The Canadian manufacturing industry is facing significant business and structural challenges that have seen their level of importance relative to other sectors in the economy, such as services, fall. Over the last several decades, the importance of manufacturing, as a percentage of GDP has steadily declined. This fall is do, in part, to changing trade patterns which have witnessed manufacturing entities relocate all or part of their manufacturing activities to lower cost countries such as Mexico and China.
The pressure on the Canadian manufacturing industry has also increased due, in part, to the weakening U.S. economy and the strengthening of the Canadian dollar. Theses two factors have served to further reduce demand for Canadian produced goods into Canada's most important market. A stronger Canadian dollar makes exports more expensive, while a relatively weak American economy serves to further reduce demand for Canadian produced goods or services.1 In response to a weakening U.S. economy, the Bank of Canada has acted with changes in its monetary stance. In December, 2007, the Bank of Canada cut its key interest rate by a quarter of a percentage point, citing the increased risks to Canada's economy from the weakness of the U.S. economy. It was the first cut in the central bank's key rate in more than 3½ years.2 A further quarter of a percentage rate cut was made in January 2008.
Recently, there has been calls for the Bank of Canada to step up its interest rate activity to further weaken the value of the Canadian dollar in hopes of improving the competitiveness of the Canadian manufacturing sector. However, such a request is likely to fall on deaf ears. Firstly, the Bank of Canada has a clear mandate to keep (core) inflation in check as their primary policy objective. Any action taken to weaken the dollar will need to not increase inflationary expectations. It is the view of the central bank that continued weakening of the dollar would only serve to increase inflation, while not serving to increase economic activity over the long run.
Secondly, the strength or weakness of the Canadian dollar may be beyond the control of the Bank of Canada, especially over the long run. A strong commodities sector in Canada has resulted in a steady increase in the demand for Canadian dollars, which has kept the value of the dollar relatively strong. Consequently, the value of the Canadian dollar will likely remain high, all other things constant, as long as demand for Canada's resources remain high.
Canadian manufacturing entities must, therefore, do more to help their competiveness by seeking remedies that do not involve actions by the federal government. One issue that comes to mind involves looking at the Canada-Barbados tax treaty (the "Treaty")3. While locating in Barbados has clear advantages of lower tax rates and thus improved profitability levels, doing so must be done in such a way that key requirements set out in the Treaty and Barbados legislation are met.
The establishment of an International Business Company ("IBC") in Barbados by a Canadian corporation is one mechanism which can bring about significant tax advantages for a Canadian manufacturing corporation. This article will attempt to list those benefits, as well as the requirements that Canadian manufacturers must comply with to take advantage of this opportunity.
IBCs: What are they?
An IBC is a vehicle used for offshore operations in Barbados that is created under the International Business Companies Act, 1991-244 (the "IBC Act"), under the Laws of Barbados. A company may obtain IBC designation if it is resident in Barbados (meaning incorporated or registered under the laws of Barbados5), and carries on, or intends to carry on, the business of international manufacturing or international trade and commerce from within Barbados.6
International manufacturing is defined as the business of making, processing, preparing or packaging within Barbados any product which is exclusively for export7.
International trade and commerce includes (1) the business of being a broker, agent, dealer, buyer or seller within Barbados of goods existing outside Barbados, (2) selling services to or for persons residing outside Barbados, (3) providing a prescribed service for a company carrying on an international business8, and, subject to the IBC Act, any other business carried on from Barbados.
Numerous benefits exist for Canadian entities that wish to establish an IBC.
The Treaty has the goal of avoiding double taxation has the goal of avoiding double taxation. This treaty allows for dividends paid out of the active business income of a foreign affiliate operating in Barbados to be fully deductible in the determination of taxable income of a recipient Canadian resident corporation9.
IBCs pay tax at low marginal rates. The current rates are as follows10:
(a) 2.5 per cent on all profits and gains up to $10,000,000;
(b) 2 per cent on all profits and gains exceeding $10,000,000, but not exceeding $20,000,000;
(c) 1.5 per cent on all profits and gains exceeding $20,000,000 but not exceeding $30,000,000;
(d) 1 per cent on all profits and gains in excess of $30,000,000.
