Magazine article The Journal of Lending & Credit Risk Management

Breaking the Barriers between the U.S. and Canada

Magazine article The Journal of Lending & Credit Risk Management

Breaking the Barriers between the U.S. and Canada

Article excerpt

The state of Washington and the province of British Columbia enjoy a strong relationship from a business and a cultural perspective. The major cities in each, Seattle and Vancouver, are on the water and near the mountains. Both cities have populations of around 2 million and both are very livable. Tourism is important to both; each city attracts more than 6 million visitors annually.

Trade between the two regions is at an all-time high level and growing rapidly, as are economic ties. This growth has been facilitated by reduced duties and tariffs resulting from the North American Free Trade Agreement (NAFTA). Canadian firms are expanding their business in the U.S. by opening branches or subsidiaries in Washington State, and U.S. firms, particularly large retailers, are also moving into Canada.

Business Structures

The predominant business structure in both Canada and the U.S. is the regular corporation. Partnerships are also used, more so in the U.S. than in Canada. Two special corporate forms found in the U.S. are the limited liability corporation (LLC) and the sub-chapter S corporation.


Partnerships are conduits or pass-through entities in both countries. They are not taxable entities. Their income and other attributes pass through to each partner in relation to that partner's ownership share. Each partner's share of the partnership income must be included in the partner's own tax return.

Limited Liability Corporation

A recent development in the U.S. is the recognition of the LLC by federal and most state authorities, including Washington State. An LLC has the liability protection of a corporation, yet it is taxed like a partnership: no tax at the LLC level, with income or losses passed through to a shareholder. Since another corporation can be a shareholder of an LLC, this structure is often very helpful when a Canadian company is buying part of a U.S. company. Banks should be careful with dividend covenants when lending to an LLC because owners usually need distributions to pay their taxes.

Subchapter S Corporation

This corporate entity, named after the subchapter S of the U.S. tax code, has been in existence for many years. Like the LLC, it provides the protection of the corporate veil with pass-through taxation to the shareholder. The number of shareholders is limited, and a corporation cannot be a shareholder.


A Canadian company can operate in the U.S. as a branch. A 30% tax rate is imposed by U.S. tax authorities on the profits of a branch.

Lending Structures

There are four basic structures available for cross-border lending. For example, if a Canadian parent corporation desires financing from a Canadian bank for a subsidiary in the U.S., the following options are available to the Canadian bank:

1.Make a direct loan to the U.S. subsidiary of the Canadian corporation. To compensate for withholding tax, the bank will need to require that loan payments be "grossed up," or increased, to reimburse the bank for taxes withheld.

2. Have a U.S. branch of the Canadian bank make a loan to the U.S. subsidiary.

3. Make a loan to the Canadian corporation, which will then lend, or "downstream," the funds to its U.S. subsidiary. However, in the U.S., both state laws and federal bankruptcy law allow a subsidiary's guaranty of parent debt (whether or not the guaranty is secured) to be set aside unless the subsidiary has sufficient net worth to cover the guaranty or except to the extent the subsidiary demonstrably receives value from the bank.

4. Issue a guaranty or letter of credit to support a loan to the U.S. subsidiary of the Canadian corporation by another lender in the U.S.

These four key lending structures are also applicable if the locations of borrower and lender are reversed. The major difference is that Canada does not restrict the upstream guaranties of a subsidiary for a loan to a corporate parent. …

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