PLEASE NOTE: THIS INFORMATION WAS ORIGINALLY SUBMITTED BY COOPERS & LYBRAND, CANADA
A corporation resident in Canada will currently pay income tax on its worldwide income in the range of 25% to 46%. The exact rate will depend on the type of its activities and in which Canadian province or territory it is resident. One particular type of corporation is subject to only a 25% income tax that is totally refundable when income is paid out in dividends to its non-resident shareholders. Such a company, known as a non-resident-owned investment corporation ("NRO"), if properly structured, ultimately incurs no Canadian income tax. NROs can be very useful to non-residents when investing in Canadian corporations. The balance of this article will briefly outline some of the NRO requirements, uses and advantages.
In simple terms, an NRO is a Canadian corporation owned by non-residents that, effectively, is taxed as if it were a non-resident of Canada. It pays a refundable federal tax of 25% on its taxable income (excluding certain capital gains). This tax is refunded as the NRO pays or is deemed to pay dividends to its shareholders. The foreign shareholders are subject to a withholding tax on the dividends. Under Canadian domestic law, the dividend withholding rate is 25%. However, in many cases, this rate is significantly reduced under terms of Canada's international tax treaties. For example, a reduction to 10% can apply where a shareholder owning at least 10% of the NRO is resident in the United States.
With the exception of Ontario and Quebec, which impose taxes on gains from the sale of certain assets, no provincial income taxes are payable by an NRO. An NRO is not subject to the federal large corporations capital tax and it can be structured to minimise or eliminate provincial capital taxes.
An NRO is a Canadian incorporated company that meets a set of specific requirements, including the following:
- All shares and debt of an NRO must be beneficially owned by non-residents of Canada or other NROs.
- An NRO must elect to be taxed as an NRO no later than 90 days after the beginning of its first tax year. This election can subsequently be revoked by the company, if desired.
- An NRO can only derive its income from specified sources, principally passive income sources. This can include interest on the debt of a related Canadian operating company.
- Not more than 10% of an NRO's gross revenue for each taxation year can be in the form of rents, hire of chattels, charterparty fees or related remunerations.
- The NRO's "principal business" in each taxation year cannot be from the making of loans or trading and dealing in securities.
The term "principal business" is interpreted to mean its main activity. Theoretically, it may be argued that a company that made one loan and had no other source of income has a "principal business" of making loans during the year in question. Therefore, an NRO is often structured so that it purchases an existing debt so that it clearly will not lend any money, but rather be a purchaser of debt. By structuring the NRO's investment in this manner, it is arguable that the NRO has acquired a loan receivable (i.e. is not the original lender), and thus is not in the money lending business. An advance tax ruling published by Revenue Canada confirms that the acquisition of a loan by an NRO from a third-party bank should not cause the NRO to be engaged in the principal business of making loans, as prohibited by the NRO requirements.
This leads to a planning technique for a non-resident who wishes to invest or expand operations in Canada. Such a party could invest in the capital of an NRO which would purchase the debt of a related Canadian operating company or acquisition target.
If properly structured, this will enable interest deducted by the Canadian debtor at its higher corporate tax rate to be taxed at the NRO's lower rate. The NRO's tax is subsequently refunded when the NRO pays a taxable dividend to the non-resident. As the dividend is subject to non-resident withholding tax, this planning technique enables the effective Canadian tax rate to be reduced and interest payments to the non-resident to be converted to dividends. An NRO is therefore useful as a "mixer" corporation to combine interest and dividends into the same base for calculating foreign tax credits in various foreign tax jurisdictions. In some cases, the NRO's tax can be recovered by the payment of a stock dividend, the receipt of which may not be subject to tax in the shareholder's home country.
Where the non-resident has borrowed to purchase NRO share capital, a "double dip" or double interest deduction may be possible. One interest deduction could be claimed by the non-resident NRO shareholder in its home country, and another interest deduction by the Canadian operating company.
The information provided herein is for general guidance on matters of interest only. The application and impact of laws, regulations and administrative practices can vary widely, based on the specific facts involved. In addition, laws, regulations and administrative practices are continually being revised. Accordingly, this information is not intended to constitute legal, accounting, tax, investment or other professional advice or service.
While every effort has been made to ensure the information provided herein is accurate and timely, no decision should be made or action taken on the basis of this information without first consulting a Coopers & Lybrand professional. Should you have any questions concerning the information provided herein or require specific advice, please contact your Coopers & Lybrand advisor, or:
David W. Steele PricewaterhouseCoopers 145 King Street West Toronto, Ontario M5H 1V8 Canada Fax: 1-416-941-8415 E-mail: Click Contact Link
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