Incorporating Across the Border: Canadian Corporation, US C Corporation, LLC, or ULC, and Why the Owner's Residence Decides

The question of where to incorporate is usually asked as a question about the business: where are the customers, where is the work done. For a cross-border owner, the answer turns on something else: where the owner is tax resident, because each country's treatment of the other's entities depends on it. A Canadian resident who forms a US LLC is double-taxed; a US resident who keeps a Canadian corporation has a controlled foreign corporation. The entity has to fit the owner first and the business second.

Key takeaways

• Canadian-resident owner: a Canadian corporation (CCPC) for the Canadian business, taxed at the small business rate (about 9% to 12% combined on the first $500,000 of active income) with the small business deduction; a US C corporation subsidiary for US operations if a US entity is needed; never a US LLC owned personally.
• US-resident owner: a US entity (LLC, S corporation, or C corporation) for the US business; a Canadian corporation only if the Canadian business requires it, with Form 5471 and CFC exposure; a Canadian unlimited liability company (ULC) if US flow-through treatment of a Canadian entity is wanted.
• The LLC trap: Canada treats an LLC as a corporation; the US treats a single-member LLC as disregarded and a multi-member LLC as a partnership. A Canadian owner is taxed in the US on the LLC's income currently and in Canada on distributions later, with no matching credit. The treaty's limitation-on-benefits and hybrid entity rules deny treaty benefits to LLCs in some configurations.
• The ULC: an Alberta, BC, or Nova Scotia unlimited liability company is a corporation for Canadian purposes and can be a disregarded entity or partnership for US purposes, giving a US owner flow-through treatment of Canadian income. The treaty's anti-hybrid rule can deny treaty benefits on payments from a ULC to its US parent unless structured carefully.
• Permanent establishment: a Canadian corporation can sell into the US without a US entity if it has no permanent establishment; once it has one (a US office, employees, a dependent agent), it files Form 1120-F on the attributable profits and pays branch profits tax.

The Canadian corporation

A CCPC gets the small business deduction on the first $500,000 of active business income (combined federal and provincial rate about 9% to 12%) and pays the general rate (about 26% to 27%) above it. Investment income inside is taxed at about 50% with a refundable portion. The lifetime capital gains exemption ($1.25 million) shelters gain on qualified small business shares. The CCPC status depends on the corporation not being controlled by non-residents; a Canadian owner who moves to the US ends it, and the corporation becomes a CFC.

For a Canadian-resident owner selling into the US: no US entity is needed unless the business has a US permanent establishment. Below that threshold, the Canadian corporation files a Form 1120-F with Form 8833 to claim treaty exemption (a protective filing, required if any US-source income was reported on a 1042-S) and pays nothing. Above it, the Canadian corporation is taxed in the US on the PE's profits, and a US subsidiary is usually cleaner.

The US C corporation

Taxed at 21% federally plus state tax (Florida 5.5%, Texas franchise tax, California 8.84%, none in a few states). Dividends to a Canadian corporate parent owning 10% or more are withheld at 5% under the treaty and are exempt surplus in Canada; dividends to a Canadian individual owner are withheld at 15% and taxed in Canada with a credit. Form 5472 is required for a 25% foreign-owned corporation's transactions with the foreign owner. The C corporation is the standard vehicle for a Canadian-owned US business.

The LLC

For a US-resident owner, the LLC is the default US entity: flow-through taxation, limited liability, flexibility. For a Canadian-resident owner it is a trap. Canada classifies a US LLC as a corporation (it has separate legal personality and limited liability), so the owner is taxed in Canada only on distributions, as dividends from a foreign corporation without the Canadian dividend tax credit. The US taxes the owner currently on the LLC's income (disregarded or partnership). The US tax paid in year one is creditable in Canada only against Canadian tax on the same income in the same year, and Canada does not tax it until distribution. The treaty's Article IV(6) and (7) rules for fiscally transparent entities can deny treaty benefits on payments to or from the LLC. A Canadian who already has one usually converts it to a C corporation or has a Canadian corporation acquire it.

The S corporation

Not available to a non-resident alien shareholder. A Canadian resident who is not a US person cannot own an S corporation; a Canadian who moves to the US can.

The ULC

Alberta, BC, and Nova Scotia allow unlimited liability companies: corporations for Canadian purposes (taxed as corporations, with shareholders liable for debts on dissolution) that can elect disregarded or partnership treatment for US purposes. A US owner of a Canadian business through a ULC gets flow-through treatment in the US (income taxed on the owner's 1040 with a foreign tax credit for Canadian corporate tax) while Canada taxes the ULC as a corporation. The treaty's Article IV(7)(b) denies treaty benefits on amounts (dividends, interest) paid by a ULC to a US resident where the US treats the ULC as fiscally transparent, so the rates on those payments revert to 25% domestic withholding unless the structure is adjusted (commonly by capitalizing dividends as a paid-up capital increase and then reducing it).

The owner who moves

The entity choice made for a Canadian-resident owner reverses when the owner becomes a US resident: the CCPC loses its status and becomes a CFC (Form 5471, Subpart F, tested income); a US LLC or S corporation becomes available and appropriate. The reverse move (US to Canada) makes an LLC a foreign corporation for Canadian purposes with FAPI exposure and makes the S corporation election terminate if a non-resident alien becomes a shareholder. The move date, not the incorporation date, is the deadline for restructuring.

Worked example

A Toronto software consultant with a CCPC earning $400,000 a year plans to serve US clients and may move to Austin in three years.

• Now (Canadian resident). Keep the CCPC; bill US clients from it; no US PE (no US office or employees); Form 1120-F protective filing with Form 8833 if a 1042-S is issued. If US clients require a US entity, form a Texas C corporation subsidiary owned by the CCPC.
• Avoid. A Texas LLC owned personally.
• At the move. Wind up the CCPC (pay the CDA, distribute the surplus as a dividend) before the departure date, or accept CFC status. Form a Texas LLC or S corporation as a US resident for the ongoing business.
• If the move is uncertain. The C corporation subsidiary is the structure that works in both states of the world; the CCPC above it is wound up or kept depending on the final decision.

Official sources

"It is not controlled directly or indirectly by one or more non-resident persons ... [and] it is not controlled directly or indirectly by one or more public corporations." — Canada Revenue Agency, Type of corporation (Canadian-controlled private corporation), https://www.canada.ca/en/revenue-agency/services/tax/businesses/topics/corporations/type-corporation.html

"[Allowable shareholders] may not be partnerships, corporations or non-resident alien shareholders." — Internal Revenue Service, S corporations, https://www.irs.gov/businesses/small-businesses-self-employed/s-corporations

"Corporations file Form 5472 to provide information required under sections 6038A and 6038C when reportable transactions occur with a foreign or domestic related party." — Internal Revenue Service, About Form 5472, https://www.irs.gov/forms-pubs/about-form-5472

Practitioner note

The entity that fits a Canadian-resident owner is wrong for a US-resident owner, and vice versa, and the owner who does not know which they will be in three years should choose the structure that survives both: a Canadian corporation with a US C corporation subsidiary. The LLC owned by a Canadian is the mistake we unwind most often, and the unwinding is a taxable event.

See also: Planning a move? Start with the Canada-to-US tax checklist and browse every corridor by city, province, and state.

Next step

Fairlight prepares the entity choice analysis by owner residence, the U.S. and Canadian corporate filings, and the restructuring plan when the owner moves. See cross-border pricing or book a call.