Canadian start-ups, including those in the information technology sector (i.e. mobile apps, computer software and other information technologies (\u201cIT\u201d)) may benefit from certain tax and corporate advantages of operating both a Canadian corporation (\u201cCanCo\u201d) and a U.S.-based corporation (often a Delaware corporation, \u201cDelawareCo\u201d). There are plentiful tax and capital funding incentives offered to tech start-ups operating in Canada, particularly in provinces such as British Columbia and Ontario, (i.e. with Venture Capital Corporations and Labour-Sponsored Funds).\u00a0In order to exploit the advantages of operating on both sides of the 49th parallel, entrepreneurs are considering innovative strategies to take advantage of these unique incentives.\u00a0For those CanCo\u2019s and their seed shareholders having some operations in Canada and some operations in the U.S., the \u201cDelaware-CanCo Straddle\u201d is becoming a favoured cross-border structure.\u00a0The following explores why Canadian entrepreneurs are seeking to structure their operations utilizing both a CanCo and a DelawareCo sister corporation.<\/p>\n
Why Incorporate a CanCo?<\/b><\/p>\n
For those carrying on business in Canada, contracting with Canadian resident suppliers, employing Canadian residents or simply seeking Canadian funding (whether it be seed capital, private equity, or venture capital), a presence in Canada, which is normally by way of a Canadian-Controlled Private Corporation (\u201cCCPC\u201d), is a very tax efficient and operationally useful approach.\u00a0It permits CanCo to be eligible for certain investment tax credits under the Scientific Research and Experimental Development Program (\u201cSR&ED\u201d), both provincially and federally. Some provinces also offer additional SR&ED tax credits only to CCPC\u2019s while other or foreign-owned companies are only eligible for non-refundable tax credits up to 15% of eligible expenditures. CCPC\u2019s under the small business income limit of under $500,000 and the taxable capital requirements limit of under $10,000,000, may receive up to 35% of eligible expenditures as refundable tax credits.\u00a0Eligible SR&ED expenses include labour, materials, overhead, and subcontracting costs, among other allowances.\u00a0 For CanCo to qualify for the SR&ED program, all research and experimentation must be conducted in Canada and CanCo either has to own the intellectual property (\u201cIP\u201d) or IT resulting from this work or have a legally binding agreement that confirms that all SR&ED tax credits belong to CanCo.\u00a0<\/p>\n
Other government funding programs such as the Industrial Research Assistance Program (\u201cIRAP\u201d), the Canadian Renewable Conservation Expense (\u201cCRCE\u201d), Sustainable Development Technology Canada (\u201cSDTC\u201d), the Canada Media Fund (\u201cCMF\u201d), and the Canadian Feature Film Fund (\u201cCFFF\u201d), mandate that all eligible recipients be incorporated in Canada.\u00a0Certain provincial funding programs also require that businesses be incorporated and operate in the provinces at issue and thus Canadian operations can exponentially increase federal and provincial government funding opportunities and tax incentive programs.\u00a0Finally, because Canada is a less litigious country than the U.S., it is prudent to house the major assets of the operations (namely the IP, IT and other material agreements) in Canada.<\/p>\n
Why Incorporate a DelawareCo?<\/b><\/p>\n
There are many reasons why Canadian entrepreneurs consider incorporating in Delaware more often than any other state in the United States.\u00a0Canadian entrepreneurs seeking to set up a DelawareCo do so to attract U.S. angel investors, U.S. venture capital companies, and U.S. institutional investors who are more comfortable investing in early stage or start-up technology businesses that are governed by U.S. state laws, preferably Delaware.\u00a0In addition, U.S.-based tech incubators and tax driven funding programs may require U.S. incorporation in order to access those particular programs.\u00a0Furthermore, creating a U.S.-based sister corporation may result in enhanced cross-border travel and freedom of movement of employees and key personnel and executives who have access to work visas (i.e. L-1A, L-1B and E-2 visas) and other opportunities for executive management habitually resident in Canada to move freely to and from the U.S.<\/p>\n
Top 8 Reasons to Incorporate a DelawareCo:<\/b><\/p>\n The \u201cDelaware – CanCo Straddle\u201d Defined<\/b><\/p>\n This type of cross-border structure is becoming increasingly popular.\u00a0The strategy involves establishing sister corporations, one in Canada (\u201cCanCo\u201d) and one in the U.S. (\u201cDelawareCo\u201d), which are owned by the same shareholders and which have identical share ownership percentages. The DelawareCo is customarily a Subchapter \u201cC\u201d corporation.<\/p>\n Depending upon the particular facts, circumstances, and related considerations, including but not limited to the size and scale of operations and the location of seed shareholders, angels, founders, officers, directors, employees, and contractors, as well as the feasibility of entering into new jurisdictions, the Delaware – CanCo Straddle makes logical sense.\u00a0<\/p>\n On the one side, there is a significant benefit to be gained from the optimization of government grants in Canada. To do so, CanCo has to own the IP and any and all research or development associated with such IP with an effective licence strategy – usually under exclusive licensing arrangements to the DelawareCo for use in the United States.\u00a0<\/p>\n Often when a Canadian tech start-up is acquired by a U.S. company there could be significant tax complexities on both sides of the border.\u00a0In the absence of an already established U.S. sisterco, the parties often attempt to mitigate cross-border tax issues through acquisition structures such as the \u201cexchangeable share transaction\u201d.\u00a0This is complex and adds significant costs to any merger or acquisition transaction.\u00a0 In some cases an acquisition can reduce the complexities and additional costs associated with such \u201cexchangeable share transactions\u201d if a portion of the target is already set up as a DelawareCo.\u00a0<\/p>\n Furthermore, by creating separate sister corporations, Canadian shareholders of CanCo will be able to take advantage of Canada\u2019s lifetime capital gains exemption with respect to the sale of shares of a CCPC, and in the absence of the Delaware – CanCo Straddle, if U.S. operations were carried out under the Canadian company\u2019s governance and direction (either directly by the CanCo or by a U.S. wholly-owned subsidiary of a CanCo) and if such operations were substantial, the exemption may not be available.<\/p>\n While \u201cdual incorporation\u201d provides a broad range of corporate advantages, Canadian tech start-ups should be cognizant of the fact that operating sister corporations will result in additional legal, tax, and financial responsibilities, both administrationally and managerially, as follows: tax returns must be filed in both countries and there must be Canadian and U.S. tax paid; work visas will be required for Canadians travelling to and from the U.S. to attend to the DelawareCo operations; U.S. investors may be sensitive about IP being owned directly by CanCo and being outside the \u201creach of the U.S.\u201d, thus requiring a sophisticated agreement between the two sister corporations regarding the use and licensing of the IP. \u00a0IP licensing issues can also give rise to certain transfer pricing issues under Canadian and U.S. tax laws; therefore, careful planning is paramount.\u00a0<\/p>\n Ultimately, while there are operational and financial gains to be made when undertaking cross-border operations, every CanCo has its own needs and special requirements.\u00a0Therefore, it is prudent to seek out specialized professional advice for legal, tax, and accounting issues to determine which cross-border structure is the most effective for your particular circumstances because each Canadian tech start-up has its own unique parameters.\u00a0<\/p>\n\n