Business Management Articles
Power Structure: How Canadian Companies Succeed in America
Dom Cocco
BDO Dunwoody LLP
January 2005, Biz Magazine
Do you dream -- like many Canadian entrepreneurs – of expanding your business into the opportunity-rich American marketplace?
The good news is that most Canadian business owners and executives seem to be optimistic that the second term of US president George W. Bush will have a positive impact on Canadian access to the US marketplace.* A continuing stream of Canadian businesses crossing the border appears to back up this optimistic outlook. “The flow of trade and business from Canada to the US is at a strong, steady pace – and we see no signs of this abating,” confirms Jon Gardner, a partner of Kavinoky Cook LLP, an American law firm with offices in Buffalo and Toronto that helps Canadian companies do business in the US.
At the same time, Americans -- always a patriotic populace – are more inclined than ever to demonstrate their patriotism. The September 11, 2001 terrorist attacks, the subsequent war on terror and the war in Iraq – all of these events have drawn Americans closer together. So within this environment of national loyalty, how do Canadian companies expand into the US marketplace?
Certainly price has always been an advantage in gaining the attention of American buyers. But with the value of the loonie rising dramatically over the past year, Canadian entrepreneurs can’t count on price as their sole selling advantage.
Service is another aspect that appeals to American buyers. The ability of Canadian companies to provide responsive, timely service, however, has been impacted by heightened border security. Post-9/11, the focus of US Customs has shifted from access to security. Canadians crossing the border to serve American customers need proper work authorization, must allow more time for customs inspections – and still face the risk of being denied entry. None of this makes for very efficient customer care.
This is among the reasons why Canadian companies establish US locations. Not only does this allow for greater ease in crossing the border, but US tax specialist and BDO Dunwoody partner Harry Uhrig, who helps many Canadian business owners set up in the US, says “Americans like the reassurance of seeing a bricks and mortar commitment to their business.” But he also adds, “Americans like to do business with Americans.”
So what’s the point of establishing a US location if American buyers won’t buy from a Canadian company?
It’s all in the approach. Take the example of ASI Group, a southern Ontario-based water and wastewater environmental engineering company. ASI has three divisions: engineering, ecological and marine, that provide industry and government worldwide with services ranging from environmental impact surveys, design, construction and project management to contract plant operations, inspections and repair.
Sheila Ingram, the controller of this growing company with 100 employees and sales exceeding $10 million, says that ASI has always had a few US clients. However, the company was finding it increasingly difficult to service these clients from Canada. Management was also finding that many prospects in their US market niche, comprising large industrial clients and hydroelectric companies, were restricted in the amount of business they could do with non-US suppliers. ASI realized that in order to take advantage of the American market, it would have to set up a US company across the border.
Then came the decisions around how best to do this – in terms of both business development and financial effectiveness.
The majority of Canadian companies that conduct cross-border business go to great lengths not to establish a fixed place of business in the US. The reason? As soon as they set up a “permanent establishment,” i.e. an office, branch or factory -- the company is required to pay US tax. Many will therefore access the American marketplace by simply sending employees or agents to the US to make sales calls (but not sign contracts), visit customer sites or carry out consulting contracts.
If it becomes challenging to service their US business, some companies establish a sales agency over the border. This arrangement does not require a US business structure; the Canadian company simply arranges with an American agent to sell its products or services. There is generally a contract with that individual or organization and payment of commissions.
Should a Canadian business owner decide to make an investment in the US market, it’s best to do so through the Canadian parent company. A Canadian who owns US assets personally would have potential exposure to US estate tax, which can reach as high as 47% of the total value of the US business. The Canadian company serves as a buffer between the Canadian owner and the US enterprise – thereby avoiding these liabilities.
As a company’s US business expands, there may be a need for local employees to service the market. A branch has the advantage of providing a US presence. From a marketing perspective, however, it’s still a branch of a Canadian company. And from a financial perspective, a branch can create tax complications because the company must pay taxes in two countries.
A US subsidiary is often easier and less expensive to structure initially, but also has tax disadvantages. A typical subsidiary may pay combined federal and state taxes of about 40%. Some 60% flows back to the Canadian corporation – minus a 5% withholding tax. But the profits are still at the corporate level. For the owner to get those funds into his or her hands, there’s another layer of dividend tax in Canada, bringing the total tax bill up to about 60%. Ouch!
