Expanding business across the border? Get up to speed with the tax implications

As supply chains increasingly cross borders, today’s business environment calls upon Canadian private companies to engage with international customers to a greater extent than ever before. This trend presents an opportunity for Canadian businesses to expand their market share in new and developing markets and could be an opportunity to increase shareholder value. The strategic decision to do business internationally should always take into consideration the tax implications of such a move – and in particular the impact the expansion could have on shareholders in the medium and long-term.

A key consideration for the private company owner is their ability to access the Lifetime Capital Gains Exemption (“LCGE”) should they eventually decide to sell the shares of their company. The LCGE is also integral to many company owners’ estate plans. Individuals using their LCGE are able to shelter over $824,000 in capital gains on the disposition of their shares. Depending on the province where a shareholder resides, this could mean an actual tax saving to each individual shareholder of between $183,378 and $242,100 in the year of sale. The savings may be multiplied when a number of family members or trusts are part of the shareholder group.

Accessing the LCGE requires the company and its shareholders to meet three main tests set out in the Income Tax Act. For the purposes of this discussion we will focus on one, the “Asset Test,” which requires that throughout the 24 months before a disposition of the shares, more than 50% of the fair market value of the assets within the corporation must have been used principally in an active business carried on primarily in Canada. If the corporation does not meet this test at any point in time during the 24 month period preceding a sale, the LCGE is unavailable.

Doing business outside of Canada may result in the Canadian corporation inadvertently falling offside the test. The Canada Revenue Agency (“CRA”) has said they will interpret “principally” and “primarily” to mean more than 50% for purposes of this test. In determining if a business is carried on primarily in Canada, they may apply the test based on several different metrics, including: the gross or net assets employed, revenues generated, the number of employees, or the amount of profits generated in Canada or abroad. Furthermore, in determining where an asset is principally used, the CRA may apply factors such as the time an asset was used, the revenues generated from the asset or the value of the assets employed.

Suppose a Canadian business wins a significant contract from a foreign customer which requires a substantial commitment of resources in order to fulfil the contract. Meeting the contract could mean moving people, machinery or other assets outside of Canada for a period of time. Depending on the specific facts and the metrics used by the CRA, the foreign business activity may be sufficient to put the company offside the Asset Test at some point in time.

It would be an unfortunate irony for shareholders, if doing business abroad raised the value of their company (or made it a more enticing target for potential buyers) - only for the owners to discover they had inadvertently reset the clock on their 24 month holding period and could not use the LCGE upon the sale of their shares.

While an international expansion may present both an opportunity and a potential future tax hurdle to a company’s owners, the tax issues may be avoided through judicious upfront planning. A number of tax strategies exist which are tailored to maximize shareholder value in the context of a cross-border business, including preserving access to a shareholder’s LCGE. If you considering doing business outside of Canada, or have recently taken steps to do so, consider speaking to one of MNP’s international tax advisors.

Jennifer Hanna, LLB, is a Partner with MNP’s International Tax Group. Jennifer has over 15 years of experience in the areas of international tax structuring and cross-border transactions. Contact Jennifer at 403.537.7672 or jennifer.hanna@mnp.ca.