As in the case of the United States, Canada has experienced growth in the formation of both closed-end and open-end investment companies.
A certain number of closed-end companies were organized in the 1920s. The first open-end company was formed in 1932 by Calvin Bullock, an American firm. Since that time other open-end companies were formed which were aimed, for the most part, at satisfying the investment objectives of Canadian investors. In 1952 a number of open-end funds that specialized in Canadian securities were organized for distribution to investors in the United States. The earliest of these funds differed from their American counterparts only in this specialization in Canadian stocks and bonds.
Late in 1953 a new kind of fund was approved by the Securities and Exchange Commission (SEC) for sale in the United States. These funds would retain and reinvest earnings rather than pay dividends, thereby affording substantial tax advantages to United States investorsparticularly those in high income tax brackets, who could forego current income in the expectation of capital gains. The major requirements imposed upon these non-resident owned (NRO) companies were (and still are) that they be incorporated and operated in Canada but be at least 95 percent owned by non-Canadians. Securities and cash owned by the fund were required by the SEC to be kept in the United States. At the end of 1959, the combined total assets of the nine NRO companies then in existence amounted to $396 million.
What are the various tax advantages that these companies can offer?
1. Since no dividends are paid, so long as a United States citizen retains his shares no United States tax liability is incurred.
2. If these shares are held for at least six months, profits on liquidation are not taxable at ordinary income rates but at the lower capital gains rate.
3. Under Canadian law, capital gains are not regarded as taxable items of income.
4. The NRO companies can choose between two tax treatments:
- They can pay a 15 per cent tax on all net investment income, and there will then be no further tax liability to the Canadian government by the fund
- The company can pay the regular Canadian corporate tax rate of 21 percent on the first $25,000 earned and 50 percent on the balance exclusive of all dividends. Dividends received by Canadian corporations from other tax-paying Canadian corporations are not taxable. If this latter choice is made, an investor must pay a 15 percent Canadian withholding tax on whatever portion of his proceeds represent undistributed dividend income of the fund.
Despite the tax advantages mentioned, the great stock of natural resources, and the reasonable expectation of considerable long-term economic growth in Canada, the recent down-drift of the Canadian economy has made it difficult for the NRO companies to meet earlier expectations. It must be remembered that the investor in NRO funds has to be able to forego current income and that he must be willing to assume the inherent risks of investing in any growth situation.
The thought of investing in a tax-free foreign entity can be incredibly enticing, but there are certain strings attached with any foreign investment. As always, the investor must do plenty of research on current laws and regulations before safely investing in any foreign NRO or other enterprise.