Structuring Your Cross-Border Investment in a Tax Efficient Manner
Co-Authored with:
Introduction
Sharing the longest border in the world, the United States and Canada have strong political and cultural ties and, together with Mexico, an unprecedented degree of economic integration. The United States and Canada are each other’s largest export markets and direct investment by the United States in Canada reached US$618.2 billion in 2023, accounting for 45.7% of total foreign investment.
Corporate and tax planning are key aspects of cross-border investments and acquisitions. One uniquely Canadian corporate structure available to prospective U.S. buyers or investors is “unlimited liability corporations” or “ULCs”.
While ULCs are treated the same as “normal” limited liability corporations from a Canadian income tax perspective (i.e., as taxable corporations), from a U.S. federal income tax perspective, ULCs are potentially attractive corporate vehicles as they are treated as “flow-through” or “fiscally transparent” entities, such as partnerships or disregarded entities (i.e. branches). ULCs are a very flexible entity type for U.S. federal income tax purposes as they are considered “eligible entities” that could also make an election to be classified as a corporation for U.S. federal income tax purposes.
In Canada, ULCs can be incorporated under the corporate statutes of four out of 10 provinces, British Columbia (“BC”), Alberta, Prince Edward Island (“PEI”) and Nova Scotia. In BC alone, approximately 5,000 ULCs currently exist.
Given this range of corporate options across jurisdictions, this bulletin will provide a general overview of ULCs, their common features and differences across provinces, and their potential advantages or disadvantages for U.S. investment and tax planning.
What are ULCs?
The unique attribute of unlimited liability corporations or companies (or “unlimited companies” in Nova Scotia), as their name suggests, is that their shareholders and, under certain circumstances their former shareholders, are liable for the debts and liabilities of the ULC. This stands in contrast to one of the fundamental features of modern business corporations, namely that no shareholder of a company is personally liable for the debts, obligations, defaults or acts of the company. The scope of shareholder liability in ULCs varies among Canadian jurisdictions and is further discussed below.
Nevertheless, ULCs retain their separate legal personality and are treated as corporations for Canadian corporate and tax purposes. The rules regarding authorized capital, share and other corporate transactions, shareholder rights and remedies, director powers and liabilities, and financial accountability are generally the same for ULCs and other business corporations. Further, none of the four jurisdictions that permit ULCs require Canadian-resident directors.
ULCs can be created by incorporation, amalgamation, or conversion, and, in some cases, by continuance from another jurisdiction. However, as outlined below, certain restrictions apply to such fundamental changes.
Liability of Shareholders and Former Shareholders
One of the key features of all Canadian ULCs is the liability of shareholders (called "members" in Nova Scotia) and former shareholders. However, the extent of such liability is different in the four jurisdictions that permit ULCs.
In Alberta and PEI, shareholders are immediately and directly responsible to creditors for any liability, act or default of the ULC when it occurs. Such liability is joint and several, so that creditors may seek recovery from the ULC and all of its shareholders, or any of them. Former shareholders also remain jointly and severally liable for a period of two years after they ceased to be shareholders with respect to any act, liability or default of the ULC that existed at the time they disposed of their shares in the ULC.
In contrast, in both BC and Nova Scotia, shareholder liability is more limited, although equally joint and several. In BC, shareholders would be responsible for paying the ULC’s debts or liabilities if there is a shortfall in the ULC’s assets on liquidation, or, if the ULC is dissolved without liquidation, for any remaining debts or liabilities after dissolution. In Nova Scotia, shareholders must contribute to the assets of the ULC on winding up in amounts sufficient to pay its debts and liabilities, the costs of winding up, and any unpaid issue price for shares.
Former shareholders are also treated similarly in BC and Nova Scotia. They are not liable for the ULC’s debts or liabilities if they ceased to be shareholders at least one year before the commencement of liquidation or the date of dissolution (in BC) or before the commencement of the windup (in Nova Scotia). Debts and liabilities arising after former shareholders ceased to be shareholders of the ULC are excluded from such liability. Even if former shareholders disposed of their shares less than a year before the winding up or dissolution, they will not be liable in BC or Nova Scotia unless the responsible court finds that the existing shareholders of the ULC would be unable to satisfy the ULC’s debts and liabilities.
