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Should Canadian companies establish a U.S. entity?

 Frederick G. Attea and David J. Murray, Phillips Lytle LLP

One of the most frequently asked questions when a Canadian company is expanding into the U.S. is:  should it establish a U.S. entity, and if so, in what form?

The form of entity that a Canadian business uses to operate in the United States is largely dictated by U.S. and Canadian tax considerations.  In most situations, Canadian investors elect to conduct a U.S. business through a corporation rather than a pass-through entity, such as a limited liability company or by establishing  a “branch” of the Canadian corporation.  If a corporation is used, the Canadian investors should consider whether it is more advantageous from a Canadian income tax perspective to have the owners of the Canadian corporation own the new corporation directly or as a subsidiary of the Canadian corporation.

The state in which the Canadian investor chooses to incorporate in the U.S. is not usually a significant decision; however, there are some advantages in incorporating in the State of Delaware.  (One should note that a company need not establish a physical presence in its incorporating state.)  Delaware has modern and flexible corporate laws.  Moreover, most corporate law practitioners throughout the United States have familiarity with Delaware corporate law.  However, many advantages of Delaware corporate law are not important in the context of a non-public corporation, and unless the business will operate in Delaware, the additional expense of maintaining the corporation there may not be justifiable.  New York has also traditionally been a popular jurisdiction for incorporation and its laws are sophisticated and well known.  If you intend to operate primarily in New York State, you should consider incorporating under New York law.  Your attorneys can assist you in selecting the best jurisdiction for your particular business.

In capitalizing the U.S. Corporation, its debt-equity ratio must be reasonable under the circumstances and less leverage is usually permitted for tax purposes than is common in Canada.  There may also be transfer pricing issues.  Nevertheless, if these issues are properly handled, a Canadian investor can substantially limit its exposure to U.S. tax to the business of its U.S. entity. 

Protection of the Canadian investor from responsibility for liabilities of the U.S. corporation can be maximized by respecting the separate existence of the corporation.  In that connection, the Canadian investor should observe the formalities of dealing with the U.S. corporation by having agreements reflecting transactions between the shareholder and the corporation.  Separate directors and officers should be designated and board and shareholder meetings should be held and minutes taken.  Approvals of transactions should be recorded and separate bank accounts should be maintained. 

Once the U.S. corporation is in business, it may be necessary to qualify it to do business in other states in which it has a certain minimal presence.  Each state has its own “jurisdictional presence” or “nexus” requirements.  Typically, having an office or warehouse, locating employees or providing installation or other services in a state will subject an entity to that state’s qualification requirements.  That will lead to annual filing requirements, including state income or franchise tax returns. 

Although the process of establishing a corporation to conduct U.S. business can be quickly accomplished, legal formalities should be observed, and the financing of the U.S. corporation and the pricing of intercompany transactions must be reasonable.  These steps will help make the transition successful.

Frederick G. Attea  and David J. Murray are both Partners in the Corporate Department at Phillips Lytle LLP. Mr. Attea can be reached directly at 716-847-7010 or by email at fattea@phillipslytle.com. Mr. Murray can be reached directly at 716-847-5453 or by email at dmurray@phillipslytle.com.

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