Business Start-Up Canada or USA?

Technology businesses in Canada frequently need or wish to draw in investment from outside investors, especially from the United States. Although US funding is frequently welcomed, US investors' interests may collide with those of Canadian entrepreneurs and staff members. Because many investors prefer—and in some cases insist—that the organization be established under U.S. law, it can be challenging to decide whether to incorporate in Canada or the United States due to these conflicting interests. While there is frequently a lot of temptation to incorporate as soon as possible when starting a new company, entrepreneurs should carefully consider the advantages and disadvantages of incorporating in the US vs Canada because it is expensive and difficult to change course after the initial incorporation.US venture capital funds significantly increased their investments in Canadian portfolio companies in the late 1990s and early 2000s. Many US venture capitalists made direct investments in Canadian-incorporated businesses back then. It became clear in the early 2000s that US venture capitalists would run into problems with Canadian income taxes when attempting to sell their Canadian holdings. The necessity that a non-resident get a section 116 certificate when selling shares of a Canadian corporation or risk a 25% withholding tax constituted the most significant issues. Anytime a buyer purchases taxable Canadian property (TCP) from a non-resident of Canada, they must obtain a section 116 certificate.

All private Canadian company shares were TCP until 2010.

Many US VCs shied away from making direct investments in Canadian companies due to the lengthy reporting procedures and delays in getting section 116 certifications. Many of the most promising Canadian enterprises either incorporated in the US initially or underwent company reorganization in order to obtain US venture capital funding after these issues became evident.In 2010, following a vigorous effort by the innovation industry, the Income Tax Act (Canada) (ITA) was amended to address the section 116 issue. The term TCP was redefined on March 4, 2010, when the ITA underwent amendments. The new definition eliminates shares of corporations whose value is derived, at any point in the 60 months preceding the time of determination, from more than 50% of Canadian real or immovable property, Canadian resource property, Canadian timber resource property, or options or interests pertaining to any of the aforementioned. This change eliminates the requirement for buyers to withhold 25% of the purchase price when buying shares of the majority of privately held Canadian companies from US-based sellers. It also removes the seller's need to apply for a section 116 certificate prior to receiving the entire purchase price.The majority of US venture capitalists are now at ease making direct investments in Canadian businesses. The numerous tax advantages that come with Canadian incorporation will still be available to entrepreneurs and their businesses, which is excellent news for Canadian firms.

The following section discusses a few benefits and drawbacks of Canadian incorporation.

Whether or whether the business will be a Canadian-controlled private corporation (CCPC) is the main consideration when determining whether or not it makes sense to incorporate in Canada.A Canadian-incorporated private corporation (CCPC) is any private corporation that is not controlled, either directly or indirectly, by any number of public corporations or non-residents of Canada at any point throughout the year (or any combination thereof). For the purposes of this discussion, control refers to two things: first, legal or de jure control, which is defined as possessing more than half of the voting rights necessary to elect a majority of the Board of Directors; second, factual or de facto control, which is defined as any direct or indirect influence that, if used, would result in control of the corporation in reality, whether through a shareholders agreement, an option to purchase shares, convertible debt, or other methods.What defines a CCPC's de facto control lacks a clear-cut criteria. A normal startup firm that is incorporated in Canada would be eligible for CCPC status if it is founded by individuals who are residents of Canada. That firm can remain a CCPC long after it has launched, provided it can subsequently obtain venture capital or other equity financing from Canadian sources.Through the Scientific Research and Experimental Development (SR&ED) Program, the federal government of Canada encourages investment and employment in the country by offering investment tax credits (ITCs).

In certain situations, ITCs may be refundable to the corporation in the event that it is not taxable.

Alternatively, ITCs may be utilized to lower tax that the corporation would otherwise be required to pay. For eligible CCPCs, the SR&ED ITC rates are currently 35%, whereas for other organizations, the rates are 15%. Refundable, the 35% rate is applied to the first CA$3 million in eligible SR&ED expenses each year. If SR&ED expenses over the CA$3 million expenditure cap, they will be eligible for ITCs at a discounted rate of 20 percent.A CCPC is qualified for the small business income tax rate once it begins to receive income from an active business. This means that the first CA$500,000 of income from an active business will be taxed at a lower federal tax rate.For the creators of a CCPC, the one-time, lifelong capital gains exemption of CA$800,000 is one of the biggest benefits. If a shareholder in Canada sells off any qualifying shares, they will receive a capital gain to the extent that the proceeds of the sale exceed the shares' adjusted cost base plus any reasonable disposal expenses. As long as the shares were held by the taxpayer for at least 24 months, the first CA$800,000 (or, if the exemption has already been used by the individual, the unused portion of the CA$800,000 exemption) of capital gains realized by an individual on the sale of shares of a CCPC will not be subject to income tax where the disposition is of qualifying shares. If they haven't used up the exemption, first-generation entrepreneurs stand to gain significantly from this tax incentive. Even bigger tax savings may come from dividing founder shares with a spouse or family trust. The sale of shares of US-incorporated corporations is not eligible for the CA$800,000 lifetime capital gains exemption, as it is limited to the sale of specific qualifying shares of CCPCs.