Tax laws impact Canada’s VC industry

The Canadian dollar may be strong, but the taxes in the North American country are prohibitive.

A survey released last week by Deloitte, a financial advosry firm in Canada, found that investors worldwide cite Canada’s unfavorable tax environment as a key reason for not investing in Canadian companies. This level of concern is five times higher than for any other country in the survey.

The Global Trends in Venture Capital 2007 Survey, sponsored by Deloitte in cooperation with Canada’s Venture Capital & Private Equity Association and other VC organizations, surveyed 528 VCs worldwide about their foreign investment strategies. The survey found that 40% of U.S. Investors and more than one out of four worldwide respondents said that they consider the Canadian tax structure as an impediment to investing in the Great White North.

Specifically, the survey found that the majority of foreign VCs face a delay of many months to work through the tax clearance process—commonly known as the Withholding and Section 116 Certificate process. In addition, many foreign VCs are structured such that each of the investors in the firm—which sometimes number in the hundreds or thousands—is subject to the Canadian clearance process as if they each held the investment directly, which can result in hundreds of pages of documents that are required for signature and processing for a single investment or sale.

“Deloitte’s study confirms what many U.S. and global venture capitalists have long known that Canada may have the most unfavorable tax environment for foreign VC investment in the industrialized world,” says Stephen Hurwitz, a partner in the Boston-based law firm of Choate Hall & Stewart, which is a Canadian-U.S. cross-border tax issues advocate.

“The unnecessary paperwork required by Section 116 will cause more and more foreign VCs to take their money elsewhere, which will result in the loss of future jobs and tax revenue,” he says.

The survey pointed to a drop in venture capital investment in Canadian companies over the last five years as evidence that the tax concerns are already affecting the industry. In the third quarter of 2007, $517 million was invested in Canadian companies, which is almost 21% lower than in the third quarter of 2002, when $653 million was invested. In addition, almost a third fewer Canadian operating companies (147) were funded by venture firms in the third quarter of 2007 compared to the third quarter of 2002 (215).

Indeed, Canada remains a relatively low priority for U.S. venture activity. Behind China (34%) and India (24%), Canada is attracting the attention of just 11% of U.S. investors, the survey reported.