NVCA Today

In March 2010, Canada’s Federal Government announced much anticipated changes to the country’s investment infrastructure. A long-awaited change to Canada’s Income Tax Act was adopted in the Budget, granting a more favorable tax treatment of U.S. and other foreign investors. Under the new law, the rules governing the flow of capital from U.S. and other foreign venture capitalists, private equity groups, and institutional investors are simple, easy, and clear-cut. U.S. venture capitalists have a new incentive to re-examine the attractiveness of investing in Canadian technology.

Former State

Under the previous tax regime, non-residents of Canada were required to pay tax on the sale of ‘taxable Canadian property,’ which included shares of Canadian private companies. Purchasers of taxable Canadian property were also required to withhold and remit a portion of the purchase to the Canada Revenue Agency. If the investor was from a country having a tax treaty with Canada, essentially providing a tax exemption, the seller could have obtained a ‘Section 116’ certificate to forgo paying tax on the sale. In the case of a U.S. venture capital fund, the Canada Revenue Agency required an application for every individual investor in the fund. This particular requirement created a tremendous bureaucratic burden, as many venture funds can be comprised of hundreds, and in some cases, thousands of individual investors. Compounding the problem further, Canada’s Income Tax Act required 25% of the gross sale proceeds to be withheld by the buyer from the outset until the Section 116 clearance certificate was granted, and the proceeds released to the foreign investor. When withheld proceeds were in stock of a listed public company buyer, the stock value was in risk of plummeting if during the long wait there was a decline in public markets – potentially adding an additional cost to the transaction, that is, liquidity risk as a result of withholding the proceeds until the release of the Section 116 certificates. Because of the aforementioned administrative barriers and additional risk of delay, foreign investors faced tremendous disincentives to investing in Canadian companies. Simply put, the cost of complying with Section 116 was too high. This is no longer the case.

Looking Ahead

The delivery of Budget 2010 spelled a revised treatment for foreign investors. The definition of taxable Canadian property was amended such that equity interests in Canadian private corporations, partnerships, and trusts are excluded, unless more than 50 percent of the value of such equity (or during the 5-year period preceding the sale) is derived from Canadian real property. Dispositions of investments in Canadian companies that do not hold Canadian real property are no longer subject to Canadian tax, and the withholding tax and clearance certificate regime is no longer applicable. These amendments apply to dispositions made after March 4^th, 2010.

The modifications to Section 116 have opened the door to U.S. investors wanting to easily invest in Canadian technology companies. With many Canadian companies reaching key milestones in 2010, the race for the next Biovail and Research and Motion is on.

Also earlier this year, the Canadian government made a public commitment to implement the lowest statutory corporate income tax rate in the Group of Seven (G7) nations by 2012. Canada is expected to have an overall tax rate on new business investment that is the lowest in the G7 and below the average of the Organization for Economic Co-operation and Development (OECD). Budget 2010 builds on these fiscal measures, sending a strong message to U.S. and other foreign venture capitalists, private equity groups, and institutional investors: Canada is open for business.

Peter A. Brenders is president and CEO of BIOTECanada, the national industry association representing the Canadian biotechnology sector.