CHAPTER 20:

Domestic and International

Business Expansion

Prepared by

Kristie Dewald
University of Alberta
Electronic Presentations in Microsoft PowerPoint

Copyright 2016 McGraw-Hill Education Limited

Domestic and International Business

Expansion
I.
II.

Domestic Business Expansion

International Business Expansion

I.

Domestic Business Expansion

Must attempt to create an expansion structure that
will:
minimize the start-up cash requirements and
maximize the return of cash to the business for
reinvestment.

I.

Domestic Business Expansion

The following tax considerations are relevant:

1.What will be the annual tax cost on new profits generated
from the expansion?
2.How and when can operating losses during the start-up
period be offset against other taxable income to generate
cash flow?
3.What are the tax implications if the expansion fails and is
discontinued?
4.How can the original capital invested, and accumulated
profits, be returned from the expansion with a minimum
amount of tax?
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A. Expansion with Existing Resources

Two structural alternatives are available:
1. Operated as a division:

The expansion activity can be operated as a division of

the existing corporation; or

2. Operated as a separate corporation

A subsidiary of the parent corporation.

Loss utilization
A major difference between the two structures is the
ability to use any losses in the start-up years:
Divisional structure all losses incurred can immediately be
offset against other divisional income.
Corporate structure start-up losses can only be used by the
separate corporation. Not available to the other divisions.

Expansion failure
The losses and related obligations will be funded by the
initial capital invested, or
The losses will require further funding to meet the
obligations.
Potential losses - limited to the capital invested:
both structures permit the eventual use of the incurred losses for offset
against other income.

Potential losses greater than capital invested:

Impact of limited liability must be weighed against the after-tax cost of
absorbing the losses.

Taxation of expansion profits

The amount of tax paid on profits can vary depending
on whether:
A division or a separate corporation is established,
If the expansion activity crosses provincial boundaries, and/or
The nature of the expansion profits differs from existing profits.

Repatriation of capital and accumulated

profits
Similar under both structures for domestic expansion that
does not involve new equity participants.
Separate corporate structure dividends are normally
distributed tax-free between corporations.

B. Expansion with New Equity Participants

Common to require additional financial resources for

expansion opportunities.
Two strategies:
1. Limited expansion and slow growth; or
2. Rapid expansion through the raising of additional equity from
new participants.

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B. Expansion with New Equity Participants

Must choose between alternative business

strategies and
Then choose between alternative business
structures:
1. Separate corporation
2. Standard partnership
3. Limited partnership

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Expansion of the small-business deduction

May be desirable to give more equity for higher after-tax
returns
A private corporation may consider a structure that increases
the amount of income eligible for the SBD.

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II. International Business Expansion

A. Basic Issues

Two fundamental approaches to conducting foreign

business operations:
1. Informal Structures: Foreign activity conducted from
home base in the form of direct export sales to
consumers or distributors; or
2. Formal Structures: develop foreign structure that
involves a physical presence in the foreign jurisdiction.

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II. International Business Expansion

A. Basic Issues

Formal structures can include the following:

1. A simple branch location.
2. A separate foreign corporation as a subsidiary.
3. A separate foreign joint venture, partnership, or limited
partnership.
4. An advanced, broadly based, foreign structure that
includes foreign holding corporations, finance
companies, and sales and manufacturing entities.

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Formal Structures
Shareholder

Shareholder

Shareholder

Corporation

Corporation

Corporation

Direct
Sales

Foreign
Branch

Canada
Foreign
Country

Foreign
Corporation

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Tax Perspective of Expansion

Main issues are:

1. Extent of tax imposed by the foreign jurisdiction on foreign
business operations?
2. Application of Canadian tax the foreign business profits?
How can losses on foreign operations be utilized?
3. What tax treatment is applied to transactions between the
foreign operation and the Canadian owner?

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B. Foreign Currencies
Foreign exchange gains or losses will occur when
transactions are completed in foreign currencies
Two questions relating to foreign exchange gains or losses
must be answered:
1.
2.

Is the gain or loss a capital item or business income?

The timing of the tax recognized on an accrual basis or
when settled?

Tax Act is silent on these issues

. Treatment is determined by the underlying transaction(s) that
created it
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C. Direct Export Sales

Direct sales are treated as domestic sales,
Fully taxable in Canada as business income.

Foreign tax purposes, most foreign countries tax only

those non-residents who carry on business in the
foreign country.
Usually applies to business activity implemented from a
permanent establishment.

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D. Foreign Branch Location

The foreign branch location does not constitute a

separate legal entity.
The tax treatment of profits earned by the foreign
branch location is as follows:
1. Branch profits will be subject to the income taxes
applicable in the foreign jurisdiction.
2. The foreign branch profits form part of the world income
of the Canadian corporation, and are therefore also
taxable in Canada as normal business income.
3. Canadian taxes payable on the business profits of the
foreign branch can be reduced by the foreign tax credit.

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D. Foreign Branch Location

One major advantage:
losses incurred by the foreign branch can immediately be used
to offset profits made in Canada.

Future profits can be repatriated to the Canadian

corporate owner without further tax consequences.

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E. Foreign Subsidiary Corporation

Business profits are subject to the following tax
treatment:
1. Subsidiary is subject to income taxes of the foreign country.
2. Foreign corporation is not subject to Canadian tax on
business profits earned within the corporation.
3. After-tax profits can be distributed to the Canadian parent
corporation as a dividend.
4. Most countries impose a special tax on dividends paid to a
foreign shareholder.

The tax is withheld and remitted to the foreign jurisdiction.

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F. Alternative Cash Flows from a Foreign

Subsidiary
Foreign entity often requires significant support by the
home-based entity.
Capital
Equipment
Technology
Management

Canadian
Corporation

Foreign
Corporation

Interest
Rent
Royalties
Management fees

Foreign countries impose a special withholding tax on

such payments to non-residents.

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G. Foreign Tax Credit (FTC)

FTC affects the taxation of
Foreign branch income and
Payments from a subsidiary of:

Dividends,
Interest,
Rent and royalties, and
Management fees are

The foreign tax credit is designed to limit the total tax to

an amount that is no greater than the one imposed by the
country with the higher rate of tax.

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H. Intercompany Transfer Pricing

Whenever there is a difference in tax rates between the
Canadian parent corporation and the foreign subsidiary
corporation,
Creates a desire to shift profits to the country with the lowest
tax rate.

Canadian tax law uses a reasonableness test with

respect to the pricing of goods sold to foreign subsidiary
corporations.
Deemed to have been sold at a price that would reasonably
have been expected in arms length transactions.

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I. Converting a Foreign Branch to a Foreign

Subsidiary
Foreign business expansion often involves a progression
from one structure to another.
The conversion to a foreign subsidiary involves a transfer
of assets.
Foreign-branch assets are transferred ONLY at FMV;
Results in Canadian tax if FMV > Tax Cost

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