Creating ULCs by Conversion or Amalgamation
As noted above, ULCs can not only be formed by incorporation, but also by converting an existing business corporation into a ULC or by amalgamation with one or more other business corporations, resulting in a ULC.
As the conversion or amalgamation into a ULC makes the shareholders liable for the debts and liabilities of the ULC, both BC and Nova Scotia require unanimous approval by all shareholders, protecting minority shareholders against involuntarily assuming such liability. In comparison, Alberta and PEI only require special resolutions (or two-thirds of the votes cast) to authorize the conversion or amalgamation into a ULC. BC also imposes certain restrictions on amalgamations involving foreign (non-BC) corporations and BC ULCs or amalgamations resulting in BC ULCs.
Accordingly, the desired corporate structures are usually achieved in a two-step process of first continuing the foreign corporation to BC and then immediately proceeding with the amalgamation or conversion.
It is also possible to convert or amalgamate a ULC into a corporation with limited liability. In these circumstances, shareholders need to be aware that they generally remain responsible for the debts and liabilities that arose while the corporation was a ULC.
In general, neither the continuance of a corporation from another jurisdiction in Canada, nor the conversion of a corporation from a limited liability company to a ULC, is considered to be a taxable event for Canadian income tax purposes.
If the Canadian corporation already has U.S. shareholders, care should be taken to ensure the conversion or amalgamation to create a ULC is not considered a taxable transaction for U.S. federal income tax purposes.
Continuances Involving ULCs
ULCs can also be created by moving or “continuing” an existing corporation from one jurisdiction to a province which permits the existence of ULCs. In such a case, the original corporation continues to exist, but is now governed by the laws of the province to which it is continued.
Import Continuance
Alberta, Nova Scotia and PEI allow direct continuances as ULCs by corporations from another jurisdiction. In BC, the same is generally achieved by a two-step process of first continuing and then converting to a ULC, as noted above. Alberta and Nova Scotia ULCs can use a simplified continuance process.
Continuances to another jurisdiction must be permitted by the corporation’s home jurisdiction. For example, Nova Scotia does not permit the export continuance of a Nova Scotia ULC to Alberta or PEI, as doing so would prejudice the shareholders due to the more expansive shareholder liability regime in Alberta. To export to any other jurisdiction, a special resolution of members is required, and the Registrar must be satisfied that the proposed continuance will not adversely affect creditors or members of the continuing ULC.
Alerting Shareholders and the Public about Unlimited Liability
Informing existing and future shareholders, as well as the public, about the nature of ULCs is a common feature across Canadian jurisdictions. In BC, PEI and Alberta, the name of every ULC must end with the corporate designation “unlimited liability company” (in BC), “unlimited liability corporation” (in PEI and Alberta), or “ULC”, and no other person may carry on business in these provinces with a corporate, business or trade name containing these designations. In Nova Scotia, in comparison, other corporate designations or their French equivalents are also permitted (namely, “unlimited liability company”, “ULC”, “Corporation”, “Corp.”, “Company”, or “Co.”).
Similarly, in BC, PEI and Alberta, the constating documents of a ULC must contain a statement to the effect that the shareholders of the ULC are jointly and severally liable. The exact language is prescribed by the applicable corporate statute and is added in the normal course as part of the incorporation, amalgamation, continuation or conversion process that creates a ULC in each of these three provinces.
As a further precaution, each of BC, Alberta and PEI require that warning language alerting to the unlimited liability of shareholders be prominently set out on the share certificates issued by a ULC. Nova Scotia has not adopted any such shareholder protection steps.
The Costs of Establishing and Maintaining a ULC
The government filing fee charged by corporate registries for establishing a ULC (whether by incorporation, conversion, amalgamation or continuance) varies considerably across the four jurisdictions. At the time of writing, the fees were lowest in PEI, followed by Alberta and BC, ranging from just over C$200 to $1,000. Annual maintenance costs and other filing fees are comparable in all three provinces and are well below C$100.00.
