Canadian owning US Business, Tax Implications
Let's say you have a holding company here in Canada and you're a Canadian resident. You're looking to invest into US businesses (actual businesses, real estate, hotels, etc). What are the tax implications? I hear there is a withholding tax?
Here's an example. Your holding company here in Canada invests with a group in the US that purchases a Hotel. The Hotel does well and the profits are distributed in the form of a dividend to the group. Let's say my share is $1000 for the year. I've read that there is a 15% withholding tax, which would mean that you pay $150 to the IRS. Once the money is back here in Canada, you would then pay dividend tax on the $850 at the full rate?
I know when the company is in Ontario, you can pay out tax free dividends from the operating business to the holding company.
Am I right or confused?
Except for the transfer pricing issues, I'm not an expert on the other US and international tax concerns. Please consult an actual tax professional for proper advice.
Withholding tax is generally levied on cross-border distributions of passive sources of income, like rents, royalties, interest, and dividends. Withholding tax will only apply when income gets distributed, and it is possible that withholding may not apply, depending upon how the income is distributed. Also, it is possible that a rate lower than 15% might apply. For example, I think that interest on related-party debt between Canadian and American companies can get a 0% withholding tax treatment. Funding the US business with both equity and debt could be tax efficient. You should consult someone who is an international expert (or at least a US tax expert) for more information on this.
Another way to get money out of the US without it being subject to US withholding taxes is for the Canadian holding company to provide (real, verifiable) services to the US business (from Canada), like management services. The US business should get a deduction. And the payment from the US business to the Canadian holding company for the services is not subject to withholding tax. The holding company would have to claim this as income in Canada, but there is an element of tax arbitrage here, since US corporate tax rates are higher than Canadian corporate tax rates. One pitfall here is that the pricing of the management services (referred to as transfer pricing) needs to be in line with "arm's length" pricing. This means that you can't just bleed the US business dry with excessive management fees.
The same transfer pricing restriction applies if you choose to fund the US business with debt issued to the Canadian holding company. The interest rate needs to be in line with an arm's length interest rate. In addition, there are thin capitalisation issues that need to be addressed. You can't just stuff the US company's balance sheet full of debt.