Branch Profits Tax Explained for Canadian Companies
The second-level tax on U.S. branch earnings, the treaty's 5 percent rate, and why most Canadian companies choose a subsidiary
Reviewed by the Fairlight Accounting cross-border tax team — U.S. & Canadian Tax Desks
The branch profits tax is a 30 percent U.S. tax on a foreign corporation's U.S. branch earnings not reinvested in the U.S. business — the dividend equivalent amount. It mirrors a subsidiary's dividend to a foreign parent. The Canada–U.S. treaty cuts the rate to 5 percent and exempts the first C$500,000 of cumulative earnings.
On this page
How it works
| Step | What happens |
|---|---|
| 1. Effectively connected earnings | The branch's U.S. profits are taxed at the 21 percent corporate rate on Form 1120-F |
| 2. Dividend equivalent amount | After-tax earnings, adjusted for the change in the branch's U.S. net equity — earnings reinvested in U.S. assets reduce it, withdrawals increase it |
| 3. Branch profits tax | 30 percent of the dividend equivalent amount — 5 percent under the Canada–U.S. treaty, with the first C$500,000 of cumulative earnings exempt (a lifetime amount shared with associated companies in the same or a similar business) |
| 4. Branch-level interest tax | Interest the branch deducts above the interest it actually pays is treated as paid to the Canadian company by a U.S. subsidiary (section 884(f)) — 30 percent by statute, 0 percent under the treaty's interest article (Article XI) for a qualifying Canadian company |
Branch or subsidiary?
| U.S. branch | U.S. subsidiary | |
|---|---|---|
| U.S. corporate tax | 21 percent on effectively connected income | 21 percent on taxable income |
| Second-level tax | Branch profits tax (5 percent with the treaty) | Dividend withholding (5 percent for a 10 percent parent under the treaty) |
| Losses | Pass to the Canadian parent's return | Stay in the subsidiary |
| Liability | The whole Canadian corporation | The subsidiary only |
| Canadian tax on profits | Taxed in Canada, with a foreign business-income tax credit for the U.S. tax (Income Tax Act s. 126(2)) | Dividends from exempt surplus generally received tax-free |
Most Canadian companies with a U.S. permanent establishment choose a subsidiary — the liability wall and the exempt surplus treatment outweigh the branch's start-up loss benefit (the Canadian company expanding to Florida guide).
Who it catches unexpectedly
A Canadian company that forms a U.S. single-member LLC — disregarded in the United States — has a U.S. branch for tax purposes, with Form 1120-F and the branch profits tax (the Canadian resident owning a U.S. LLC guide's corporate version). Because Canada treats the LLC as a corporation, the treaty's hybrid-entity rule (Article IV(7)(a)) can deny the 5 percent rate and the C$500,000 exemption, leaving the 30 percent statutory rate.
Frequently asked questions
What is the branch profits tax rate for a Canadian company?
5 percent under the treaty (30 percent by statute), on the dividend equivalent amount, with the first C$500,000 of cumulative earnings exempt.
What is the dividend equivalent amount?
The branch's after-tax U.S. earnings, adjusted for changes in its U.S. net equity — earnings kept invested in the U.S. business aren't taxed until withdrawn.
Does a U.S. LLC owned by a Canadian company pay branch profits tax?
Yes, if it's disregarded — the LLC is a U.S. branch of the Canadian parent for U.S. tax, and the treaty's hybrid-entity rule can leave it at the 30 percent statutory rate rather than 5 percent.
Is a subsidiary always better?
Usually, for liability and Canadian surplus reasons; a branch can make sense for a U.S. operation that will lose money for several years.
Official sources
The IRS instructions for Form 1120-F state: “A foreign corporation should also file a protective return if it determines initially that it has no U.S. tax liability under the provisions of an applicable income tax treaty (for example, because its income is not attributable to a permanent establishment in the United States).” — Internal Revenue Service, Instructions for Form 1120-F (2025), https://www.irs.gov/instructions/i1120f
IRS Publication 597 states: “This publication provides information on the income tax treaty between the United States and Canada. It discusses a number of treaty provisions that most often apply to U.S. citizens or residents who may be liable for Canadian tax.” — Internal Revenue Service, Publication 597 (10/2015), Information on the United States–Canada Income Tax Treaty, https://www.irs.gov/publications/p597
Next step
Fairlight Accounting is a cross-border accounting and tax practice with a U.S. Tax Desk and a Canadian Tax Desk. Our U.S. Tax Desk and Canadian Tax Desk handle branch versus subsidiary modeling, Form 1120-F and branch profits tax computations, treaty exemption tracking, and U.S. entity structuring for Canadian companies. See pricing or book a call.
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