US Business Entering Canada: Branch or Subsidiary?

Does a US business need a Canadian company to sell or work in Canada?

No Canadian company is required just to have Canadian customers. Ask separately whether the US corporation carries on business in Canada (a T2 filing question), has a Canadian permanent establishment under the treaty (a business-profit tax question), and must register to do business in a province.

A non-resident corporation that carries on business in Canada files a T2 return even when a treaty exempts its profits from Canadian income tax. Canada's Income Tax Act, section 253 extends “carrying on business” to activities such as making goods in Canada or soliciting orders there through an agent, even if contracts are completed elsewhere. Merely having Canadian customers does not, by itself, settle the question; gather where salespeople, workers, inventory and contract authority are located before deciding (CRA: T2 filing).

How do a branch and a subsidiary compare for tax?

A branch is the US business operating in Canada; a subsidiary is a separate Canadian corporation that can sign contracts, employ staff and hold assets in its own name (Corporations Canada). Decide which entity should take on those local obligations, then compare Canadian and US tax, profit transfers and annual filings. Neither structure is automatically cheaper.

The tax rows below use a US C corporation as the parent. Partnerships, S corporations and LLCs can compare the same legal structures, but their Canadian and US taxpayers may differ; see the entity section below.

The treaty generally lets Canada tax a US resident's business profits only to the extent attributable to a Canadian permanent establishment. That does not erase a T2 filing triggered by carrying on business in Canada (treaty, Article VII; CRA: T2 filing). Treaty access also depends on who is entitled to its benefits, including the treaty's limitation-on-benefits rules.

When does a US business have a permanent establishment in Canada?

A US treaty resident generally has a Canadian permanent establishment when it carries on business through a fixed place there. The treaty also covers certain agents, construction work and sustained services, so a lease is not the only way to create one (treaty, Article V).

A fixed place or stock used solely to store, display or deliver the US business's goods is excluded; other activities at that place can change the result. A Canadian subsidiary does not automatically become its US parent's permanent establishment merely because the parent controls it (treaty, Article V). Count days across a rolling twelve-month period, and document who can bind the US business to contracts.

How is a Canadian branch taxed, including branch tax?

When a treaty-eligible US corporation has a Canadian permanent establishment, Canada may tax profits attributable to it. Canada can also charge Part XIV branch tax on Canadian earnings after adjustments for income tax and qualifying Canadian reinvestment. Wiring cash to the US does not itself determine the tax (treaty, Articles VII and X(6); Income Tax Act, section 219).

The branch files a T2 in Canadian dollars. It attaches Schedule 97 for non-resident information, Schedule 91 when claiming a treaty exemption, and Schedule 20, which also tracks the treaty allowance, whenever it earned income from a business carried on in Canada (CRA: non-resident corporation filing; CRA: Schedule 20). A treaty-exempt corporation can still face a late-filing penalty if it misses its T2 (Income Tax Act, section 162(2.1)).

How is a Canadian subsidiary taxed, and why is it not a CCPC?

A Canadian subsidiary files its own T2 every year, including years without tax payable. If non-residents control it, it is not a Canadian-controlled private corporation (CCPC), so it cannot use the small business deduction reserved for eligible CCPCs (CRA: T2 filing; CRA: corporation type). See How corporations are taxed for federal and provincial rates.

The subsidiary's fees, interest and other dealings with its US parent need supportable pricing. Related-party transactions can require Form T106, and parent loans can face thin-capitalization and excessive-interest limits (Income Tax Act, sections 233.1, 247, 18 and 18.2). Record intercompany agreements, invoices and loan terms from the start. See Filing a corporate return for the T2 process.

How do profits get back to the US from each option?

A branch can move its own cash to the US head office without declaring a dividend, although branch tax may apply to Canadian earnings. A subsidiary can pay a dividend to its US shareholder, which can require Canadian withholding even after the subsidiary pays income tax (Income Tax Act, section 219; treaty, Article X).

For a treaty-eligible US company that beneficially owns at least 10% of the Canadian company's voting stock, the treaty caps Canadian dividend tax at 5%. The treaty ceiling in other cases is 15%. These are ceilings, not a promise that every payment qualifies (treaty, Article X(2)). Interest, service fees and royalties have different rules; do not treat them as interchangeable ways to extract profit.

How does the US tax each option?

For a US corporation, Canadian branch income generally remains in its US tax results as it is earned; eligible Canadian income tax may be considered for a US foreign tax credit, subject to separate-category and other limits. If the Canadian operation is a foreign branch under IRS rules, its direct US operator generally files Form 8858. A US corporation uses Form 1118 to claim any allowable corporate foreign tax credit (IRS: Form 8858; IRS: Form 1118).

If the branch is a treaty permanent establishment, its net loss is a dual consolidated loss: it generally cannot offset the corporation's other US income unless a domestic use agreement, signed by the person who signs the return, is attached to the timely filed return for the loss year. Certain events through the fifth following tax year, such as disposing of half or more of the branch's assets, then trigger recapture with interest (Treasury regulations, sections 1.1503(d)-1, -4 and -6).

Owning a Canadian subsidiary instead brings foreign-corporation reporting, often Form 5471. A controlled foreign corporation can cause a US owner to include income before any dividend under section 951A or other rules. A US C corporation may qualify for the section 245A deduction on the foreign-source portion of a later dividend, subject to its conditions; that deduction is for domestic corporations, not individuals, and Canadian tax withheld on a dividend it covers is neither creditable nor deductible in the US (IRS: Form 5471; US Code, sections 951A and 245A). See US owners of foreign companies for ownership forms and current-income rules.

