Often the determination of what type of entity to acquire a business with is driven by the most tax efficient structure. Here we will review some of the most commonly used entities and how amounts that are extracted from a business by those entities are taxed in Canada. The most commonly used entity is the corporation. In Canada, a corporation is considered a separate legal entity from its shareholders and is taxed accordingly. Where a corporation acquires business assets and generates income from those assets, that income will be subject to corporate income tax. Where a corporation has acquired shares of a Canadian corporation, generally, dividends paid to the acquiring corporation from the Canadian corporation are deductible in calculating the acquiring corporation’s income for the year.
In recent years, the use of unlimited liability companies (ULC) has increased. ULCs are different from ordinary corporations because a ULC’s shareholders are directly liable for the ULC’s debts and liabilities. Alberta, British Columbia and Nova Scotia are jurisdictions that offer ULCs. In Canada, the ULC is taxed as a regular corporation, but in the U.S., it may be treated as a disregarded entity or a partnership depending on the number of shareholders in the ULC. The ability to be treated as “fiscally transparent” for U.S. tax purposes but as a corporation for Canadian tax purposes has increased the popularity of ULCs for Canada-U.S. cross-border transactions. However, the Canada-U.S. tax treaty has eliminated some of the tax benefits for Americans acquiring Canadian ULCs (treaty reduced rates may not be applicable for dividends repatriated to the U.S.).
Joint ventures and partnerships are useful where more than one acquiring party is involved. Joint ventures are not legal entities but are situations where two or more parties enter into an agreement to carry out, typically, a discrete project, with the parties normally intending to profit from the venture. Each party to the joint venture will recognize its own share of revenue and expense from the project when filing for taxes and preparing financial statements; the joint venture is treated as a flow through conduit.
Another popular vehicle is a general or limited partnership (the liability of limited partners are limited to their investment in the partnership). Again, partnerships are technically not entities but are relationships where persons carry on a business in common with a view to profit. For tax purposes, a partnership is not considered a person, but unlike a joint venture its income is calculated as if it were a person (at the partnership level) and is then allocated to its partners who are responsible for reporting and paying tax on that income.
The selection of the most tax efficient acquisition vehicle is a complicated endeavour but can provide prospective buyers significant tax savings in the long run.