Optimal Ownership Structures
So far, I have discussed the use of Forco within the context of a relatively simple structure where it would be a wholly-owned subsidiary of Canco.
In many situations, that simple structure will be appropriate, but in others situations, there may be a better alternative. Two common variations are discussed below.
Ownership by Canadian Sister Corporation of Canco
If the shareholders of Canco are Canadian resident individuals, consideration should be given to the possible application of the “capital gains exemption”, currently applicable to up to $800,000 in capital gains from the sale of “qualified small business corporation shares”.
As a general rule, the shares of Canco will only qualify if “all or substantially all” (usually interpreted as being 90% or more) of the fair market value of its assets is represented by assets used in an active business carried on in Canada, or shares of connected Canadian corporations that qualify.
Shares of a foreign corporation would never be a “good” asset for the purposes of applying this rule. As such, if Canco’s investment in Forco is, or might grow to be, an asset of significant value, it is possible that this could mean that the shares of Canco would no longer be “qualifying small business corporation shares”.
In such situation, it may be preferable to form a new Canadian corporation, which would also be owned by the shareholders of Canco, to be the holder of the Forco shares. In that way, there will be no risk that the value of the interest in Forco could disqualify the Canco shares.
Ownership by Foreign Holding Company
In certain cases, there can be an advantage to holding the shares of Forco in holding company formed in an appropriate foreign jurisdiction.
This would most likely be relevant in the following two types of situations:
(a) If Forco will be paying dividends out of “taxable surplus” or “hybrid surplus”, as opposed to “exempt surplus”, receipt of such dividends by Canco may entail a Canadian tax cost. Using a foreign holding company as an intermediary will effectively allow such taxes to be deferred while the distributed funds remain in the holding company.
(b) If the shares of Forco will be sold, ownership of such shares by the foreign holding company will allow the recognition of the capital gain that would otherwise arise to be deferred as long as the funds remain in the foreign holding company. This will be the case as long as the shares of Forco are “excluded property” at the time of the sale, which they will be as long as “all or substantial all” of Forco’s assets are used in an active business.
In the next article in this series, I will discuss some issues in relation to the new “upstream loan” rules.