CHAPTER 20:

Domestic and
International Business
Expansion

Prepared by
Matthew Roman, CPA, MTax
KPMG, LLP

Electronic Presentations in Microsoft® PowerPoint®

Copyright © 2021 McGraw-Hill Education Limited

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 Domestic and International Business Expansion

I. Domestic Business Expansion

II. International Business Expansion

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 I. Domestic Business Expansion
• Must attempt to create an expansion structure that will:

– minimize the start-up cash requirements and

– maximize the return of cash to the business for reinvestment.

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 I. Domestic Business Expansion
The following tax considerations are relevant:
1.What will be the annual tax cost on new profits generated
from the expansion?
2.How and when can operating losses during the start-up
period be offset against other taxable income to generate
cash flow?
3.What are the tax implications if the expansion fails and is
discontinued?
4.How can the original capital invested, and accumulated
profits, be returned from the expansion with a minimum
amount of tax?

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 A. Expansion with Existing Resources
Two structural alternatives are available:

1. Operated as a division:
• The expansion activity can be operated as a division of the
existing corporation; or

2. Operated as a separate corporation

• A subsidiary of the parent corporation.

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 Loss utilization
• A major difference between the two structures is the
ability to use any losses in the start-up years:

– Divisional structure – all losses incurred can immediately be

offset against other divisional income.

– Corporate structure – start-up losses can only be used by the

separate corporation. Not available to the other divisions.

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 Expansion failure
• The losses and related obligations will be funded by the
initial capital invested, or

• The losses will require further funding to meet the

obligations.
– Potential losses - limited to the capital invested:
• both structures permit the eventual use of the incurred losses for offset
against other income.
– Potential losses – greater than capital invested:
• Impact of limited liability must be weighed against the after-tax cost of
absorbing the losses.

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 Expansion failure

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 Expansion failure

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 Taxation of expansion profits
• The amount of tax paid on profits can vary depending
on whether:

– A division or a separate corporation is established,

– If the expansion activity crosses provincial boundaries, and/or

– The nature of the expansion profits differs from existing profits.

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 Taxation of expansion profits

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 Taxation of expansion profits

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 Taxation of expansion profits

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 Taxation of expansion profits

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 Repatriation of capital and accumulated profits

• Similar under both structures for domestic expansion that

does not involve new equity participants.

• Separate corporate structure – dividends are normally

distributed tax-free between corporations.

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 Which of the following statements is true concerning
domestic expansion of a business?
A. Cash funding requirements will be lower to establish a
new corporation than a corporate division if the
expansion activity incurs substantial start-up losses.
B. Cash funding requirements will be higher to establish a
new corporation than a corporate division if the
expansion activity incurs substantial start-up losses.
C. Obligations of a new division will have no impact on
the founding corporation.
D. The main advantage of incorporating an expansion
activity is the use of start-up losses from the new
corporation against income from the founding
corporation.
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 Trim Co. is a CCPC based in Province/Territory 1 (PT1).
The company is planning to expand into Province/Territory
2 (PT2). Profits of $100,000 are expected in PT1, and
$25,000 in PT2. The provincial/territorial rates at the time of
the expansion are 12% in PT1 and 11% in PT2. If the
expansion is done through direct sales, what is the tax for
the PT2 operation?
A. $0
B. $2,750
C. $3,000
D. $5,750

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 C Co. is a CCPC based in Province/Territory 1 (PT1). The
company is planning to expand into Province/Territory 2
(PT2). Profits of $100,000 are expected in PT1, and $25,000
in PT2. The provincial/territorial rates at the time of the
expansion are 12% in PT1 and 11% in PT2. If the expansion
is done through a branch location in a permanent
establishment run by personnel from PT2, which of the
following is correct?
A. The profits will be excluded from C Co's income for tax
purposes.
B. The tax rate of PT1 will be applied to the PT2 branch profits.
C. The branch profits for tax purposes may potentially differ
from what is actually earned at the branch.
D. The branch profits will be taxed as a separate legal entity.
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 When a company expands into another province by direct
sales, the provincial income tax is determined by
A. The rate in each province after
splitting the profit according to
sales and payroll.
B. The rate in the original province
where it was established.
C. The rate in each province
according to the profit earned in
each province.
D. The rate in the new province
since it is a new business.

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 What is the major difference between domestic expansion
by setting up a branch in a new province and setting up a
subsidiary company in a new province?
A. Nothing. Both alternatives offer the
same tax treatment of profits and
losses.
B. Losses in a branch can be used by the
company whereas losses in a
subsidiary cannot be used.
C. A branch can be taxed in the province
on its own profits and losses.
D. A subsidiary does not have to pay tax
in the province in which it operates.
The parent company will pay all the
taxes.
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 B. Expansion with New Equity Participants
• Common to require additional financial resources for
expansion opportunities.
• Two strategies:
1. Limited expansion and slow growth; or
2. Rapid expansion through the raising of additional equity from
new participants.

