Tax-Efficient Repatriation of Profit

June 01, 2017

Article_Repatriation-of-Profit_Banner_Landing_679x220.jpg

International business expansion is a complex process that must be done strategically in order to minimize risk, limit potential tax liabilities and maximize profits.  Our Doing Business Globally series is designed to give Canadian companies the advice they need to reduce risk and limit exposure as they expand into the global marketplace.  Part 2 of this 4 part series explores tax-efficient ways to repatriate profits. 

In today’s interconnected marketplace, international or even global expansion is increasingly a goal of Canadian businesses. Opportunities abound to sell to foreign customers, open offshore operations, or purchase foreign corporations. Yet as businesses set up companies in foreign jurisdictions, one key question becomes: how do you bring the profits back home?

When shareholders are clamouring for a return on investment, bringing cash back into Canada quickly becomes a priority. When looking to repatriate profits, however, companies must proceed with caution to avoid incurring unnecessarily high effective tax rates, or running afoul of transfer pricing and other tax initiatives such as Base Erosion and Profits Shifting (commonly known as BEPS).

There are many ways to repatriate profit from a foreign affiliate to the Canadian parent company in a safe and tax-efficient manner, each with its own benefits and pitfalls. Three of the most common methods of repatriation are through use of dividends, interest, and management fees.

Dividends

One of the most commonly used methods of profit repatriation is through dividend payments from the foreign subsidiary to the Canadian parent. Canada’s tax system makes dividends a particularly attractive method of repatriation in many situations.

For a dividend payment to be an optimal solution, there are a number of factors that need to be considered, including the country of foreign operation, that country’s tax treaty status with Canada, and the nature of the foreign business operations. Provided that the foreign affiliate is situated in a country with which Canada has a tax treaty and the business generates active business income, dividends from the foreign subsidiary can be returned to Canada free of Canadian income tax. There are also withholding tax rate considerations of the foreign jurisdiction that need to be taken into account. For example, if the foreign operations are in the U.S. or the UK, dividends are subject to a 5% withholding tax.

For foreign entities earning passive income (such as income from interest, rent or royalties), profit repatriation through dividends can become more complicated. Generally such income is taxable in Canada, though the business should also get a credit for any tax paid in the foreign jurisdiction.

Interest

Interest is another common method of repatriating funds. To enable this kind of payment, instead of getting a loan from a bank or other third party to finance operations outside of Canada, the Canadian corporation can loan surplus funds to the foreign affiliate. If the foreign affiliate is located in a country with which Canada has a tax treaty, the interest payments on the loaned funds can then be repatriated back to Canada and be taxed at Canadian tax rates, with a tax deduction in the foreign jurisdiction, in some cases without any withholding taxes. However, companies using this method of repatriation need to remain cautious of “earnings stripping” rules in the foreign jurisdiction, which can limit interest deductions. In addition to the earning stripping rules, care must to be taken to ensure that the interest rate charged on these related party loans adhere to transfer pricing rules. Failing to do so could cause an unfavourable tax result.

Management Fees

If the Canadian parent company provides services to the foreign subsidiary, management fees can be an effective way to repatriate profits.  Using this method of repatriation, the Canadian parent company charges the foreign affiliate at fair market value for any services provided. This can include a wide range of charges such as support fees, administrative fees, headquarter fees, technical support fees, and more. Such fees don’t generally attract withholding tax when paid, however a transfer pricing analysis will be crucial to any management fees charged between related companies

Other Methods of Repatriation

There are a wide variety of other methods of profit repatriation that can be used instead of or in addition to the methods discussed above. Another commonly used method is repatriating the cost base of the foreign shares. If there is a large cost base in the shares of the foreign company, it may be possible to bring some of that cost out to Canada tax-free.

Royalty payments are another option, one that operates similarly to interest. This method is ideal where the Canadian company has a special technology or patents and sets up a subsidiary to service a foreign market. The Canadian parent can license the technical know-how to the subsidiary and receive compensation in the form of a royalty. If the subsidiary is located in a country with which Canada has a tax treaty, it may be possible to structure the royalty payment so that no withholding tax applies.

Choosing the Optimal Repatriation Strategy

When it comes to profit repatriation, there’s no single optimal solution. The appropriate strategy is highly dependent on the individual company, country or countries of operation, number of subsidiaries, industry, and more. For many companies, the ideal approach is a hybrid of multiple repatriation methods that may change year by year. The key is to carefully consider all repatriation options and choose a legal approach that fits the individual corporate needs, meets Canadian and foreign tax rules, and delivers a tax-efficient result.

However, there are two key areas that all companies should take into account when developing a plan for profit repatriation:

  1. The corporate expansion and growth strategy. Understanding not only the current situation but also the long-term corporate outlook is critical when developing a tax-effective repatriation strategy. Consider where cash is needed now, as well as where funds will need to be over the next two, five, or even ten years. For example, if a company is looking to expand into the United States in the immediate term and into South America two years from now, a repatriation strategy can anticipate using cash from the successful U.S. operations to fund the expansion while also bringing profit back into Canada.
  2. The interplay between corporate parent and subsidiary/subsidiaries. Consider: what is Canada doing for the global operation? What are the other affiliates doing? Which entity bears most of the risk? This information can help illuminate the best options for the unique corporate situation, show where transfer pricing techniques can be used to move money from high-tax or other jurisdictions into Canada, and potentially take advantage of tax arbitrage.

Before engaging in any repatriation strategy, you should carefully weigh your options and choose the methods that best serve your long-term business goals. Profit repatriation strategies are unique and dependent on your company’s individual situation.

For personal advice and support on your international business expansion, please contact a member of our International Tax Team or your BDO advisor.

Catch up on Part 1 of our Doing Business Globally series here.

Contributor:

Harry Chana
Partner, International Tax


The information in this publication is current as of June 1, 2017.

This publication has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The publication cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it.