Canadian Corporation With a US Co-Founder: Where to Incorporate

The split of control decides most of the answer. A Canadian corporation is a Canadian-controlled private corporation (CCPC) only if non-residents do not control it (section 125(7)). With a US-resident founder holding half the shares or less, and no other non-resident shareholders, a Canadian corporation can keep the 9% federal small business rate, the 35% refundable SR&ED credit and the Canadian founder's capital gains exemption. Above half, all three are gone, and the company becomes a controlled foreign corporation (CFC) for the US founder.

At any split, the US founder has US filings for a Canadian company: Form 5471 for the year the shares are acquired (at a stake of 10% or more), a yearly passive foreign investment company (PFIC) check, and often FBAR and Form 8938. What makes a case not simple: options or vetoes that shift control, a founder who is a US citizen living in Canada, a US founder who signs contracts from the US, and raised cash sitting in the bank. Gather the cap table, the shareholders' agreement, each founder's residence and citizenship, and where each founder works.

One founder in Canada, one in the US: Canadian corporation, Delaware or both?

A Canadian corporation favours the Canadian founder; a Delaware corporation favours the US founder and US investors. Each choice gives one founder a tax benefit on exit and the other a filing load.

QSBS needs stock of a "domestic corporation" (26 U.S.C. 1202), so a US founder in a Canadian corporation gives it up; in a Delaware corporation, up to 100% of the gain can be excluded after five years (small business stock exclusion). The capital gains exemption needs shares of a CCPC (section 110.6). If you pick Delaware, the Canadian founder's filings and the risk that Canada taxes the company are in Canadian owner of a US corporation. If both founders live in Canada and US funds are coming, see Delaware or Canadian corporation for a startup.

A corporation incorporated in Canada is resident in Canada wherever its directors meet (section 250(4)), and the US treats it as a foreign corporation. A US director does not change either answer.

Does a US co-founder stop our Canadian corporation from being a CCPC?

Not at half or less, unless something else gives non-residents control. Section 125(7) has two control tests, and section 251(5)(b) adds a third twist:

• Control by non-residents. A corporation "controlled, directly or indirectly in any manner whatever" by non-residents is not a CCPC. That phrase covers control in fact: any influence that, if used, would control the company (section 256(5.1)). A casting vote, a board majority or a veto over ordinary business can tip a half-and-half company.
• All non-resident shares as one holder. If every share owned by non-residents were owned by one person and that person would control the company, it is not a CCPC. A later US angel's shares add to the US founder's.
• Options and rights. A right to acquire shares, now or later, counts as if exercised (section 251(5)(b)). A US founder at half with an option for more is treated as already holding more.

Residence counts, not citizenship. A US citizen living in Canada is a resident for this test, so the company can be a CCPC and a CFC at once; see American owners of Canadian corporations. When US funds later take control, the tax year ends early; see losing CCPC status to foreign investors.

What does the US founder file each year for a Canadian corporation?

The US founder files Form 5471 in the year the shares are acquired, and every year once the company is a CFC. Other forms depend on PFIC status, account signing and the value of the shares.

The Form 5471 instructions set the categories; the penalty for a missing form starts at US$10,000. Category details, penalties and relief are in US owners of foreign companies.

FBAR applies to signing authority alone, and a founder owning more than 50% of the company also has a financial interest in its accounts (IRS FBAR page; 31 CFR 1010.350). Shares reported on a timely Form 5471 or 8621 still count toward the Form 8938 threshold but need not be listed again (Form 8938 instructions).

Could the Canadian company be a CFC or a PFIC for the US founder?

A CFC needs US shareholders holding more than half; a PFIC needs only passive income or passive assets. A US founder at exactly half avoids CFC status but can still hold PFIC stock.

When is the Canadian company a CFC?

A foreign corporation is a CFC when US shareholders own more than 50% of its vote or value (26 U.S.C. 957). A US shareholder is a US person owning 10% or more, counting shares of family members under the attribution rules. Add up every US shareholder: a US founder at half plus a US angel at 10% makes a CFC, and so does a Canadian co-founder who is a US citizen.

Can a pre-revenue startup be a PFIC?

Yes. A foreign corporation is a PFIC when 75% or more of its gross income is passive, or 50% or more of its assets produce passive income (26 U.S.C. 1297). A startup whose only income is interest on raised cash meets the income test, and the cash counts toward the asset test.

• Start-up exception. It covers only the first year with gross income, and only if the company is not a PFIC in either of the next two years (26 U.S.C. 1298(b)(2)). Interest is gross income, so the clock can start before the first sale.
• No election. A gain on sale is treated as an excess distribution and spread over the years held: the part for earlier PFIC years is taxed at the highest rate with an interest charge, the rest as ordinary income (Form 8621 instructions).
• QEF election. The founder includes a share of the company's ordinary earnings and net capital gain each year, which is nothing in a loss year, but only with a PFIC Annual Information Statement from the company. The founder makes it on Form 8621 by the due date, including extensions, of the return for the first year it applies.
• Dividends. A dividend from a company that is a PFIC in the year paid or the year before is not a qualified dividend (26 U.S.C. 1(h)(11)(C)(iii)).

A US shareholder of a CFC is generally outside the PFIC rules for that stock while the company is a CFC.

What did the 2025 US tax law change for a US owner of a foreign company?

