Outsourcing to Canada:

General Legal Aspects of Setting up a Business & the Regulatory Environment Robert E. Elliott Charles Todd

The Regulatory Framework Canada is a federal state with three levels of government: • The Federal Government • 10 Provincial and 3 Territorial Governments • Municipal Governments, e.g. Toronto Federal and Provincial laws are each supreme within their own fields of legislative competence

Similar to the US...

…but Different • •

That division of powers is much different than the Federal/State division The applicable law will depend on such factors as the nature of the activity in question, where the transaction is taking place and what the parties have chosen as the law of contract

Quebec • Those seeking to conduct business in Quebec should be aware that it is a civil law jurisdiction, so many of the issues discussed here are not necessarily applicable to Quebec, and in fact many other issues arise when conducting business in that Province • Also, language of business in Quebec is French

Methods of Outsourcing to Canada • Contract with an existing Canadian third-party service provider • Create a Canadian subsidiary of the nonCanadian client • Create a Canadian branch of the non-Canadian client

Canadian Third-Party Service Provider Advantages: • Smoother facilitation of transfer • Highest potential for costs savings, especially in the short term • Knowledge of Canadian legal and business landscape

Canadian Third-Party Service Provider Disadvantages: • Loss of some control • Some loss of value of current operations • Usual contractual uncertainties associated with an outsourcing

Canadian Subsidiary or Branch Advantages: • Maintain full control • Maintain more value in existing operations • Possibility of providing third parties with services

Canadian Subsidiary or Branch Disadvantages: • Higher initial investment • Time and resources required to set up & maintain

Canadian Subsidiary versus Branch • Bringing a branch to Canada is simpler than creating a new corporation, as it only takes extraprovincial registration in whatever province you wish to carry on business in • However, companies generally choose a subsidiary for organizational purposes, and to avoid Canadian liability issues flowing back to the non-Canadian entity • There are also tax differences (discussed later)

Incorporating a Subsidiary • Federal incorporation under the Canada Business Corporations Act (CBCA) • Ontario incorporation under the Ontario Business Corporations Act (OBCA) (or other provincial/territorial incorporations) • Nova Scotia Unlimited Liability Corporation (ULC)

Federal Corporation under the CBCA • More international recognition (“A Canadian Corporation”) • More stringent name requirements to satisfy • However, easier to move around the country after incorporation as provinces recognize Federal name requirements and ease their own search process • 25% of directors (or at least 1 director as the case may be) must be resident Canadian

Ontario Corporation under the OBCA • Quick registration process • Less stringent name requirements (i.e. no exact matches, but otherwise anything goes) • Can still carry on business anywhere in Canada, but will have to register as extraprovincial corporation outside of Ontario and undergo stringent name searches

Nova Scotia ULC • •

• •

Only jurisdiction that offers this entity in Canada Like OBCA and CBCA company, can still carry on business anywhere in the country upon extraprovincial registration Directors need not be residents of Nova Scotia or Canada Favoured by US companies because of its numerous US tax advantages

Nova Scotia ULC • Specifically, the ability to flow through losses (as they not treated as a separate corporate entity like a subsidiary) • However, recent changes to the Canada-U.S. Tax Convention could have a significant impact on those advantages, so anyone contemplating a ULC should speak to a tax expert before moving forward

General Canadian Taxation • Canadian residents taxed on world-wide income • Non-resident (“NR”) corporations subject to CDN income tax if they carry on business in Canada • Under Canada’s tax treaties, even if you carry on business in Canada, CDN tax liability eliminated if you don’t carry on business through permanent establishment situated in Canada • Certain withholding taxes on repatriation from Canada • Always consider Goods and Services Tax (GST) and any Provincial Sales Taxes • There are certain potential withholding tax issues re: NR persons performing services in Canada

Taxation: CDN Third-Party Service Provider • NR corporation should not be considered to be carrying on business in Canada if: • Arm’s-length CDN service provider • Non-core services (i.e. accounting and clerical) performed by CDN service provider for NR corporation • CDN service provider not an agent and cannot contract in name/on behalf of NR corporation • NR corporation not involved in day-to-day management/decisions of CDN service provider

Taxation: Canadian Subsidiary • NR corporation should not be considered to be carrying on business in Canada if: • Arm’s length fee charged (also transfer pricing issue) • Subsidiary cannot be agent of NR corporation i.e. has no authority to contract in name/on behalf of NR corporation • Non-core services performed in Canada • CDN corporation pays its own employees • CDN corporation not a mere “extension” of NR corporation

