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Can you advice on what’s the best way to expand into US if i have a Canadian Corporation. Would an LLC make more sense or a US C-Corp if the Corporation will own shares of US Corp. I heard there are issues with Foreign Tax Credits claim? Also, Any thoughts on 5471 or 5472 Filing that needs to be done along with this?
Hi Ashwin,
Great question — this is one that comes up often for Canadian business owners expanding into the U.S. and wondering whether to set up an LLC or a C-Corporation, and how the Canadian foreign tax credit, section 113(1)(a), GRIP, and eligible dividends all fit together. Let’s go through this carefully.
When a Canadian corporation wants to expand into the United States, it typically has two main options: a U.S. LLC or a U.S. C-Corporation. While LLCs are popular in the U.S. for their simplicity and flexibility, they generally create double taxation problems for Canadians. This happens because the IRS treats an LLC as a flow-through entity, meaning its income is taxed directly to the owner, while the CRA treats that same LLC as a corporation. As a result, income can be taxed once in the U.S. and again in Canada without any foreign tax credit relief under the Canada–U.S. Tax Treaty. For that reason, a U.S. LLC is not recommended when a Canadian corporation is the owner.
In contrast, a U.S. C-Corporation is recognized as a corporation by both tax authorities. It pays its own U.S. corporate tax (currently 21%), and when it pays dividends to its Canadian parent company, those dividends can generally qualify for a foreign tax credit and a treaty-reduced withholding tax rate of 5%, provided the Canadian parent owns at least 10% of the voting shares. This structure aligns perfectly between both countries and avoids double taxation.
On the compliance side, the U.S. C-Corp must file Form 1120 each year, and the Canadian parent must file Form 5471 and a T1134 information return with its T2 corporate return. If an LLC were used instead, it would typically file Form 5472 with a pro-forma Form 1120.
Now, about the section 113(1)(a) deduction, GRIP, and eligible dividends — this is where the integration between U.S. and Canadian tax systems really works in your favour. When your U.S. subsidiary earns active business income and pays U.S. corporate tax, that income becomes part of its “exempt surplus” account under Canadian tax rules. If the U.S. subsidiary then pays a dividend to the Canadian parent, that dividend can be deducted under subsection 113(1)(a) of the Income Tax Act. This means the dividend is not taxed again in Canada, because the underlying profits were already taxed in the U.S.
Even though this dividend is non-taxable in Canada, it still increases the Canadian corporation’s General Rate Income Pool (GRIP). The GRIP represents income that has already been taxed at the higher, general corporate rate, either in Canada or abroad. The CRA treats an exempt-surplus dividend received under 113(1)(a) as equivalent to high-rate-taxed income, so it adds to the GRIP balance.
The benefit of this is that when the Canadian parent eventually pays a dividend to its individual shareholders, it can designate that payment as an eligible dividend. Eligible dividends are taxed at lower personal rates because they come with an enhanced dividend tax credit. In effect, the income that was taxed in the U.S. flows up to the Canadian shareholders efficiently — taxed once at the corporate level abroad and then at favourable personal rates in Canada.
For example, imagine your U.S. subsidiary earns $1 million USD, pays 21% U.S. tax, and distributes the remaining $790,000 as a dividend to your Canadian holding company. That dividend qualifies for the 113(1)(a) deduction, so there’s no Canadian tax on receipt. The $790,000, however, increases the Canadian company’s GRIP, allowing it to pay up to $790,000 in eligible dividends to you personally at a reduced tax rate.
To summarize the flow:
U.S. subsidiary pays U.S. tax → pays dividend to Canadian parent → dividend deducted under 113(1)(a) → GRIP increases → Canadian parent pays eligible dividends to shareholders.
This setup ensures full tax integration and prevents double taxation while taking advantage of both treaty benefits and the Canadian eligible-dividend system.
If you’d like tailored advice based on your current structure and expansion plans, I recommend booking a 30-minute cross-border consultation ($140 + HST) here:
👉 https://madanca.com/contact-us
We can walk through the optimal structure, confirm treaty eligibility, and cover all required filings such as Forms 1120, 5471, and T1134.
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