Public Law 119-21 changed the CFC rules for tax years beginning after December 31, 2025, counted on the foreign corporation's tax year for the two ownership rules (Public Law 119-21, sections 70323, 70353 and 70354):

• GILTI became net CFC tested income, and the tax-free return on tangible assets was repealed. A startup with few tangible assets loses little from the repeal.
• Pro rata share. A US shareholder who owns CFC stock on any day of the year includes subpart F income for the period owned, not only the owner on the last day.
• Downward attribution limit restored. A US person is again not treated as owning stock held by a foreign person. This matters mostly for groups with a foreign parent, not for two individual founders.

The corporate deduction and credit percentages for net CFC tested income reach an individual only through a section 962 election; see US owners of foreign companies.

How does each founder get paid from a Canadian corporation, and who withholds?

Pay follows where each founder works; dividends follow where each founder lives.

If the company under-withholds a dividend, it owes the shortfall (section 215(6)), and its directors, a US founder on the board included, can be personally liable for Canadian withholdings it fails to deduct or remit, until two years after they leave the board (section 227.1). On US payroll, a person responsible for paying over withheld tax who willfully fails can owe it personally (26 U.S.C. 6672).

Canada taxes a non-resident's employment income only for duties performed in Canada (section 115(1)(a)(i)). Days the US founder works in Canada change that. US payroll accounts and state rules are in hiring an employee across the border; treaty forms and NR4 slips are in non-resident owners of a Canadian corporation.

A US founder who works from a US office, or habitually signs contracts for the company in the US, can give it a US permanent establishment under treaty Article V(1) and V(5) (treaty). Then the Canadian corporation may owe US tax and a US return. The treaty covers only federal income taxes (Article II(2)(b)), so a founder working in a state can bring state filings even without a permanent establishment; see Canadian corporation US tax return.

What changes if the US founder holds more than half the shares?

The company stops being a CCPC and becomes a CFC. Both sides lose something:

• Canadian tax. No small business deduction, so active business income is taxed at the 15% federal general rate plus the provincial rate. SR&ED drops to the 15% non-refundable credit, usable only against tax (section 127). The Canadian founder loses the capital gains exemption.
• US tax for the founder. Form 5471 every year with the company's financial statements. Interest on raised cash is generally subpart F income, but subpart F income cannot exceed current earnings and profits, so a loss year usually produces no inclusion (26 U.S.C. 952(c)); a later profitable year can recapture it. Once profitable, net CFC tested income is included each year unless an exclusion applies.
• High-tax exclusion. A non-CCPC paying the general rate may pass the 18.9% high-tax test; whether it does depends on the province and the year's numbers. See US owners of foreign companies.

What should we decide before the shares are issued?

Settle control and paperwork before anyone signs a share subscription; both are hard to undo after.

1. The split, counting every right. Options, warrants and convertible instruments count toward control in Canada. Plan where the US founder lands after the first round, not just at founding.
2. Board and vetoes. Who appoints the board, who has a casting vote, and what needs the US founder's consent.
3. Who is a US person. Citizenship and green cards of every founder and family shareholder.
4. Where each founder works and who signs contracts. This sets payroll and the US permanent establishment risk.
5. Information rights. Put the company's duty to give financial statements for Form 5471 and a PFIC Annual Information Statement in the shareholders' agreement.
6. Vesting. A US founder with vesting shares has 30 days from issuance to file an 83(b) election (26 U.S.C. 83(b)(2)); see founder shares that vest.
7. Bank signers. A US founder signing on Canadian accounts brings FBAR filings.

Example

All figures are illustrative and in Canadian dollars unless marked US dollars. Federal tax only.

Half and half: Toronto and Seattle

• An Ontario corporation issues 50% of its shares to a Toronto founder and 50% to a Seattle founder, with an even board and no casting vote. It is a CCPC; the Seattle founder is not a CFC owner.
• In the issuance year, the Seattle founder files Form 5471 (Category 3, and Category 2 as a director) with Form 1040.
• The company then raises CA$2,000,000 from Canadian angels and earns CA$60,000 of interest with no sales. All its gross income is passive, so it is a PFIC unless the start-up exception holds, which needs the company to pass neither PFIC test in either of the next two years. The Seattle founder decides on a QEF election and asks the company for an annual information statement.

60/40 to the US founder

• The Seattle founder holds 60%. The company is not a CCPC and is a CFC.
• It pays CA$500,000 of qualifying SR&ED salaries. As a CCPC it would get 35%, CA$175,000, in cash. Now it gets 15%, CA$75,000, non-refundable and carried forward until it has tax to offset.
• The Seattle founder files Form 5471 every year. The interest on its cash is subpart F income, but in loss years the earnings-and-profits limit keeps the inclusion at zero.

Paying the Seattle founder

• In the half-and-half company, the Canadian corporation pays the Seattle founder US$120,000 for work done in Seattle. It runs US payroll and withholds no Canadian tax.
• It also pays a CA$20,000 dividend. The company withholds 15% under the treaty, CA$3,000, instead of 25% (CA$5,000), remits it and issues an NR4 slip.
• The Toronto founder takes CA$100,000 salary through Canadian payroll, with no EI because she controls 50% of the votes.

Different for you?

• Both founders live in Canada and US funds are coming: see Delaware or Canadian corporation for a startup.
• The Canadian-resident founder is a US citizen: the CFC and small business rate interaction is in American owners of Canadian corporations.
• You chose Delaware: see Canadian owner of a US corporation.
• US investors are about to take control: see losing CCPC status to foreign investors, or moving a Canadian startup under a Delaware parent if they want a flip.
• The US founder missed Form 5471 or 8621 filings: see US owners of foreign companies.
• Two countries, a CCPC test the cap table can end, and US forms each year: get cross-border tax help before the shares are issued.