian taxes paid.

Incorporating a Canadian Branch

From a Canadian tax perspective, it is possible to convert the Canadian branch to a Canadian subsidiary, generally on a tax-deferred basis through the use of section 85 rollover. However, non-Canadian tax implications should be considered prior to implementing this.

Snapshot of Canadian Subsidiary versus Branch

Description	Subsidiary	Branch	Notes
Corporate tax rate	23% - 30%	23% - 30%	Depending on the province of operation.
Branch tax	❌	5% - 25%	Branch tax applies on Canadian profits not reinvested in Canada. Lifetime CAD $500,000 of profits may be exempt from branch tax under the applicable tax treaty.
Withholding tax on dividend	5% - 25%	❌	Subject to the applicable tax treaty.
EIFEL	✔️	✔️
Thin-Capitalization Rules	✔️	✔️
Part XIII Tax	✔️	✔️	Canadian branch may be deemed to be Canadian person for Part XIII tax purposes.
Regulation 105 (as the service provider)	❌	✔️	Branch would be considered as a non-resident for purposes of Regulation 105. Therefore, provided that the branch provides services in Canada, its income would be subject to Regulation 105 withholding. See previous article on Regulation 105 here.
Losses	Remains with the subsidiary	May flow up to the parent
Scope of CRA Audit	Records of subsidiary	Records of the foreign parent

Special Mention: Use of Canada's Unlimited Liability Corporation ("ULC")

Generally, for US companies considering Canadian expansion, one structure deserves special attention: the ULC.

ULC may be formed under one of the following provincial corporate law:

• Nova Scotia

• British Columbia

• Alberta

• Prince Edward Island
  

What makes them unique is that, under Canadian tax law, ULCs are treated as a normal corporation. But under US federal tax law, it is our understanding that they can be treated as a disregarded entity or a flow-through entity. In effect, this means that for Canadian tax purposes, the expansion occurs through a Canadian subsidiary, while for US tax purposes, the expansion is viewed as if it occurred through a Canadian branch.

This hybrid treatment — a corporation in Canada but a flow-through entity in the US creates unique cross-border planning opportunities. That said, businesses should approach the ULC structure with caution, particularly given the legal liability considerations and the impact of anti-hybrid tax rules.

Takeaway

This article provided a comparative overview of the tax implications of carrying on business in Canada through a subsidiary or a branch. While tax considerations are often central to the decision, businesses should also evaluate non-tax factors, including legal liability exposure, administrative obligations, and commercial realities.

This concludes the three part “Carrying on Business in Canada” series. If your organization is considering Canadian expansion or advising clients entering the Canadian market, feel free to contact me to discuss the most effective structure for your situation.

Contact Francis Do at Francis@francisdo.com or 416-572-9633 for more details.

Disclaimer: The information provided in this article is for general informational purposes only and does not constitute professional advice. Readers should seek advice from a qualified professional regarding their specific situation before taking any action.