28 May 2015 IFA Roundtable Q. 3, 2015-0581511C6 - IFA 2015 Q.3: Entity Classification

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: Whether the CRA still follows a "two-step" approach for entity classification, and are there any new entities or arrangements being considered?

Position: General comments, no position taken; Florida LLLPs and LLPs are presently being considered and interested parties are invited to provide comments.

2015 International Fiscal Association Conference
CRA Roundtable

Question 3 – Entity Classification

It is our understanding that the CRA generally follows a so-called "two-step" approach in classifying foreign entities or arrangements, as follows:

1. Determine the characteristics of the foreign entity or arrangement by reference to any relevant law and the terms of any relevant agreements relating to the entity or arrangement; and

2. Compare the characteristics of the foreign entity or arrangement to the characteristics of entities or arrangements that exist under Canadian law.

The classification of the foreign entity or arrangement for Canadian income tax purposes is then based on the entity recognized under Canadian tax law (i.e. a partnership, corporation, trust or co-ownership) that the foreign entity or arrangement more fundamentally resembles.

Can the CRA confirm that it still follows this "two-step" approach, and can you update us on any new entities or arrangements that are being considered?

CRA Response

We believe it is important to consider specific Canadian legislation dealing with the meaning of corporation, in order to properly classify these entities. Specifically, the definition of "corporation" set out in subsection 248(1) of the Income Tax Act (the "Act") provides some guidance on this issue. In this regard, the English version of this definition is essentially inclusive and states that ""corporation" includes an incorporated company". On the other hand, in the French version of the Act the definition of the term "société" could be interpreted as going a bit further as a direct translation of that definition seems to be that the term "corporation" ("société") "is understood to be a "legal person"" ("personne morale"). Other potential sources of guidance are the definitions of "corporation" and "personne morale" set out in subsection 35(1) of the Interpretation Act ("IA"), and section 21 of the IA which sets out certain rules applicable to corporations in certain circumstances. In establishing the context for these various rules and definitions, we also find it relevant to consider the timing of the adoption of these various provisions, or modifications thereto.

However, given the seemingly contradictory guidance provided by these two statutes, we believe a two-step approach is still the most appropriate approach to be followed and, in particular, that one should not simply consider any entity that has legal personality to be a corporation. Thus, we stand by our previous positions whereby we determined that general partnerships and limited partnerships governed by the laws of Delaware are to be treated as partnerships for the purposes of the Act. However, given the uncertainties, we expect taxpayers to be consistent in their treatment of these entities, both among the members of the same entity and with respect to similar entities in the same group.

In terms of new developments, we would note that we are currently analyzing "limited liability limited partnerships" ("LLLPs") governed by the laws of the State of Florida. This analysis has also led us to consider the status of "limited liability partnerships" ("LLPs") governed by the laws of Florida. Neither of these types of entities has previously been the subject of a specific determination by the Income Tax Rulings Directorate.

We have not yet concluded our analysis. Our preliminary view is that these entities have many characteristics in common with "limited liability companies" ("LLCs") that exist in the U.S., which are generally considered to be corporations for the purposes of the Act, but that they also have many characteristics in common with the various forms of partnerships that exist in the U.S., which are generally considered to be partnerships for the purposes of the Act. A particular area of focus for us is the exact nature of the limitation of liability for the partners. Our preliminary finding is that the limitation of liability for these LLLPs and LLPs seems to go beyond the type of limitation of liability applicable to partnerships governed by the laws of the Canadian provinces.

As many of you know, partnerships governed by the laws of many states of the U.S. have legal personality, meaning that they own property in their own right and they have the right to sue and be sued in their own name. Under some states' laws, such partnerships can also be converted to LLCs and "regular" corporations without causing any change in the ownership of their assets. Our preliminary findings in respect of Florida LLLPs and LLPs are that they also have these elements of legal personality.

To summarize, our main cause for concern with these LLLPs and LLPs is that they seem to have both legal personality and full, or at least very extensive, limited liability for all members, at least where they do not affirmatively opt out of such limitation. Thus, notwithstanding the other partnership-like features of these entities, we wonder whether these two factors, taken in the context of U.S. law, should be considered to be so significant that these entities should be classified as corporations for Canadian tax purposes.

In order to finalize our analysis in this matter, we are inviting comments from the tax community on all aspects of the above discussion, as well as any other important elements that may not have been covered. Please send your comments to the Income Tax Rulings Directorate, Director of the International Division.

Please also note that the Department of Finance is aware of our plans in this regard and will be consulted.

Yannick Roulier
2015-058151
May 28, 2015