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Mergers and Acquisitions in Canada

In addition to the tax payable in respect of income from a business carried on in Canada, a non-resident corporation which carries on business in Canada directly (as contrasted to carrying on business through a Canadian subsidiary) is subject to a tax in respect of after-tax branch profits of the corporation which are remitted outside of Canada. This tax is commonly referred to as a “branch tax” and is a rough equivalent to the withholding tax which would be payable on any dividends paid by a Canadian subsidiary to its foreign parent corporation.

Branch tax is payable at a rate of 25 percent on the after-tax profits of the branch operation in excess of the corporation’s investment allowance, but is reduced to the treaty rate on dividends paid by a corporation resident in Canada to a non-resident corporation that owns all the shares of the Canadian corporation. For example, under the Treaty, the rate of branch tax is reduced to 5 percent for U.S. residents who can benefit from the Treaty. In addition, the Treaty eliminates the branch tax on the first CA$500,000 of income subject to branch tax.

The “investment allowance” represents the accumulated after-tax profits that the corporation has re-invested in its Canadian branch operations. It is calculated based on the assets and liabilities of the branch. Debt will reduce the corporation’s investment allowance for branch tax purposes if the interest on such debt is deductible by the corporation in computing branch profits, or would be deductible but for certain interest deductibility restrictions. The investment allowance is re-calculated at the end of each year. The amount deducted in computing branch profits for a particular year is added back into the branch tax base in the immediately following year. This method of calculating the branch tax base ensures that the tax is payable on after-tax profits of the branch that are not re-invested into the Canadian branch operations.

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