• CDN subsidiary still subject to Canadian tax

Taxation: Canadian Branch • If a branch is deemed to be carrying on business in Canada, the NR corporation will be subject to CDN Tax on CDN operations • Whether or not carrying on business will depend on nature of NR business and nature of services/activities performed in Canada • Important for CDN services/activities to be ancillary to main business and/or of a preparatory or auxiliary character • No profit-making contracts/activities in Canada • Minimize presence in Canada to extent possible

Human Resource Issues • The transfer of employees from current operations to the new service provider is often necessary and can be complicated in the cross-border scenario • It could be a small number of key employees moving to the Canadian third-party service provider, or • A large number of those formally employed by NonCanadian Parent moving to a new Canadian subsidiary or branch

Human Resource Issues • First, immigration requirements need to be addressed as soon as practicable after a decision is made to transfer employees, to ensure work permits are viable • The differences between Canadian and U.S. labour laws also need to be considered, e.g. there is no concept of “employment at will” in

Canada, so notice (or money in lieu of notice) will be required to terminate employees here • Even if individuals are employed by the US-based company, but are resident in Canada, all applicable Canadian labour laws will have to be observed, such as employment, health and safety standards, workers compensation legislation, human rights legislation, employment equity statutes or pension regulations

Human Resource Issues: Pensions • If a defined benefit plan is involved, pensions can be a complicated aspect of transferring existing employees to a new entity, both actuarially and legally • Employer-sponsored pension plans are not required by law in Canada, but if one exists or is created it would be subject to regulation and apply to both full and part-time employees • Conceptually, Canadian pension regulation is similar to that in the U.S., though the details and vehicles are different

Typical Intellectual Property Issues • Outsourcing will often involve the transfer and/or creation of valuable intellectual property • General principles of copyright, patent and trademark law apply in Canada, so the normal precautions for transfer of such rights need to be taken.

However...

We have “Moral Rights” • In Canada we also have the concept of moral rights, so anyone involved in the creation of computer software, for example, has moral rights in it and can block certain usages of that work product in the future • So, companies need to ensure they secure express waivers of moral rights in any software they are bringing to Canada, or that employees are creating here

Financial Services Regulatory Issues • General prohibition on non-Canadian or “foreign banks” and entities associated with them carrying on business activities in Canada, unless they are permitted under the Bank Act • Definition of a “foreign bank” is very broad • Before non-Canadian financial institutions groups consider establishing business operations in Canada through a branch or a subsidiary, Canadian regulatory advice should be sought

Financial Services Regulatory Issues • Foreign banks and entities associated with them may need one or more regulatory approvals from the federal Minister of Finance to carry on business activities in Canada • Some foreign banks qualify for an exemption order, others for a designation order under the current legislation • Some foreign bank groups may require an approval to engage in data processing activities in Canada; some groups may require an approval to engage in certain information services and Internet related activities, and investment thresholds may apply

Financial Services Regulatory Issues • Legislative amendments to the Bank Act may come into force within months, which will impact on approval requirements • If approvals are required, they can take 8 weeks or more from the time a complete application is submitted to the Office of the Superintendent of Financial Institutions (“OSFI”) to obtain the ministerial approval

OSFI Outsourcing Guidelines • If a service provider is looking to contract with a Canadian federally regulated financial institution (bank, branch of a foreign bank, trust or loan company, insurance company or branch of a foreign insurance company) (“FRFI”), they should understand the contractual requirements the FRFI must consider when outsourcing to a service provider

OSFI Outsourcing Guidelines • OSFI expects FRFIs to meet certain minimum requirements when they undertake “material” outsourcings to third party service providers • Comprehensive due diligence on service provider to assess the risk of the outsourcing • Contracts must deal with issues such as the scope of the service, performance indicators, reporting requirements to assess performance, dispute resolution procedures, defaults and terminations, contingency planning, audit rights for the FRFI or its auditor (and the regulator)

Canadian Privacy Framework • The private sector privacy regime in Canada is composed of Federal legislation (the Personal Information Protection and Electronic Documents Act - PIPEDA) and provincial legislation in BC, Alberta and Quebec (leaving aside personal health information legislation) • Generally, these privacy acts are indifferent as to whether the subject individuals, or the collecting/using/disclosing organizations, are Canadian • Rather, the nexus for their application appears to be whether the activity of collecting, using or disclosing personal information ("PI") occurs in the applicable Canadian jurisdiction

Canadian Privacy Framework • There are some significant differences among the legislation, but all of them effectively contain the following two "pillars" of obligations: • Consent obligations: each organization must obtain consent for their collection, use or disclosure of PI, unless a consent exemption applies • Administrative obligations: each organization is required to appoint a privacy officer, to develop internal privacy policies/procedures regarding their use of PI, to retain the PI for a certain period of time, to respond to access requests, etc. • Penalties can include fines (personally and corporately), and, more significantly, the loss of goodwill resulting from being publicly "named" in a privacy finding