Canada: Canadian Budget Implications For U.S./Foreign VCs

Last Updated: April 10 2007
Article by Thomas Houston and Andrea C. Johnson

On March 19, 2007, Canada’s minority Conservative government announced the 2007 Budget, which includes a number of tax measures intended to give technology companies that are incorporated in Canada greater access to international sources of capital.

Canadian founders of technology start-ups face a difficult choice when deciding whether to incorporate in Canada or the United States. On the one hand, there are numerous tax advantages associated with carrying on business as a Canadian-controlled private corporation (CCPC), which can only be incorporated in Canada. For example, CCPCs are eligible for lower tax rates on certain income; CCPCs are eligible to receive investment tax credits (ITCs) for scientific research and experimental development (SRED) at a favourable rate and on a refundable basis; Canadian founders may be able to take advantage of the lifetime capital gains exemption on the sale of shares of a CCPC (increased in the Budget from $500,000 to $750,000); and certain tax deferrals and deductions are only available for stock options granted by a CCPC. On the other hand, U.S. and other non-resident investors can experience tax problems on an exit from a Canadian-incorporated company. These tax issues have meant that many U.S. venture capitalists will not consider a direct investment in a Canadian corporation. As a result, some of the most promising Canadian technology companies have either incorporated in the U.S. in the first instance, or have reorganized as U.S. corporations, in order to secure U.S. venture capital investment.

What has been addressed?

The Budget proposes to address some of the more serious tax issues encountered by U.S. and other non-resident investors in Canadian corporations, as detailed below.

1. LLCs under the Canada-U.S. Tax Treaty

Many U.S.-based venture capital funds are structured as limited liability companies (LLCs). Currently, the Canada Revenue Agency (CRA) does not recognize LLCs as U.S. residents for the purposes of the Canada-U.S. Income Tax Convention (the "Treaty"), because of the status of such corporations as disregarded entities for U.S. tax purposes. As a result, any gain (or loss) from the sale of shares of a Canadian corporation by a LLC is fully taxable in Canada. For this reason, a direct investment by a LLC in a Canadian corporation is not tax effective for the LLC or its shareholders, and LLCs have been forced to either decline the investment or put in place costly off-shore holding company structures as a "work around". The Budget proposes to extend Treaty benefits to LLCs. However, the implementation of this proposal depends on finalizing treaty negotiations with the United States, currently expected to occur in the near future with effect likely to be in 2008.

2. Elimination of Withholding Tax on Interest

A Canadian corporation is required to withhold and remit withholding tax on interest payable to non resident lenders. The withholding tax rate is either 10% or 25%, depending on whether the payee is covered by the Treaty. The Budget proposes to eliminate non-resident withholding tax on interest on all arm’s length payments of interest to non-residents and eventually to non-arm’s length U.S. treaty residents. This is good news for Canadian-incorporated technology companies that want to access the well-established U.S. venture debt market without having to agree to tax gross-ups typically required by non-resident lenders. In addition, this measure will make it more attractive for U.S. venture capitalists to finance Canadian corporations through bridge debt and other debt instruments. Timing of the elimination of non-resident withholding tax vis-ŕ-vis U.S. lenders depends on finalizing treaty negotiations with the United States. This measure will only be effective for the calendar year following ratification by the two countries (making 2008 the earliest possible date for implementation). The proposal to eliminate withholding on non-arm’s length interest is expected to be implemented over a 3-year transition period commencing with the implementation of the Treaty.

3. Public Offerings on AIM

Some Canadian technology companies have recently had success in raising substantial capital on the Alternative Investment Market (AIM) of the London Stock Exchange plc. However, AIM is not a "prescribed stock exchange" for the purposes of the Income Tax Act (Canada) (the "ITA"). This means that the shares of a Canadian-incorporated company are "taxable Canadian property" for the purposes of the ITA, and that shareholders not resident in Canada will be subject to Canadian capital gains tax when the shares are traded (unless a treaty exemption is available). Non-resident shareholders will also be required to obtain a clearance certificate from CRA prior to disposing of the shares. These factors have forced some Canadian technology companies to employ complex "work-arounds" (such as reorganizing as a mutual fund corporation) if they wish to undertake an AIM-only IPO. The Budget has proposed a wholesale rewrite of the concept of "prescribed stock exchange" which means that a Canadian corporation will be able to go public on AIM without extraordinary tax structuring. This proposal will be effective immediately on Royal Assent to the Budget. However, as we currently have a minority government in Canada, there can be no assurance when or if Royal Assent will be obtained.

