The Canadian Opportunity: An Overview for Investors

July 15, 2012

Canada: A World-Class Economy

“Canada ranks No. 1 in our annual look at the Best Countries for Business.”
Canada is one of the world’s safest countries to invest in.
Dun & Bradstreet’s Global Risk Indicator
Canada rated as the no. 1 place to do business in the G-7 for the next three years.
Economist Intelligence Unit

At US$1.74 trillion, Canada is the world’s tenth largest economy as measured by GDP at 2011 exchange rates. Canada’s economy is larger than those of India, South Korea and Mexico and continues to thrive despite global economic turmoil. Over the past 10 years, Canada has enjoyed more robust economic growth than any other G7 country.

Canada also ranks as one of the most cost-effective global investment destinations, due in part to its low corporate tax rate and a duty-free manufacturing tariff regime. In 2012, for the eighth consecutive year, KPMG’s Competitive Alternatives study found that Canada leads the G-7 with the lowest overall business costs. The study also found that Canada was the lowest-cost G-7 country in 14 of 17 industrial categories, including aerospace, agri-food, automotive, chemicals, electronics, medical devices, pharmaceuticals, precision manufacturing, telecommunications, back office/call centers, software design, web and multimedia, biotechnology and product testing.

As well, Canada is a significant part of the global supply chain in a wide range of sectors. Its membership in the North American Free Trade Agreement (NAFTA), which has largely governed the trading relationships among Canada, the United States and Mexico since 1994, ensures access to more than 450 million consumers and a combined GDP of more than US$17 trillion. Trade between Canada and the United States has almost doubled since 1994 and now totals more than half a trillion dollars annually. On a typical day, more than US$1.5 billion in goods cross the U.S.- Canada border. Nearly every major Canadian city is within a few hours, by road or rail, of major U.S. markets. A striking example of the close economic ties between the two countries is the economic integration of Canada’s industrial heartland of southern Ontario and Quebec with the Northeastern and Midwestern states – particularly with respect to the auto industry and other heavy industry, but increasingly with respect to high-technology, communications and other growing areas of business.

Advanced Research and Development Capability

From next-generation cars to smartphone technology, Canadian innovations touch the lives of millions worldwide. In Canada, scientific talent is available at competitive costs. KPMG’s 2012 Competitive Alternatives study reports that Canada has the G-7’s lowest costs in R&D-intensive sectors (up to 10.7% lower than the U.S.). In high value-added activities, Canada offers the additional advantage of lower labor costs compared to other advanced economies and ranks first in the G-7 with respect to the availability of qualified engineers. Canada’s Scientific Research & Experimental Development (SR&ED) tax incentive program is the single largest federal program supporting business R&D in Canada, providing more than C$3.6 billion in tax assistance in 2011. All companies that carry on business in Canada and invest in R&D may qualify, irrespective of their size, industry sector or technology area – as long as they perform qualified R&D. Generally, the program allows for both the deduction of current expenditures on qualifying SR&ED carried on in Canada from the company’s related business income and the application of a tax credit based on these qualifying SR&ED expenditures (subject to certain adjustments).

In certain cases, a company may also be able to deduct part of its current R&D expenses incurred abroad on Canadian R&D projects. To streamline the SR&ED program, Canada’s 2012 federal budget proposed several changes, including eliminating the deduction for qualifying SR&ED capital expenditures, adjustments to the amount of overhead expenses that may be claimed, limits on the credits that may be claimed with respect to contract payments and further restrictions on the credit refunds that can be claimed. These proposals are generally applicable (some on a rolling basis) after 2012.

The general SR&ED tax credit rate is currently 20 per cent, and, although it is non-refundable, it is not subject to a ceiling. A non-refundable tax credit can be used to offset Canadian federal taxes payable in the current year, in the previous three years and/or in the next 20 years. For taxation years that end after 2013, the 2012 federal budget has proposed to reduce this general rate from 20 per cent to 15 per cent. When part of a business’s taxation year is in 2013 and part is in 2014, the decrease will be prorated.

