Torys’ Tips™: Cross-Border Funding for Life Science Companies
By Cheryl Reicin and Adam Falconi
If you plan to do business in Canada and the U.S., you may already have (or are planning to set up) an entity in both jurisdictions. When preparing for a cross-border financing round, you will often have to decide whether the investment should be made in your U.S. or Canadian entity. Most commonly, the investments are made at the parent company level.
So, which company should be the parent company, and which should be the subsidiary?
Here are key considerations to weigh:
- Ideally, you will want to determine the appropriate jurisdiction for your parent company when first setting up your business. While you can change the parent company's jurisdiction at the time of a financing round, it is best to do so before there is significant value in the company so that you can avoid adverse tax consequences. For example, if a Canadian company with Canadian shareholders wishes to reorganize so that it has a US parent company, the Canadian shareholders will be subject to tax for the increase in value of their shares when they exchange the Canadian company shares for those in the U.S. company. This tax will be applicable regardless of whether such shareholders sell their shares.
- To receive reimbursable and enhanced Scientific Research and Experimental Development (SR&ED) tax credits, a company needs to be a Canadian-controlled private corporation (CCPC). The rate for. enhanced reimbursable SR&ED credits is 35% federally for qualified expenditures and each province has additional reimbursable tax credits for CCPCs. Although it may be possible to implement corporate structures that allow a company to access enhanced SR&ED credits with a U.S. parent company, this structuring can be complex and costly.
- U.S. shareholders will not be able to access capital gains exemptions under the Qualified Small Business Stock (QSBS) regime if investing in a Canadian entity.
- Canadian shareholders will not be able to access the lifetime capital gains exemptions for Qualified Small Business Corporations (QSBC) if the shares are held in a U.S. corporation.
- Corporate law in Canada is very similar to Delaware corporate law (the jurisdiction of choice for most U.S. corporations), with recent changes in Ontario and Alberta corporate law bringing them even more in line.
- Many cross-border tax-related issues, such as withholding taxes and PFIC status, have been. addressed by changes in laws in both jurisdictions, allowing for less obstacles in doing business.
In addition to determining if investments should be made into your U.S. or Canadian entity, there are several other cross-border fundraising considerations to keep in mind.
U.S. versus Canadian dollars?
- The price of shares and options can be set in either U.S. or Canadian dollars, regardless of where your parent company is. However, using multiple currencies can create accounting complications.
Where should you hold your intellectual property?
- We generally recommend that companies hold their IP (including U.S. patents) outside of the U.S. due to higher U.S. corporate tax rates and the difficulty of moving IP outside of the U.S. at a later date. For these reasons, Canada is generally preferable to the U.S. as an IP holding jurisdiction.
Canada may soon become even more attractive as the Canadian government is currently considering the implementation of an “IP box” regime that would set lower tax rates for income from IP than for other business income.
Differences in Deal Documents?
The Canadian Venture Capital & Private Equity Association (CVCA) has publicly made available model venture capital documents which are based on the U.S. National Venture Capital Association (NVCA) model documents. Therefore, investment deal documentation will be similar whether investing in a Canadian or U.S. entity.
Each company’s situation is unique and so there is not a one size fits all approach to these issues. The analysis of what best works for each company can be complicated and it is important to obtain advice from legal and accounting professionals who are experts in dealing with cross-border issues affecting life science companies. They can guide and assist you in arriving at the best solution for your business.
For more information on the work Torys does to support life science companies, reach out to our team.