Doing business outside Canada: A look at foreign Taxes and Law
(As originally appeared in Canadian Mining Journal, December 2010)
By James McDonald, Senior Manager, Tax, Ernst & Young LLP
When doing business outside of Canada, it’s all too easy to forget that people in different countries don’t necessarily do things the same way. They have different laws, different cultures, and often different priorities. While it might seem obvious in hindsight, companies considering setting up foreign operations need to understand these nuances and face any potential challenges head on.
Before establishing operations outside of Canada, whether by way of grassroots exploration or acquisitive expansion, companies need to establish a proper understanding of the tax and legal implications of operating a business in a foreign jurisdiction and equip themselves with the necessary resources to get the job done right.
As with so many other things in life, getting it right the first time provides the greatest benefits. In particular, companies will avoid spending valuable management and administrative resources putting out fires, to the detriment of current issues.
For example, the failure to adequately plan prior to commercial discovery of “the shiny stuff” (or “gooey black stuff” in the case of oil) can effectively prevent post-discovery corporate reorganizations due to increased values of mineral properties and the risk of triggering capital gains tax in the operating jurisdiction. To further illustrate these recommendations, we need to look no further than Colombia. Over the past few years, mining in Colombia has become one of the country’s most important economic sectors. In Canada, many BC, Alberta and Ontario-based mining and oil and gas companies currently hold investments there with development interests gaining momentum every day.
While many jurisdictions require the use of a local subsidiary, this is not the case in Colombia. Indeed the usual and recommended manner for Canadians to invest in Colombia is to set up an offshore holding company (“Holdco”) which in turn establishes another offshore company (“Offshore Co”), usually in the same jurisdiction, which then establishes a branch in Colombia (“branch”).
In the past, both Holdco and Offshore Co typically may have been incorporated in tax havens. Colombia has, however, recently announced that a list identifying countries as tax havens will be issued this year, which will have the effect of bringing into effect a previously enacted law which requires withholding taxes of 33% to be applied to tax-deductible payments made to tax havens. Though this law is not expected to affect the pure holding function (as dividends are not tax deductible payments) – with general anti-tax-haven initiatives in place around the world and the ever-increasing need for commercial substance – we recommend that companies planning to set up in a tax haven consider the merits of other alternatives.
Under current Colombian law the Colombian branch should only be subject to tax on Colombian source income, whereas a Colombian incorporated company would be subject to tax on its worldwide income. In addition, Colombia does not impose a tax on profits which are repatriated by a branch to its foreign head office, whereas it does in the case of dividends declared by a local company to the extent of any untaxed profits.
Finally, Colombia does not tax a sale of shares in a non-resident entity even if the value of those shares is principally derived from a Colombian source, whereas the sale of shares of a Colombian incorporated company would generally attract tax in Colombia unless treaty relief were applicable (Colombia has comprehensive tax treaties with the Andean community, Chile and Spain, and has signed treaties with Canada, Mexico, Portugal, South Korea, and Switzerland, with more under negotiation). Accordingly, Holdco could sell shares in Offshore Co without triggering Colombian tax. In addition, provided certain conditions are met, Canada should also not tax such a disposition, until such time as the profits from the sale are declared back to Canada as a cross-border dividend (and even then appropriate planning may mitigate the Canadian tax).
Colombian companies and branches are required to allocate 10% of their annual net profits to a legal reserve, up to a limit of 50% of the capital of the company or branch. With appropriate allocation of funding to a branch, the branch’s capital for the purposes of this reserve can be controlled, thereby minimising the impact of this requirement. As of December 2008, however, a new type of Colombian corporation was created (a Simplified Share Company or SAS) which, in contrast to other companies, may have one shareholder, and is not required by law to create this legal reserve.
As laws constantly change, keeping abreast of latest developments is imperative for companies doing business beyond their own borders. In June 2010 Canada completed its domestic approval process to implement the Free Trade Agreement with Colombia. Once Colombia has completed its processes, the two Parties can decide when they will come into force. Also, in the global scramble to increase its share of the tax base, on December 30, 2009 Colombia introduced an equity tax equal to 4.8% of a taxpayer’s net worth as of January 1, 2011, payable over a four year period. With appropriate planning, it might not be too late to take action to minimise the impact thereof.