Additionally, small Canadian-controlled private corporations (CCPCs) with taxable income of up to C$500,000 and taxable capital of up to C$10 million, can receive a refundable 35 per cent tax credit on qualifying current and capital SR&ED expenditures, to a maximum of C$3 million per year. For amounts over the C$3 million SR&ED expenditure threshold, the credit rate is reduced to 20 per cent, of which 40 per cent may be refundable. A refundable tax credit represents an injection of non-dilutive capital into a company, which in turn can be used for sustaining future R&D activities. The potential federal tax refund exceeds C$1 million per year. There are several ways for a U.S. investor to benefit from the favorable tax treatment of R&D activity by Canadian CCPCs:

  • A Canadian subsidiary can undertake SR&ED activities for a U.S. parent company;
  • A Canadian company can be contracted by a U.S. company to carry out SR&ED activities and factor the tax benefits into the contract price;
  • A Canadian company can have an American minority shareholder (so long as it does not control, or have future rights to control, the Canadian company); or
  • A Canadian company can enter into a joint venture with an American company.

When additional tax credits from provincial governments are taken into account, foreign investors can, on average, save 30 cents of each R&D dollar invested in Canada.

Abundance of Natural Resource Opportunities

In their domestic and international operations, Canadian companies control an abundance of base metals (in particular, iron, copper, zinc and nickel), precious metals (in particular, gold, silver and platinum), uranium, diamonds, coal, oil and natural gas. Canadian exploration companies are continually looking for acquirors, investors and joint-venture partners. The size and influence of the country’s mining industry has made Canada – specifically Toronto – the world’s leading mining equity finance center. Fully 55 per cent of the world’s public mining companies are listed on Toronto’s TSX (senior) or TSX Venture (junior) exchanges. Currently, these TSX/ TSX-V listed companies are involved in nearly 10,000 projects worldwide, about half of which are outside Canada.

Over the past five years, TSX/TSX-V listed issuers have led all international stock exchanges with more than 10,000 mining equity financing transactions – over 80 per cent of all mining equity financings worldwide. (By comparison, the ASX had 9 per cent, LSE-AIM 8.5 per cent and all U.S. markets combined had just 0.35 per cent.) Over the same period, TSX/TSX-V equity financings saw mining and exploration companies raise C$136.9 billion – one-third of the value of mining equity financing worldwide (LSE-AIM accounted for 20 per cent, the ASX for 11 percent and U.S. markets for less than 9 per cent.)

Oil & Gas

Canada is the world’s third largest producer of natural gas. Moreover, its proven oil reserves are exceeded only by those of Saudi Arabia. Current oil supply and demand metrics have made Canada’s non-conventional petroleum resources highly attractive to foreign investors, with well over C$100 billion in announced projects in Alberta’s Athabasca oil sands alone. In the energy sector, the TSX and TSX-V list more oil and gas companies than any other exchange in the world, with a particularly large concentration of junior issuers. Larger Canadian energy companies are typically inter-listed on the NYSE and constitute “foreign private issuers” under U.S. securities laws.

“Plan Nord” in Quebec

Launched on May 9, 2011, Plan Nord is the province of Quebec’s 25-year, $80-billion economic, social and environmental development project for the 463,000 square-mile territory north of the 49th parallel that comprises roughly three quarters of the province. (Quebec as a whole is more than twice the size of Texas.)

Plan Nord is intended to define the future of Quebec’s North as a unique model of sustainable development in the mineral resources, forestry, energy, bio-food production and tourism sectors, balancing social and economic development with environmental protection. The project will be structured to reflect a representative approach using a new model of partnership among the government, the private sector, and Aboriginal and local communities.
Plan Nord covers one of the world’s largest freshwater reserves and accounts for over three-quarters of Quebec’s installed hydroelectric power generation capacity, as well as approximately the same potential of untapped water, wind and solar energy resources. It contains over 77,000 square miles of commercial forests, representing more than half of Quebec’s usable forests, as well as an array of mineral ore deposits, including nickel, cobalt, platinum group metals, zinc, iron ore and ilmenite. The area also has a significant gold production component and deposits of lithium, vanadium and other rare-earth metals increasingly used in the energy, transportation and high-tech sectors. Of the total private and public investment envisaged by Plan Nord, C$47 billion is to be directed toward developing renewable energy and C$33 billion toward the mining sector and public infrastructure such as roads and airports. Investissement Québec, a public investment agency, will manage a C$500 million allocation over the first five years to cover equity participation in Plan Nord projects. However, the plan may be subject to change in light of the September 2012 provincial election that resulted in a new government in Quebec.

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