What if the US business is an LLC or an S corporation?

Confirm who each country treats as earning the income before comparing structures. Canada generally treats a US LLC as a corporation even when the US taxes its members directly. An LLC operating directly in Canada can therefore file a non-resident T2 and face Part XIV branch tax. Treaty relief under Article IV(6) depends on each qualifying US-resident member; the CRA's archived guidance says the treaty's lower company branch-tax ceiling does not cover an individual member's share (CRA: treaty circular, paragraphs 88–89; CRA: LLC branch example).

The US generally taxes S corporation income to its shareholders, but Canada does not treat the S corporation as transparent. If it operates directly in Canada, check the non-resident corporate T2 and branch-tax rules as well as each shareholder's US reporting and treaty entitlement. Foreign-company inclusions are generally determined at shareholder level unless the S corporation has elected, under proposed regulation section 1.958-1(e)(2), to be treated as owning the foreign company's stock (CRA: treaty circular, paragraph 111; IRS: S corporation international schedule instructions).

A US partnership also needs a partner-level analysis. Canada generally taxes partnership operating results to the partners rather than the partnership; a Canadian business can separately require a T5013 information return under the CRA's filing tests (CRA: Partnership). Part XIV branch tax is a tax on non-resident corporations, so do not apply the corporate branch table to individual partners.

What is the trap with a Canadian unlimited liability company?

A Canadian unlimited liability company (ULC) can be a separate subsidiary in Canada while the US treats it as part of its owner for income tax. A payment to the owner may then count as a dividend in Canada but not in the US. Article IV(7)(b) can deny the treaty's reduced Canadian dividend rate (treaty, Article IV(7)(b); CRA: Technical News No. 44). The CRA describes exceptions where US treatment is equivalent, so the result turns on the actual payment and classification. Review the ULC before forming it or paying its owner.

US rules treat other Canadian corporations as corporations, with no choice. A one-owner ULC is disregarded by default unless it elects corporate treatment on Form 8832, signed by the owner or an authorized officer and effective no more than 75 days before it is filed (Treasury regulations, sections 301.7701-2 and -3). A disregarded ULC is reported on Form 8858, not Form 5471 (IRS: Form 8858).

Which registrations and yearly returns come with each option?

Start with the place of operations and the legal entity that will sign contracts and employ people. Tax registration, corporate registration and annual tax returns are separate duties.

A T2 is due within six months after the corporation's tax year ends, and any Form T106 is due the same day (CRA: T2 filing date; section 233.1; see foreign reporting). Quebec and Alberta run their own corporate income taxes (CRA: establishing a business in Canada): unless exempt, a corporation with an Alberta permanent establishment at any time in the year files an Alberta return (Alberta: corporate income tax), and Quebec has its own filing test (Filing a corporate return). GST/HST registration, provincial sales tax and Canadian payroll each have their own tests. Canadian payers may withhold from fees for services performed in Canada; see withholding on services.

Example

Illustrative only. A US C corporation expects C$600,000 of Canadian sales, C$400,000 of Canadian operating costs and C$200,000 of profit. It plans to keep a Canadian office and hire staff there. The office points toward a treaty permanent establishment if the US corporation operates it. A branch would report the attributable profit on a non-resident T2. After Canadian income tax, its Part XIV earnings would be under C$200,000, inside the treaty's C$500,000 cumulative allowance if the corporation qualifies and no associated company has used it, so treaty branch tax would be nil that year; later years draw down the rest. Moving cash to US headquarters would not be a dividend.

If the group instead incorporates a Canadian subsidiary, that company would report its own C$200,000 profit on a resident T2. A later dividend to the US parent would be a separate Canadian withholding event. The figures do not show which option costs less: branch tax, provincial tax, US inclusions and credits, financing, and the timing of dividends could change the answer.

Different for you?

The answer changes when the owner's tax classification, Canadian activities or profit transfers change. Check the situation that applies before forming an entity or moving an existing business.

• You will send people to Canadian customers without an office: document their days, projects and contract authority; the services permanent-establishment test and withholding on services can still matter.
• The US company's management will move to Canada: corporate residence can change the tax result (CRA: corporate residence); get cross-border tax review before relocating decision-makers.
• You are a US citizen living in Canada who will own the Canadian company: personal US filing can change the comparison; see American owners of Canadian corporations.
• Your Canadian subsidiary will borrow from, license from or buy services from its US parent: pricing, interest limits and withholding need cross-border tax review before the agreements are signed.
• Your US owner is an LLC, S corporation or partnership: identify the taxpayers on both sides before claiming treaty relief; get cross-border tax review.
• You are choosing a ULC or moving an existing branch into a subsidiary: the payment or asset transfer can change tax in both countries, including US recapture of branch losses already deducted (US Code, section 91); get cross-border tax review before acting.
• You will buy an existing Canadian corporation instead of forming one: the acquisition of control ends its tax year, limits the use of its past losses and ends any CCPC status (Income Tax Act, sections 249, 251.2 and 111; CRA: corporation type); get cross-border tax review before closing.
• You need rates or return mechanics: see Canadian corporate tax rates, T2 filing and US foreign-company filings.

Gather the US entity's tax classification and owners, Canadian contracts and work locations, expected revenue and expenses, employee plans, proposed parent funding, and the dates profits may be sent to the US.