Starting Point of Tax Law and How it Relates to Corporate
Tax
The starting point of tax tax law in Canada is section 2 of the
Income Tax Act. Subsection 2(1) states that “an
income tax shall be paid, as required by this Act, on the taxable
income for each taxation year of every person resident in
Canada at any time of the year”. It’s important to
note that “person” in this subsection includes not only
individuals, but also corporations.
On the other hand, subsection 2(3) speaks about non-resident tax in Canada. It states that
income tax shall be paid by non-residence of Canada only on income
that was derived from (a) employment, (b) business in Canada, and
(c) disposition of taxable Canadian property.
Then, subsection 2(2) of the Income Tax Act states that
“taxable income” is the
“taxpayer’s income for the year plus the additions and
minus the deductions permitted by Division C.”
Therefore, by implication, Canada imposes income tax since
residence of a person and on the basis of type of income source.
This is why tax residence is a crucial element of Canadian tax law. In this article, we will
discuss in depth about tax residence of corporations.
Brief Overview of Corporations and Taxation
Under corporate law and tax law, a corporation is a distinct
legal entity that is separate from its own owners (that is,
shareholders), directors, officers, and employees. Therefore, it is
important to understand that even if an individual owns 100% of the
shares of a corporation, the assets belonging to the corporation
specifically do not belong to the individual. In fact, the
corporation owns the assets as it is a separate and distinct legal
entity apart from the owner and each of the owner and the
Corporation have separate and distinct tax obligations. This is a
crucial point to understand to avoid tax issues.
As discussed, the word “person” in subsection 2(1)
includes not only individual taxpayers, but also corporations. This
means that a Canadian resident corporation is obligated to report
is worldwide income to the Canada Revenue Agency. The after-tax
dollars can only be distributed to its shareholders once the
corporate taxes have been paid. Therefore, there are two levels of
taxation with respect to corporate income that flows to a
shareholder.
First, the corporation is required to pay taxes on its income,
and then the individual is required to pay taxes on the corporate dividend he or she receives from the
corporation. Despite this two-layered taxation system, through the
principle of tax integration, total taxes levied on such structure
is effectively equivalent to the amount of tax that an individual
shareholder would pay if he or she earned the same amount of income
on a personal level.
Corporate Residence – Statutory Rules
There are both statutory deeming rules as well as common law
rules for determining the residence of a corporation for Canadian
tax purposes. The most straight forward rules are the statutory
deeming rules. Paragraph 250(4)(a) states that if a corporation is
incorporated in Canada after April 26, 1965, then from that point
forward, it will be a Canadian resident corporation. If a
corporation was incorporated before April 27, 1965, then the
corporation will be a Canadian resident corporation if the
corporation is found to be a Canadian resident corporation under
the common law rules or if it carried on business in Canada.
Corporate Residence – Common Law Rules
What if a corporation was not incorporated in Canada? It may
still be a Canadian tax resident corporation under the
common law rules. Common law rules state that a corporation is a
resident in the location in which its central management and
control is exercised because this is where the actual business of a
corporation is carried on. This rule – commonly known as the
central management and control test – was based upon Lord
Loreburn’s decision in the House of Lords in the United Kingdom
in De Beers Consolidated Mines Ltd. v. Howe. Therefore,
even if a corporation is incorporated outside of Canada,
if central management and control abides in Canada, then the
company is a resident for Canadian tax purposes.
The central management and control test is a question of fact.
One of the main factors that courts will look at to determine a
corporation’s “central management and control” is the
location in which the corporation’s board of directors make
their decisions. The reason why the board of directors are
important is because board of directors have the legal power to
manage the affairs of the corporation. Thus, the residence of the
board of directors will often decide the tax residence of a
corporation.
On the other hand, the residence of shareholders of a
corporation is not important for corporate residence purposes. The reason is
because directors of a corporation do not have legal duties to
follow the instructions of their shareholders. Therefore, it is
generally presumed that shareholders will not affect the central
management and control of a corporation.
However, in some cases, the residence of shareholders may be
relevant for the central management and control test. This is the
case if shareholders control the corporation by exerting influence
over the directors of the corporation. If there is clear evidence
that shareholders have effective management and control of a
corporation, then the residence of shareholders may be the location
in which the corporation’s central management and control is
exercised.
Pro Tip: Carefully plan Which Jurisdiction to Incorporate and
who will be the Directors
You should consider the implications to corporation’s
residence status for income tax purposes when you decide in which
jurisdiction to incorporate and who will be the directors of the
corporation. Incorporating in Canada is a good idea if you want a
Canadian resident corporation, and make sure that the directors of
the corporation are Canadian residents. On the other hand, if you
want a non-resident corporation, then you should consider
incorporating in a jurisdiction outside of Canada and make sure
that the directors of the corporation are not Canadian residents.
If you would like to speak to a tax professional about your
corporate tax residency, please contact our top Canadian tax law
firm.
F.A.Q.
Are Canadian Tax Resident Corporations
Taxed?
Absolutely. Subsections 2 and 3 of the Income Tax Act
applies to “persons” and corporations are included in the
definition. Thus, Canadian resident corporations are liable to
Canadian tax on its worldwide income.
Are Corporations Separate Legal Entities?
Yes, for Canadian tax and corporate law purposes, corporations
are considered separate and distinct legal entities apart from
their owners.
Can a Corporation that was not Incorporated in Canada be
a Canadian Resident Corporation for Income Tax
Purposes?
Yes. It my still be a Canadian tax resident corporation under
the common law rules. Common law rules state that
a corporation is a resident in the location in which its central
management and control is exercised because this is where the
actual business of a corporation is carried on.
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.