An IBC may elect to take a credit in respect of taxes paid to a country other than Barbados, provided such an election does not reduce tax payable in Barbados to a rate less than one percent of the profits and gains of the company in any income year11.
All dividends, royalties, interest, fees, management fees paid or deemed to be paid by an IBC to a company carrying on an international business, or to a person residing outside Barbados, are exempt from income tax in Barbados.12 Additionally, an IBC need not withhold any portion of these payments or other income paid or deemed to be paid by an IBC to a person who is not a resident in Barbados, or who, if a resident, carries on an international business.13
No tax, or duty will be levied on an IBC, its shareholders or transferees in respect of any transfer of any securities or assets of the IBC, other than a transfer of certain proscribed taxable assets, to a person who is not a resident in Barbados.14
Other benefits of IBC status include:
- An IBC may keep its books, records, and financial statements in a foreign currency.15
- An IBC is exempt from paying any direct tax on its profits and gains in respect of an income year.16
- An IBC may import materials and equipment necessary for the IBC to carry on its international business free of customs duty.17
In order for a Canadian corporation to receive dividends from a foreign affiliate IBC free of Canadian tax, certain preconditions must be met.
Firstly, it is important that an IBC is not deemed to be a resident of Canada, and therefore subject to tax in Canada on its worldwide income. Having the central management and control of the IBC established in Barbados reduces the likelihood of the IBC being deemed to be a Canadian resident. A majority of non-residents of Canada should be appointed to the Board of Directors of the IBC, and annual meetings of the Board should be held in Barbados. The daily business of the IBC must not be conducted from or controlled from Canada.
It is also important that the IBC not carry on any business in Canada, as any profits from this would be subject to Canadian income tax. The IBC should not have employees in Canada, nor should it solicit orders or offer anything for sale in Canada through an employee or agent.
Finally, the IBC must not be regarded as a mere agent of its Canadian shareholder or as a sham. The IBC must have substance in order to prevent the Canada Revenue Agency from looking through its corporate structure and levelling Canadian tax upon it. The IBC must perform legitimate business functions in Barbados, and be regarded as an IBC in both form and substance.
The Canadian manufacturing industry has faced significant pressures relating to a strong Canadian dollar and a weakening U.S. economy. The Bank of Canada is unlikely to improve the situation by weakening Canadian exchange rates sufficiently to make Canadian manufacturers more competitive, especially over the long run. Canadian manufacturers should work to improve their level of competitiveness from an after tax perspective, by locating some of their business activities in Barbados, thus taking advantage of reduced tax rates. While locating to Barbados will require Canadian businesses to meet the requirements set out in the Treaty and Barbados legislation, doing so will improve its level of competitiveness within the global economy.
1. Canadian GDP equals Consumption plus Investment plus Government Spending plus Net Exports. A reduction in consumer confidence in the United States, results in U.S. consumers demanding fewer Canadian produced goods and services. This may be reflected by U.S. consumers demanding fewer exports being shipped from Canada, which can result in the demand for, and therefore profits earned on, Canadian produced products to fall.
2. CBC News.
3. Agreement Between Canada and Barbados for the Avoidance of Double taxation and the prevention of Fiscal Evasion with Respect to Taxes on Income and on Capital, Part XXV at s. 1(b) (Canada Barbados Treaty).
4. 1991-24. (International Business Companies Act)
5. Ibid. s. 3(2)
6. Ibid. s. 7(1).
7. Ibid. s. 4.
8. Ibid. s. 6(1).
9. Canadian Barbados Treaty, supra note 3, s 1(b)
10. International Business Corporations Act, supra note 4, s. 10(1).
11. Ibid. s. 10(2).
12. Ibid. s. 13(1).
13. Ibid. s. 14.
14. Ibid. s. 15(1)
15. Ibid. s. 17.
16. Ibid. s. 11.
17. Ibid. s. 20(1).
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.