ANY SUCCESSFUL CANADIAN LIFE SCIENCE COMPANY will at some point need both U.S. and Canadian entities. There are a different number of factors to consider in structuring these entities. Which entity should hold the IP? Which entity should hire the employees? Which company should be the parent company, in other words, which company will investors fund? A little planning at the beginning will avoid large costs and disruption down the road.
WHERE TO HOLD THE IP?
Unless a company has or expects to have significant tax losses in the U.S., we generally (but not always) recommend that companies hold their intellectual property (including U.S. patents) outside of the U.S. due to higher U.S. corporate tax rates and the difficulty of moving IP outside of the US. later. For these reasons, Canada is generally preferable to the United States as an IP holding Jurisdiction.
Canada may soon become even more attractive, as the Canadian government is currently considering the implementation of a "patent box" regime that would set lower corporate tax rates for income earned from Intellectual property held in Canada.
WHERE TO EMPLOY?
Determining where to hire employees is the easiest Issue. Companies should hire employees in the country in which they reside. Otherwise, there will be withholding taxes levied in the country of the employer, and the employees may end up paying a higher overall tax rate than others in their jurisdiction of residence.
WHICH COMPANY SHOULD BE THE PARENT AND WHICH THE SUBSIDIARY?
The main factor to consider is whether the investors seek to invest in a Canadian or U.S. company. There is no one size fits all solution. In determining the preferred structure, a number of factors should be considered. Including but not limited to:
- Who are the likely near term and longer-term shareholders? Are they individuals or are they VCs and other institutional investors? Are they Canadian or American?
- Will these investors have geographic preferences or restrictions regarding their portfolio companies?
- What is the best jurisdiction for the tax incentives to shareholders?
Canada offers a number of provincial and federal tax credits. For example, in British Columbia, investors who are Individuals can claim a refundable tax credit of 30% of their investment amount, up to $120,000 per year. For corporate investors, the 30% credit is non-refundable, but there is no annual limit. At the federal level, Canadian residents are afforded a Lifetime Capital Gains Exemption of $971,190 per person (2023).
The U.S. also offers similar advantages. The Qualified Small Business Stock (QSBS) regime for U.S. Individuals and Trusts (along with investments by Individuals through partnerships) allows for capital gains exemptions under certain criteria. To be eligible, the Investment in a U.S.-based C corporation must be held for a minimum of 5 years, and it must be made when assets are valued at $50M or less. Eligible capital gains up to the greater of $10M USD or 10x the cost basis of the investment is exempt. This exemption is a big driver for family offices and angels, but less so for the large VC with tax exempt limited partners such as pension funds and universities.
- What government grants and other fiscal incentives are available?
Each jurisdiction offers various grant and tax incentives for the Company. Most notably, Canada offers federal and provincial Scientific Research and Experimental Development (SR&ED) credits which can provide an early-stage Canadian controlled private corporation with reimbursement for more than 50% of certain research expenses.
- Some U.S. Investors are most comfortable with Delaware
corporate law. However, Canadian corporate law is very similar, and changes to Alberta and Ontario laws have removed the requirement that 25% of directors be Canadian residents.
It is therefore important to consider these and other factors as early as possible and preferably from the get-go. If a company wishes to change its parent company from a Canadian entity to a US entity after the enterprise has real value, it can have costly tax consequences or require a complex structure to avoid such consequences.
Originally published by BIOTECanada Insights Magazine
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.