Only Nova Scotia imposes a special tax on ULCs, which is payable on establishment and on every annual renewal of registration. Given the amount per filing of approximately C$1,145.00 in 2024, a Nova Scotia ULC is by far the most expensive to establish and maintain.
U.S. Income Tax Considerations for Use of ULCs
The U.S. Entity Classification Framework
Under the U.S. tax system, the classification of non-U.S. (“foreign”) entities is governed by specific criteria outlined in the Treasury Regulations. The primary factor determining a foreign entity’s classification is whether it provides limited liability to its owners. According to Treasury Regulations §301.7701-3, a foreign eligible entity is classified as follows:
- a partnership if it has two or more members and at least one member does not have limited liability;
- an association (taxable as a corporation) if all members have limited liability; and
- disregarded as an entity separate from its owner if it has a single owner without limited liability.
Based on the above, a foreign entity with at least one owner having unlimited liability can be classified as either a partnership or a disregarded entity, unless it is considered a “per se” corporation under §301.7701-2(b)(8). For example, a “Corporation” or “Company” incorporated in Canada is a per se corporation, meaning it is automatically classified as a corporation under the U.S. income tax rules (an unlimited liability company, however, is not a per se corporation).
If a foreign entity is not classified as a per se corporation under §301.7701-2(b)(8), it has the flexibility to make entity classification elections. This means the entity can choose to be treated as a corporation, partnership or disregarded entity for federal income tax purposes, depending on its ownership structure and the liability status of its members.
ULCs, as described above, are a type of foreign entity where the owners have unlimited liability. Under the U.S. framework, these entities are not automatically classified as corporations (per se). Instead, they are “eligible entities” that can elect their classification. For example, a ULC with a single owner can elect to be treated as a disregarded entity or an association (corporation), while a ULC with multiple owners can elect to be treated as a partnership or an association. The U.S. federal income tax system allows eligible business entities to choose their classification, commonly known as the “check-the-box” (“CTB”) election. To make an entity classification election, a business entity would file Form 8832, Entity Classification Election, with the Internal Revenue Service (“IRS”). This form allows the entity to choose its classification for federal tax purposes, such as a corporation, a partnership or a disregarded entity. The election can be effective up to 75 days prior to the date the form is filed or up to 12 months after the date the form is filed. This election provides significant flexibility in tax planning, enabling entities to select the most advantageous tax treatment for U.S. federal income tax purposes, without changing its legal form.
Liabilities of the U.S. Shareholder Owning the ULC
As described above, the shareholder liability in Canadian ULCs varies by jurisdiction. As such, a U.S. shareholder that would otherwise hold the shares of a ULC directly may reduce the risk of unlimited liability by interposing a U.S. subsidiary corporation between the U.S. parent and the ULC (i.e. a “U.S. blocker entity”). By interposing a U.S. subsidiary blocker entity between the U.S. parent and the ULC, the U.S. parent is protected from the unlimited liability that would otherwise be associated with directly owning an interest in the ULC, limiting the U.S. parent’s liability to its investment in the blocker entity and not beyond to the liabilities of the ULC.
Generally, the U.S. blocker entity is treated as a separate corporation for U.S. tax purposes (unless it otherwise elects to file a consolidated return with a U.S. corporate parent). This means that the income and gains of the ULC are first taxed at the blocker entity level before any distributions are made to its shareholder. The dividend distribution to a U.S. corporate shareholder who owns more than 80% of the U.S. blocker entity may qualify for a 100% dividends-received deduction.
