A key structural question many foreign businesses face early on when expanding in Canada is whether to set up a branch or incorporate a subsidiary. This impacts more than your legal footprint. It will dictate how your income is taxed, what deductions you can take, how profits are repatriated to the parent company and what your obligations will be with the CRA. Neither is universally better, but the tax implications are big enough that getting the structure wrong can cost you dearly. This guide gives you an overview of the main tax differences between a branch and a subsidiary in Canada to help you decide.
Canada: Branch or Subsidiary – What Each Structure Actually Means
Before we get into the tax part, it’s helpful to understand what each structure is.
A branch is not a separate legal entity. It is a continuation of the foreign corporation that is operating in Canada. The parent company is directly liable for all that the branch does, including its Canadian tax obligations.
A subsidiary is a separate legal entity, incorporated in Canada. Even if the foreign parent owns 100% of it, the subsidiary is considered a separate Canadian corporation for legal purposes and for CRA purposes.
Most of the tax differences between the two are driven by whether the Canadian operation is a separate entity.
Taxation of Each Structure in Canada
Branch Taxation
A branch is subject to tax on income from Canadian sources. The foreign parent files a T2 corporate income tax return with the CRA for that Canadian income. Profits attributable to the branch are taxed at federal and provincial corporate tax rates.
There is an extra layer that doesn’t apply to subsidiaries: the branch tax. Canada imposes a 25% branch tax on after-tax profits considered to have been remitted to the foreign parent as if it were a dividend. But this rate is often lowered by Canada’s tax treaties with other countries. Depending on your circumstances, businesses from the United States may qualify for a reduced rate under the Canada-U.S. tax treaty.
In some cases, losses incurred by the branch may be used to offset income in the parent company’s home country, depending upon the tax rules of that country. This is often cited as a short-term advantage for companies that incur startup losses in Canada.
Taxation of Subsidiaries
A Canadian subsidiary is taxed like a Canadian corporation. It files its own T2 return and pays corporate income tax on its worldwide income. In practice, a subsidiary typically earns income primarily in Canada.
Subsidiaries pay a withholding tax on dividends to the foreign parent company. The statutory rate under Canadian domestic law is 25%, but this is often reduced by tax treaty. For example, the Canada-U.S. treaty typically caps the withholding tax rate on dividends at 5% for qualified corporate shareholders.
The branch tax is not payable by subsidiaries. The trade-off is that withholding tax applies when profits are distributed as dividends to the parent.
Key Tax Differences Side-by-Side
Corporate tax rates are all very similar. A branch and a subsidiary are subject to Canadian corporate income tax on Canadian-source profits at the federal and provincial rates.
The main difference is how repatriated profits are taxed. A branch is subject to the branch tax on profits repatriated. The subsidiary is subject to withholding tax on dividends paid to the parent. Both are affected by treaty rates, but the mechanics are different.
If the foreign parent’s home country permits it to absorb Canadian losses, loss utilization can benefit the branch in the early years. By contrast, a Canadian subsidiary’s losses do not automatically flow to the foreign parent.
Administrative complexity is generally lower for an early-stage branch because there is no need for a separate Canadian incorporation. But foreign corporations’ branches still have significant CRA filing obligations, including the T2 and possibly GST/HST registration.
Liability isn’t a tax issue, but it does affect the overall decision. A branch exposes the parent directly to liabilities in Canada. A subsidiary offers separation.
What Structure Works Better Depends on Your Situation
There’s no one-size-fits-all answer. If you are testing the Canadian market short-term, expect initial losses you want to flow back to the parent or want to reduce setup complexity, a branch may make sense. For companies planning to expand in Canada, or wishing to limit parent liability, or operating in industries where a Canadian corporate identity is important to clients or regulators, a subsidiary is often the better long-term structure.
Your eligibility for treaties, type of business income and your home country’s rules around foreign income will determine which structure is cheaper in tax terms over time. These are not decisions to be made on the basis of general rules alone.
Choosing the Right Expansion Structure in Canada
Both branch and subsidiary structures have real tax implications that can grow over time. The branch tax, withholding tax, treaty eligibility and treatment of losses can all affect your bottom line in ways that aren’t immediately obvious. Understanding the differences is a good first step, but the right structure depends on your business, your home country and your plans for Canada.
It is much easier to get the structure right from the beginning than to change it later.
Get Your Tax Solutions Simplified: Only at The Tax Whiz
The Tax Whiz helps international businesses, foreign-owned Canadian subsidiaries, and non-resident corporations with their Canadian tax obligations, helping ensure those obligations are met properly and efficiently. Our team knows the rules when it comes to choosing between a branch and a subsidiary, cross-border filings, and CRA compliance for an existing Canadian operation, and applies them to your situation.
We provide businesses with tax solutions, whether they are just starting out or are established and need help with long-term T2 filings, GST/HST registration and treaty analysis. If you are expanding into Canada and want to get the tax structure right the first time, contact The Tax Whiz today.
FAQs
Does a subsidiary or branch pay more tax in Canada?
It depends on the specific case. Whether you qualify for tax treaty benefits, whether you are repatriating profits, etc. Both structures are subject to similar Canadian corporate income tax rates; however, the branch tax and withholding tax are applied differently. A tax professional can estimate the true cost to your business.
What is the Canadian branch tax?
The branch tax is a 25% tax on after-tax earnings that a foreign corporation’s Canadian branch is deemed to remit to its parent. It’s like the withholding tax you would have on dividends from a subsidiary. It may be reduced under tax treaty rates, depending on the parent company’s country of residence.
Does a Canadian subsidiary need to file a T2?
Yes. A Canadian subsidiary is a Canadian corporation and is required to file a T2 corporate income tax return each year with the CRA, reporting its income and calculating tax owing.