Transferring Profits Between a Canadian Parent Company and Its Wholly Owned U.S. Subsidiary: Tax Implications and Regulations

When a single Canadian individual owns a wholly owned subsidiary in the United States, the question arises: do the net profits post corporate taxes need to be taxed again when transferred to the parent company? This article explores the tax regulations and implications for such cross-border transactions, drawing parallels to well-known examples like Apple, and examining the legal and ethical perspectives.

Understanding Taxation on Foreign Companies

According to U.S. tax laws, any revenues earned by a company, regardless of the nationality of the owner, must be taxed in the same manner as if the owner were a U.S. citizen. Apple provides a compelling case study, where the company uses various legal strategies to minimize its tax burden, but even so, any dividends received by foreign shareholders are subject to the 30% withholding tax under IRC § 881a(a).

Legal and Regulatory Framework

Let's consider the specific scenario involving a single Canadian citizen owning a 100% stake in a Canadian-Controlled Private Corporation (CCPC), which in turn wholly owns a U.S. C-Corporation, also referred to as a C Corporation under the Internal Revenue Code (IRC) § 501(c)(3).

Filing a Zero Balance Return

The simplest method for the C-Corporation to avoid U.S. Corporate taxes is to charge the Canadian parent company a management fee, provided the fee does not exceed standard industry rates. This approach ensures that the C-Corporation reports a zero balance return, aligning with the zero balance return strategy often used by international companies. However, this strategy requires careful documentation to substantiate the fee.

Subpart F Income and U.S. Shareholders

Under IRC § 951A, a U.S. Shareholder (in this case, the CCPC) is required to include in its income any Subpart F income from a Foreign Corporation (FCF). Subpart F income is essentially a form of income that is subject to immediate inclusion in the U.S. shareholder's income, regardless of whether it has been distributed or not. In our scenario, the CCPC would be required to include its share of the C-Corporation's income when it is earned.

Dividend Distribution and Taxes

When the C-Corporation elects to issue dividends that amount to 100% of the net Earnings and Profits (EP), no additional U.S. Corporate taxes would be due at that time. However, the dividends would be subject to the Canada-U.S. Tax Convention, which could lead to tax savings for the parent company in Canada. It's important to consult with a tax professional to navigate the complexities of such distributions.

Losses and Profitability

Typically, a C-Corporation may experience losses for the first three years of operations. These losses, if carried forward, can offset future earnings, and no taxes would be due until profitability is achieved. By year four, the C-Corporation is likely to reach a break-even point, and by year five, it might have sufficient profits to cover previously carried losses. At that point, both U.S. and Canadian taxes would need to be considered.

Conclusion

The tax implications of transferring net profits from a wholly owned U.S. subsidiary to a Canadian parent company are multifaceted and require careful consideration. While the Canadian parent company may use strategies like management fees and dividend elections to minimize its tax burden, the ultimate requirement for a U.S. Shareholder to include Subpart F income in its income is a legal mandate. Consulting with a tax professional is crucial to ensure compliance with both U.S. and Canadian tax laws.

For more information on Canadian and U.S. tax laws, please refer to the Canada-U.S. Tax Treaty and the Internal Revenue Code.