Tax Structuring with a ULC
Structuring outbound investments as a branch has been a common planning tool deployed by taxpayers. However, the changes to the foreign branch recapture rules imposed as part of The Tax Cuts and Jobs Act (“TCJA”) added more stringent rules to prevent the perceived abuse of utilizing branches for the purpose of generating losses to offset income earned in the United States. Typically, conducting business through a branch provides flexibility to the U.S. group to utilize losses incurred during the initial phase of such outbound investment against income generated by the broader U.S. group. At the time when foreign operations become profitable, the U.S. group may choose to incorporate the branch activities to potentially defer income inclusions. However, Section 904 and Section 91 (post-TCJA) of the Internal Revenue Code (“IRC”) impose certain requirements to recapture losses on the disposition of branch assets. A U.S. shareholder is considered to dispose of branch assets at fair market value (“FMV”) when it incorporates a foreign branch. The U.S. shareholder would be required to recapture losses previously recognized with respect to such trade or business.
A Canadian ULC carrying on an active trade or business in Canada can be considered a branch of the U.S. shareholder. A branch is first taxed by the jurisdiction where it operates, while allowing the U.S. shareholder to include any income/losses from the branch concurrently and potentially offset U.S. federal income tax by the Canadian taxes paid by the branch through a foreign tax credit mechanism.
For instance, a U.S. domestic corporation that wholly-owns a ULC that is classified as a disregarded entity may later choose to incorporate the ULC by making a CTB election once it becomes profitable. Under this scenario, the U.S. corporation is deemed to have transferred substantially all of the foreign branch assets to the new ULC corporation at FMV. As a result, in the year of transfer, the U.S. domestic corporation must recognize the net losses incurred by the foreign branch over the taxable income of the foreign branch and any gain recognized on the deemed transfer at FMV. Essentially, these rules are intended to reflect the U.S. shareholder’s tax position as if the foreign business had always been operated as a corporation.
The changes resulting from TCJA substantially increase the potential income recapture during the incorporation of a branch. A ULC may nevertheless provide the flexibility for U.S. groups that are “testing the water” on their potential expansion outside of the United States, as well as potential benefits from the time value of cash tax deferred to a later year.
Upon the CTB election to treat the ULC as an entity taxable as a corporation, the incorporated branch is generally expected to be treated as a foreign corporation for U.S. federal income tax purposes. Under Section 957, a wholly owned foreign corporation is treated as a controlled foreign corporation (“CFC”) to the U.S. shareholder. Depending on the nature of activity, the U.S. shareholder of a CFC may be required to recognize income in the year of activity, irrespective of actual distributions, under the subpart F income or the Global Intangible Low-Tax Income (“GILTI”) regimes (i.e. anti-deferral tax regimes).
When deciding how to hold its foreign investments, a U.S. group typically models the tax treatments and benefits of owning the foreign investment through a foreign corporation versus a ULC classified as a branch. Notably, a U.S. corporate shareholder of a corporation treated as a CFC can claim a 50% deduction (reducing to 37.5% for tax years beginning after December 31, 2025) on any GILTI inclusions and utilize deemed paid foreign tax credits, significantly reducing the effective tax rate on foreign earnings. Additionally, the U.S. corporate shareholder may benefit from a 100% deduction on the foreign-source portion of dividends received from the CFC, further optimizing its tax position. Given these substantial differences in tax treatment and benefits, a thorough analysis is essential when determining the appropriate entity for holding or entity classification to elect for the foreign investments.
Using ULC in a Merger and Acquistion ("M&A") Transaction
Oftentimes in an M&A transaction involving a U.S. buyer, the U.S. buyer may want to structure the acquisition to achieve a step-up in the tax basis of the acquired assets (i.e., treat the stock purchase as an asset acquisition for U.S. federal income tax purposes). There are tax elections, provided certain requirements are met, that a U.S. purchasing corporation (or a Canadian acquiring company that a U.S. purchasing company forms) may be eligible to use in order to treat the acquisition of the shares of a corporation as an asset acquisition for U.S. federal income tax purposes. For a deemed asset sale election to be possible, generally the acquisition needs to be a qualified stock purchase or qualified stock disposition, which in either case requires an acquisition of at least 80% of the voting power and value of the corporate stock in a taxable transaction. In many cases this requirement may not be met, which, absent alternative planning, would mean the U.S. purchaser could not obtain a tax basis step-up in the assets of the target when the stock is acquired.