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 B. Expansion with New Equity Participants

• Must choose between alternative business

strategies and
• Then choose between alternative business
structures:
1. Separate corporation
2. Standard partnership
3. Limited partnership

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 Expansion of the small-business deduction
• May be desirable to give more equity for higher after-tax
returns
– A private corporation may consider a structure that increases
the amount of income eligible for the small business deduction.

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 Expansion of the small-business deduction

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 Expansion of the small-business deduction

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 Expansion of the small-business deduction

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 II. International Business Expansion
A. Basic Issues
• Two fundamental approaches to conducting foreign
business operations:
1. Informal Structures: Foreign activity conducted from home
base in the form of direct export sales to consumers or
distributors; or

2. Formal Structures: develop foreign structure that involves a

physical presence in the foreign jurisdiction.

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 II. International Business Expansion
A. Basic Issues
• Formal structures can include the following:
1. A simple branch location.

2. A separate foreign corporation as a subsidiary.

3. A separate foreign joint venture, partnership, or limited

partnership.

4. An advanced, broadly based, foreign structure that includes

foreign holding corporations, finance companies, and sales and
manufacturing entities.
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 Formal Structures

Shareholder Shareholder Shareholder

Corporation Corporation Corporation

Canada

Foreign
Direct Foreign Foreign Country
Sales Branch Corporation

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 Tax Perspective of Expansion
• Main issues are:
1. Extent of tax imposed by the foreign jurisdiction on foreign
business operations?

2. Application of Canadian tax on the foreign business profits?

How can losses on foreign operations be utilized?

3. What tax treatment is applied to transactions between the

foreign operation and the Canadian owner?

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 B. Foreign Currencies
• Foreign exchange gains or losses will occur when
transactions are completed in foreign currencies
• Two questions relating to foreign exchange gains or losses
must be answered:
1. Is the gain or loss a capital item or business income?
2. The timing of the tax – recognized on an accrual basis or
when settled?

• Tax Act is silent on these issues

– Treatment is determined by the underlying transaction(s) that
created it

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 C. Direct Export Sales
• Direct sales are treated as domestic sales,
– Fully taxable in Canada as business income.

• Foreign tax purposes, most foreign countries tax only

those non-residents who “carry on business” in the foreign
country.
– Usually applies to business activity implemented from a
permanent establishment.

• Permanent Establishment is defined as a fixed place to

business through which the foreign business operation is carried
on, it includes a place of management, a branch, an office, or a
factory. a fixed place used solely for the storage, display, or
delivery is deemed not to be a permanent establishment.
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 D. Foreign Branch Location
• The foreign branch location does not constitute a
separate legal entity.
• The tax treatment of profits earned by the foreign
branch location is as follows:
1. Branch profits will be subject to the income taxes applicable in
the foreign jurisdiction.
2. The foreign branch profits form part of the world income of the
Canadian corporation, and are therefore also taxable in Canada
as normal business income.
3. Canadian taxes payable on the business profits of the foreign
branch can be reduced by the foreign tax credit.

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 D. Foreign Branch Location
• One major advantage:
– losses incurred by the foreign branch can immediately be used
to offset profits made in Canada.

• Future profits can be repatriated to the Canadian

corporate owner without further tax consequences.

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 D. Foreign Branch Location

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 D. Foreign Branch Location

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 D. Foreign Branch Location

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 E. Foreign Subsidiary Corporation
Business profits are subject to the following tax
treatment:
1. Subsidiary is subject to income taxes of the foreign country.

2. Foreign corporation is not subject to Canadian tax on business

profits earned within the corporation.

3. After-tax profits can be distributed to the Canadian parent

corporation as a dividend.

4. Most countries impose a special tax on dividends paid to a

foreign shareholder.
• The tax is withheld and remitted to the foreign jurisdiction.
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 E. Foreign Subsidiary Corporation

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 E. Foreign Subsidiary Corporation

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 E. Foreign Subsidiary Corporation

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 F. Alternative Cash Flows from a Foreign
Subsidiary
• Foreign entity often requires significant support by the
home-based entity.
Canadian
Corporation
Capital Interest
Equipment Rent
Technology Royalties
Management Management fees
Foreign
Corporation

• Foreign countries impose a special withholding tax on

such payments to non-residents.

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 F. Alternative Cash Flows from a Foreign
Subsidiary

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 G. Foreign Tax Credit (FTC)
• FTC affects the taxation of
– Foreign branch income and
– Payments from a subsidiary of:
• Dividends,
• Interest,
• Rent and royalties, and
• Management fees are
• The foreign tax credit is designed to limit the total tax to
an amount that is no greater than the one imposed by the
country with the higher rate of tax.

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 H. Intercompany Transfer Pricing
• Whenever there is a difference in tax rates between the
Canadian parent corporation and the foreign subsidiary
corporation,
– Creates a desire to shift profits to the country with the lowest
tax rate.

