To determine the residence of a corporation, consider its 'head and brains'

Rules on tax and related filings depend on whether it resides inside or outside Canada

To determine the residence of a corporation, consider its 'head and brains'

For those who own corporations, tax planning is an important activity that turns on many issues. That includes the residence of the corporation which, according to tax law, could affect what income streams are taxed.

“Corporations resident in Canada are taxed on their worldwide income, while non-resident corporations of Canada are taxed only on their Canadian source income,” explained tax lawyer David Rotfleisch of Rotfleisch & Samulovitch P.C. in a recent article. “Canadian sourced income may include business income, gains from the disposition of taxable Canadian property, and property income.”

According to Rotfleisch, Canadian tax law dictates that a corporation is a resident in Canada if it was incorporated in the country after April 26, 1965. Corporations from another jurisdiction could be continued into Canada, effectively becoming subject to the country’s corporate laws once it receives its Articles of Continuance.

While some corporations may be incorporated in a country other than Canada, it could still be deemed a resident in Canada for tax purposes. Under Canadian tax law, Rotfleisch said, that happens if the “head and brains” of the corporation — its central management and control, as opposed to its day-to-day operations — is exercised in Canada.

“The country in which this is exercised is usually where the majority of the board of directors meets to make decisions,” he said. The rule could also apply to foreign subsidiaries of a Canadian parent, particularly when the Canadian parent corporation makes the central management decisions for its foreign subsidiary. If both the parent and the subsidiary have boards of directors, the subsidiary may still be counted as resident in Canada if its board merely rubber-stamps central managerial decisions handed down by its Canadian parent.

Exceptions, Rotfleisch noted, have been made in some cases where a Canadian parent sets up an intermediary corporation in a low-tax jurisdiction with a low dividend rate — a structure that allows profits to be taxed at a low rate and dividends to be paid to the Canadian parent with little to no associated tax. “Where the board of directors of the intermediate subsidiary were resident in that low-tax jurisdiction and were reasonably inactive, in some cases courts have held that the intermediary corporation was a resident of the low tax jurisdiction,” he said.

The judgement on residence under Canadian tax law could also be overridden by certain tax treaty rules. Specifically, that occurs when a corporation resides in another jurisdiction that has a tax treaty with Canada, and the treaty includes at least one provision that determines the corporation is not a resident in Canada, but a resident in the other country.

“However, court decisions have not always resulted in what a taxpayer would expect from the application of the central management and control rule,” Rotfleisch cautioned, advising owners of corporations to make residence determinations with the advice of an experienced tax lawyer.