A common solution to the potential issue above, or in some cases a preferred alternative, is the use of a ULC given their hybrid nature for U.S. federal income tax purposes. It provides the U.S. buyer with the opportunity to structure the acquisition as an asset sale for U.S. federal income tax purposes while it is legally acquiring the shares of a Canadian company or corporation. Depending on the facts, this could be accomplished by the U.S. buyer requesting the seller to convert the Canadian corporate target into a ULC prior to closing. While the transaction is treated the same for Canadian income tax purposes (i.e. as a sale of the shares of the company), the transaction may be treated as an acquisition of the assets of the company for the U.S. buyer from a U.S. federal income tax perspective.
Upon the conversion to a ULC pre-closing, the U.S. acquirer is treated as acquiring assets at closing and would be able to step-up the basis of the ULC’s assets to the FMV of the purchase price. To the extent the value is allocated to depreciable assets, the U.S. acquirer would get the benefits of depreciation post-closing. Any excess value over the assets of the ULC would be considered as goodwill which is also amortizable over 15-years for U.S. tax purposes. This ultimately creates deductions in the United States if the acquiror is a U.S. person. Alternatively, if a Canadian acquiror is formed by the U.S. person, the added deductions generally decrease any potential GILTI inclusions in income of the U.S. person. Further, the earnings and profits, if any, accumulated by the Canadian corporation would be eliminated upon its conversion to a ULC from a U.S. federal income tax perspective.
While this can be a positive outcome, consideration should be given to the implication of §901(m), which could deny portions of foreign taxes paid in Canada for the U.S. shareholder. Specifically, the U.S. acquirer company acquires the ULC where the basis in the acquired assets is stepped-up for U.S. tax purposes but not for Canadian tax purposes, creating a basis difference. The foreign taxes paid on the income from these assets may be partially or fully disallowed as a foreign tax credit to the extent of such basis difference.
The ULC also provides certain flexibility in certain M&A transactions to facilitate tax-deferred rollovers of shares of a corporation for a U.S. vendor and existing Canadian shareholders. For example, a U.S. vendor cannot contribute stock of an entity classified as a corporation to a Canadian corporation on a tax-deferred basis unless the U.S. vendor, combined with other transferors (e.g. existing Canadian shareholders injecting cash), generally holds at least 80% of the votes and value of all classes of stock (tested after the transfer). In other words, if the existing shareholders will not contribute cash or property to the Canadian parent, a transfer of appreciated property by a U.S. person to a Canadian corporation will likely be a taxable transaction. However, establishing an aggregator entity that is treated as a partnership or flow-through entity (e.g., a ULC) for U.S. tax purposes could facilitate the transaction on a tax-deferred basis. Generally, contribution of appreciated property by a U.S. person to a partnership is a tax-deferred contribution and not immediately taxed to the transferor. Further, existing Canadian shareholders can exchange their shares in the Canadian target for the ULC (also a Canadian entity) on a tax-deferred basis. While beyond the scope of this article, this aggregator ULC may also be able to facilitate tax-efficient incentive programs for U.S. participants by issuing profit interests of the ULC on a go-forward basis. All in all, the hybrid nature of the ULC provides great flexibility for U.S. investors and vendors to structure their investments in a tax-efficient manner.
The Bottom Line
In summary, a ULC is often used by U.S. taxpayers in their tax-efficient structuring to achieve certain tax benefits and is a tool tax practitioners should be well-aware of. A ULC offers U.S. persons with flexibility in its entity classification for U.S. tax purposes (i.e. by being an eligible entity to make the CTB election), which is something not afforded to a Canadian corporation or company. Nevertheless, the flexibility may come with its own set of considerations and trade-offs that need to be carefully analyzed before implementation. We are here to help navigate these complexities to ensure the most advantageous tax outcomes.
This bulletin was co-authored by Christopher Piskorz (Partner at Deloitte), Vidhur Sharma (Senior Manager at Deloitte) and Jennifer Shih (Partner at Deloitte).
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