And so, many Canadian business owners establish partnerships. Partnerships flow income to the partners, who then pay tax on the income. There is only one level of tax, not two or three as with corporations. The strategic use of these business structures can reduce the overall tax hit to about 46% for Ontario residents -- sometimes even as low as 39% with more complex structuring. As well, partnerships provide flexibility; business owners can select certain states in which to organize the partnership and other states in which to establish their place of business so as to minimize state taxes. Moreover, the partnership can be arranged such that its US business is conducted by a US corporate general partner – a definite marketing advantage.
There are two types of partnership structures: a general partnership and a limited partnership. A limited partnership has at least one general partner and one limited partner.
General partnerships often develop when a Canadian business owner and a US agent or supplier expand their business together. These arrangements have the advantages of being fairly simple to implement, the partners can agree to share the profits in whatever arrangement they choose, and the partners can change the profit participation each year depending on circumstances – all with one level of taxation. The downside? The partners are equally responsible for, and have unlimited exposure to, the debts and liabilities of the partnership.
If a Canadian entrepreneur chooses to set up a general partnership in the US, a partnership agreement is essential. This agreement addresses how each partner will participate in and exit the business and also deals with any potentially contentious issues. Harry Uhrig points out, “When you have a US partner, you must lock in your position; your partner is onsite and you are many miles away. It’s difficult to stay on top of the business to the same extent. You should have an iron-clad agreement.”
For many Canadian entrepreneurs in America, limited partnerships are a more popular option. Says lawyer David Lo Tempio, a partner of Kavinoky Cook: “These partnership structures can provide Canadians with the same type of limited liability that they would have if they were doing business through a corporation.”
Typically, a US corporation is set up to act as the general partner, which controls the daily operations of the business. The corporate structure limits its liability. The limited partner has liability only up to the amount of its investment in the business. Thus the limited partner generally contributes capital to the business and owns the assets but has minimal control over daily operations.
This is why ASI Group chose this route for its US entrée. From a financial and legal perspective, “it made sense to go the partnership route,” Sheila Ingram says. “We incorporated a US company, which is solely owned by our company in Canada, that serves as our general partner.”
ASI chose New York State in which to establish its new US office with two American employees. The company’s Orchard Park location, near Buffalo, is close to its Canadian head office, plus New York State offered certain financial incentives.
The US has a vast range of state and local incentives. Once a Canadian business owner has decided to move into the US, it’s a good idea to research what deals are available. BDO Dunwoody relies on its US colleagues at BDO Seidman to help clients locate in jurisdictions offering the best fit for tax credits, property tax deductions, low-cost debt and other incentives.
In fact, advance preparation applied to all aspects of a potential US venture will help a Canadian company succeed in America. From a legal perspective, David LoTempio suggests addressing three issues: “One: immigration planning to ensure the company has the appropriate papers for its people. Two: business structuring to secure the appropriate liability protection. Three: an intellectual property assessment to protect the company and its products or services.”
Financing is another consideration. The US banking system is distinctly different from Canada’s and investment funds are taxed differently. Moreover, without a track record in the US, it can be difficult to borrow funds. Many business owners rely on introductions by their Canadian banks to the banks’ US affiliates. ASI’s Sheila Ingram says, “Our Canadian bank supplied the US bank with all of the information it required -- and provided guarantees. Fortunately, we had immediate work in the US, so that helped us secure a line of credit.”
This is another vital aspect of succeeding in America: success in Canada. Jon Gardner of Kavinoky Cook offers this perspective: “The Canadian market is very competitive, so if a company is doing well there, the likelihood is that they’ll do well here.”
So, before setting your sights on America, ask the tough questions: “Is my business strong enough in Canada to sustain a US venture? Or am I trying to solve problems with a move into the US?”
It’s important to make the distinction because, as Harry Uhrig points out: “For the last five years, many Canadian businesses have succeeded in the US aided by a weak Canadian dollar. You could make mistakes and still have a hefty profit when you were incurring costs in Canada and selling in the US. Today, mistakes can be far more costly.”
For successful Canadian companies like ASI Group that plan carefully, however, the US market offers huge potential. As Sheila Ingram puts it, “The hard work is behind us and our US customers are very happy that we’re here. Now, the sky’s the limit.”
ASI did what was needed to succeed in America: a little research, lots of preparation – and setting up a business structure that works both for the Canadian company and for its US prospects.
Now that’s Canadian entrepreneurship…
Dom Cocco is a partner of BDO Dunwoody. You can reach him in the Hamilton office at (905)526-2092 or dcocco@bdo.ca.
* BDO Dunwoody/Canadian Chamber of Commerce weekly CEO/business leader poll, conducted by COMPAS; November 8, 2004
