Canada Now Somewhat Less Anti-Startup

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Canada isn’t shy about making life difficult for startups, and we’ve had one or two personal brawls with the country as well. But a change in Canadian tax law last week is designed to spur U.S. venture investments in Canadian startups and make Canada less of a leper colony for tech entrepreneurs.

The change allows foreign investors in most Canadian startups to avoid “literally hundreds of pages of documents” to be filed and processed on a sale of a startup, sometimes by each limited partner in a venture fund. That burden meant that most venture firms simply ignored the Canadian market, says Deloitte:

A 2007 survey by Deloitte and Canada’s Venture Capital & Private Equity Association (CVCA) of 528 VCs from around the world found that 40% of U.S. respondents and 28% of global respondents cited Canada’s unfavourable tax environment as a key reason for not investing in Canadian companies. This level of concern is five times higher than for any other country in the survey and reflects the current investment crisis within Canada’s venture capital industry. The survey also found that Canada is attracting the attention of just 11% of U.S. VCs as a primary country for expansion — behind China (34%) and India (24%).

“I predict that over time this farsighted tax legislation will help propel Canada’s extraordinary technology into global industry leadership in numerous markets, and will likely be viewed in the future as a defining moment for the Harper government in Canadian innovation,” says Stephen Hurwitz, a partner at U.S. law firm Choate Hall & Stewart.

That may be a bit optimistic, but the tax change is a nice start. Perhaps over time our frozen neighbors to the north will be known for being great at something more than playing hockey and eating poutine. A robust startups community would be very welcome.

More information:

Change in tax law sends a strong signal to international investors that Canada is “open for business”

Government removes tax barriers and stimulates flow of capital across Canadian border

TORONTO, March 4, 2010 — Canadian companies across the country are likely applauding today’s federal budget, which contains tax law changes that give them the advantage they need to compete on the global stage.

By amending the definition of “taxable Canadian property” to exclude shares of Canadian private companies (where not more than 50% of their value is derived from real property in Canada, Canadian resource property or timber resource property), the government has significantly reduced administrative and, in some cases, economic barriers to foreign investment in Canadian-based innovation and technology. This change puts Canada at the top of the list of places to invest globally.

“The changes in tax legislation announced in today’s budget are among the most significant changes to capital gains taxation since the introduction of taxation of capital gains in 1972,” explains John Ruffolo, Global Tax Technology, Media & Telecommunications Leader, Deloitte. “The Canadian government has listened to the financing community, understood the severity of the problem and removed the major tax barriers that have prevented critically needed international investment capital from crossing our borders.”

“At a minimal cost to the government, this amendment will have an immediate, positive and direct impact on Canada’s ability to grow a robust Canadian technology industry,” explains Terry Matthews, Chairman, Wesley Clover. “By sending a clear message to international investors that Canada is “open for business”, the government will make Canadian companies more attractive to foreign investors overnight. This will help Canadian companies raise the capital they need to achieve global leadership status.”

The change means a much more welcoming environment for foreign investors. In the vast majority of cases, non-residents who were not taxable on the disposition of their investments in such shares due to Canada’s broad international tax treaty network, are now exempt from tax under Canadian domestic law without having to apply for treaty relief. As a result, they are no longer required to comply with the Section 116 tax clearance certificate procedure or file a Canadian income tax return. The changes also remove what were perceived to be insurmountable barriers for many venture capitalists who considered the previous administrative requirements and economic delays for each investor to be strong deterrents to investing in Canada.

“The removal of the Section 116 tax barrier is a tax master stroke by the Canadian government enabling Canada’s emerging technology companies to access deep pools of international capital and the vast global customer markets to which those pools are connected,” notes Stephen Hurwitz, Partner, Choate Hall & Stewart LLP in Boston. “I predict that over time this farsighted tax legislation will help propel Canada’s extraordinary technology into global industry leadership in numerous markets, and will likely be viewed in the future as a defining moment for the Harper government in Canadian innovation.”

BACKGROUND INFORMATION ON THE SECTION 116 TAX BARRIERS

The following describes the tax barriers that were removed in today’s budget and that are no longer preventing international investment in Canada:

• Withholding and Section 116 certificate process — The overwhelming majority of foreign VCs are not subject to Canadian tax when they sell an investment, but face a delay of many months to work through the Section 116 tax clearance process until funds can freely flow to them. Many foreign VCs are structured such that each of the investors in the VC — sometimes hundreds or even thousands — is subject to this clearance process as if they held the investment directly. This delay results in lower returns and frequently causes direct financial loss to investors. Canadians who invest in the United States, the United Kingdom and other major global markets do not face such taxes or delays from red tape.

• Requirement to file Canadian tax returns by foreigners who don’t owe taxes creates hundreds of pages of unnecessary paperwork — Canada imposed tax filing requirements in circumstances where no taxes were payable by these investors. When a foreign VC sells an investment, each investor of the foreign VC has to file a Canadian tax return even if they don’t owe any taxes. This results in literally hundreds of pages of documents that are required for signature and processing for a single sale. This tax return filing issue also applies to certain Canadian public companies.

Why Canada was perceived by VCs as having an unfavourable tax environment
A 2007 survey by Deloitte and Canada’s Venture Capital & Private Equity Association (CVCA) of 528 VCs from around the world found that 40% of U.S. respondents and 28% of global respondents cited Canada’s unfavourable tax environment as a key reason for not investing in Canadian companies. This level of concern is five times higher than for any other country in the survey and reflects the current investment crisis within Canada’s venture capital industry. The survey also found that Canada is attracting the attention of just 11% of U.S. VCs as a primary country for expansion — behind China (34%) and India (24%).

About Deloitte Canada’s tax practice
With the largest tax practice in the country (over 1,500 professionals in 44 offices), Deloitte offers a full suite of tax services to clients in all industries across the country. The market leader in shaping the “future of tax”, Deloitte influences Canadian tax policy with the goal of creating a business climate which propels corporate growth and furthers Canada’s international competitiveness. Known for its industry-leading expertise, Deloitte’s tax practice sets the standard of excellence in Canada and is the only Big Four professional services firm in the country to receive a Tier 1 ranking in the prestigious International Tax Review (ITR)’s “World Tax 2010” report. For further information on Deloitte’s tax practice, visit http://www.deloitte.ca and for further information on the “future of tax”, visit http://www.thefutureoftax.ca.

About Deloitte
Deloitte, one of Canada’s leading professional services firms, provides audit, tax, consulting, and financial advisory services through more than 7,700 people in 58 offices. Deloitte operates in Québec as Samson Bélair/Deloitte & Touche s.e.n.c.r.l. Deloitte & Touche LLP, an Ontario Limited Liability Partnership, is the Canadian member firm of Deloitte Touche Tohmatsu. Deloitte refers to one or more of Deloitte Touche Tohmatsu, a Swiss Verein, and its network of member firms, each of which is a legally separate and independent entity. Please see http://www.deloitte.com/about for a detailed description of the legal structure of Deloitte Touche Tohmatsu and its member firms.

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