4. Other Announcements

The Budget also included other positive developments for the Canadian technology sector. For example, the Budget included commentary that the federal government will, over the coming year, identify opportunities to improve the SRED tax credit program to further encourage R&D within the business sector in Canada. However, investors are reminded that Canada is currently in a fairly volatile minority government situation and that there can be no guarantee that the government will not be forced to call an election before the proposals described above can be implemented.

What was not addressed?

Unfortunately, the Budget failed to address certain tax issues that have driven many Canadian start-up companies to incorporate or reorganize in the U.S.:

1. Non-Resident Withholding Tax on a Sale of Private Company Shares

Currently, 25% of the proceeds of disposition of the sale of shares of a private Canadian corporation by a U.S. or other non-resident seller must be withheld by the purchaser and remitted to CRA to cover the seller’s tax liability. The purchaser is only relieved of this obligation if it obtains a clearance certificate (sometimes referred to as a s. 116 certificate) from CRA. In theory, the clearance certificate is an administrative requirement only and should be available if the sale of shares is exempt from capital gains tax under the Treaty. However, in practice the withholding tax and clearance certificate requirements have created numerous problems for U.S. venture capital funds disposing of a Canadian portfolio investments. First, it can be difficult for a fund structured as a limited partnership to obtain a clearance certificate, since CRA will require detailed tax information regarding a fund’s limited partners in order to determine if a Treaty exemption is available. This can cause privacy concerns for limited partners and/or the required information may simply not be available (particularly if limited partners are themselves structured as partnerships or LLCs). Second, it has not been possible to obtain a clearance certificate at all for a seller that is LLC since these entities have not been covered by the Treaty. While the recent Budget proposals to extend Treaty coverage to LLCs will partially address this problem, we are concerned that even once this proposal is implemented that LLCs may, like limited partnerships, be required to disclose detailed tax information regarding their investors which may impair the ability to obtain a clearance certificate on a timely basis (or at all). Third, the time to process clearance certificate applications has often extended to two or three months which remains problematic for transactions which typically are required to close in a shorter time frame. Finally, in the case of a share-for-share acquisition of a portfolio company by a publicly-traded acquirer, sellers can be exposed to fluctuations in equity markets while they wait for CRA to process their clearance certificate applications.

2. No Roll-over Treatment for Canadian Shareholders

Currently, Canadian shareholders of a Canadian corporation do not receive a tax-free roll-over on a share-for-share acquisition by a U.S. acquirer. This means that a Canadian shareholder will incur a tax liability in the year of the acquisition. If the acquirer’s shares are illiquid or subject to resale restrictions, the Canadian shareholder may be in a position where he cannot sell the shares to satisfy the resulting tax liability. This issue is commonly addressed by using an exchangeable share structure, which may be costly to implement and can result in reduced liquidity for Canadian shareholders. In November 2000, CRA announced a proposal to provide roll-over treatment in a share-for-share acquisition, but to date we have not seen any action on this proposal, and this item was not addressed at all in this year's Budget.


There are of course other issues that influence where to incorporate, such as U.S. tax rules (including CFC and PFIC rules) and the stringent minority shareholder protections available under Canadian corporate statutes relative to the more permissive Delaware statute. However, if the remaining Canadian tax issues discussed above can be addressed, the new Budget proposals mean that more Canadian technology companies can be expected to incorporate in Canada and attract U.S. venture capital investment.

In summary, while impediments to direct investments in Canadian companies will continue to persist, when and if the Budget proposals described above become law, some meaningful progress will have been made to level the playing field for Canadian companies seeking U.S. or other foreign investment.

For more detailed information on these proposals please click here.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

Events from this Firm
4 Nov 2016, Seminar, Toronto, Canada

Please join us for a complimentary half-day seminar on the following topics:

  • "When “actively employed” is not enough: Employee bonus update", presented by Matthew Curtis and Chelsea Rasmussen
  • "The top 10 labour arbitration cases of the past year", presented by
18 Nov 2016, Seminar, Vancouver, Canada

Ten days following the election, join us for a discussion with Gary Doer, former Canadian Ambassador to the US, and Gordon Giffin, US Ambassador to Canada under Bill Clinton, to discuss how the new President and Congressional makeup will shape US-Canada relations for years to come.

25 Nov 2016, Seminar, Toronto, Canada

On Thursday, September 22, 2016, Dentons hosted a panel discussion about the management of liabilities and risks associated with environmental crises, including potential liabilities for directors and officers and provided insight into risk and liability techniques associated with environmental crisis management.

In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.