• Canadian tax law uses a reasonableness test with

respect to the pricing of goods sold to foreign subsidiary
corporations.
– Deemed to have been sold at a price that would reasonably
have been expected in arm’s length transactions.
– Cost plus method, a reasonable markup over the vendor's
actual cost pf the product sold.
– Resale price method, starts with the foreign subsidiary's
ultimate customer selling price and works backward by
deducting appropriate profit margin.
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 I. Converting a Foreign Branch to a Foreign
Subsidiary
• Foreign business expansion often involves a progression
from one structure to another.

• The conversion to a foreign subsidiary involves a transfer

of assets.

• Foreign-branch assets are transferred ONLY at FMV;

– Results in Canadian tax if FMV > Tax Cost

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 In the Canada-U.S. tax convention, the definition of a
'permanent establishment' does not include

A. A place of management
B. A factory
C. A storage facility
D. An office

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 R Co. is a Canadian corporation which plans to expand
internationally. The company has decided to establish a
branch in a foreign country. Which of the following is not an
impact of the international expansion?
A. The profits of the branch will be
subject to income tax in the foreign
country.
B. The branch profits will be included in
the Canadian corporation's worldwide
income.
C. A foreign tax credit can reduce the
Canadian taxes payable.
D. If the foreign country has a lower tax
rate, a tax benefit will be recognized.

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 B Co. is a Canadian corporation which plans to expand
internationally. The company has decided to establish a
wholly owned foreign subsidiary corporation in another
country. Which of the following is not an impact of the
international expansion?
A. The subsidiary will be subject to taxes in the foreign country.
B. The subsidiary's profits will be included in the Canadian
corporation's worldwide income.
C. Dividends received by the Canadian corporation from the
foreign subsidiary are excluded from the Canadian
corporation's taxable income.
D. Dividends received by the Canadian corporation from the
foreign subsidiary are most often subject to a withholding tax
in the foreign jurisdiction.

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 Acceptable intercompany transfer pricing methods between
a Canadian parent and its foreign subsidiary corporations
include all but which of the following?
A. Comparable arm's-length
selling price method
B. Profit-margin method
C. Resale price method
D. Cost-plus method

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 Which of the following is a correct statement and an
advantage for utilizing a branch structure for an
international expansion?
A. The losses of the branch may be
applied against the income of the
parent corporation.
B. Foreign branch taxes may apply to
the branch profits.
C. Dividends are paid from the branch
to the parent company.
D. The branch profits will be taxed at a
lower rate if the foreign jurisdiction
has a lower tax rate than that of
Canada.

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 Which of the following is a correct statement and a positive
aspect to operating a foreign subsidiary?
A. The losses of a subsidiary may be applied
against the income of the parent
corporation.
B. Dividends may flow tax-free from a foreign
affiliate to the Canadian corporation.
C. The profits of the subsidiary will be taxed at
a higher rate if the foreign jurisdiction has a
higher tax rate than that of Canada.
D. Losses incurred in the foreign subsidiary
cannot be applied against the parent
corporation's income.

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 Which of the following is a correct statement and a
downside to operating a foreign branch?
A. The losses of the branch may be applied
against the income of the parent
corporation.
B. If the foreign tax rate is higher than the
Canadian tax rate, the foreign branch
income will be taxed at the higher rate.
C. Dividends are paid from the branch to the
parent company.
D. The branch profits will be taxed at a lower
rate if the foreign jurisdiction has a lower
tax rate than that of Canada.

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 Foreign Co. is a subsidiary of Can Co., a Canadian
corporation. Foreign Co. earned $100,000 in Year 1. The tax
rate in the foreign jurisdiction is 25% and the withholding
tax rate on dividends paid to Can Co. is 5%. The Canadian
shareholders pay tax of 35% when the income is distributed
as eligible dividends. How much is the after-tax cash paid to
the shareholders? (Round your final answer to the nearest
whole dollar.)
A. $24,938
B. $26,250
C. $46,313
D. $48,750

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 Foreign Co. is a subsidiary of Can Co., a Canadian
corporation. Foreign Co. earned $100,000 in Year 1. The tax
rate in the foreign jurisdiction is 25% and the withholding
tax rate on dividends paid to Can Co. is 5%. The Canadian
shareholders pay tax of 35% when the income is distributed
as eligible dividends. What is the effective tax rate of the
foreign income? (Round your final answer to the nearest
whole number.)
A. 25%
B. 30%
C. 54%
D. 65%

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 Collab Co. would like to expand its operation into the
United States to take advantage of the lower taxes in the
U.S. How must Collab Co. structure its operation to do that?
A. Direct sales into the US
B. Set up a warehouse in the
U.S. from which to ship the
goods sold by Canadian
salespeople.
C. Establish a foreign branch
office in the U.S. and hire
U.S. salespeople .
D. Incorporate a separate U.S.
company

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 Tulip Co. is a subsidiary company of Jasmine Co., which is
a U.S. company. Tulip Co. relies on Jasmine Co. for
management services. A reasonable management fee would
be
A. Any fee to reduce Tulip Co.'s
taxable income.
B. A fee that reflects the work
done at an acceptable rate.
C. A fee that is negotiated
between the two companies.
D. a fee that reflects the fair
market value of the services.

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