Principal Issues: 1. Whether subparagraph 7(b) of Article IV of the Canada-United States Income Tax Convention will apply to deny treaty benefits where a Canadian resident unlimited liability company that is fiscally transparent for United States tax purposes increases its paid up capital and subsequently makes a payment that reduces its paid up capital. 2. Whether subparagraph (7)(b) of Article IV of the Treaty will apply to deny treaty benefits where a Canadian resident unlimited liability company pays interest to its United States-resident shareholder?
Position: 1. No 2. No
Reasons: 1. Subsections 84(1) and 212(2) of the Income Tax Act will apply on the increase of paid-up capital. Tax treatment of the deemed dividend income under the taxation laws of the United States would be the same if the payer of the deemed dividend were not fiscally transparent. 2. Tax treatment of the interest payment under the taxation laws of the United States would be the same if the payer were not fiscally transparent.
XXXXXXXXXX
2012-046772
XXXXXXXXXX, 2013
Dear XXXXXXXXXX:
Re: XXXXXXXXXX
Advance Ruling
We are writing in response to your request dated XXXXXXXXXX for an advance income tax ruling on behalf of the above-noted taxpayer. We also acknowledge the information provided through various e-mail correspondence in XXXXXXXXXX.
To the best of your knowledge and that of the taxpayers involved, issues involved in this ruling request are not:
(i) the subject of an earlier return of the taxpayer or persons related to the taxpayer;
(ii) being considered by a tax services office or taxation centre in connection with a previously filed tax return of the taxpayer or persons related to the taxpayer;
(iii) under objection by the taxpayer or persons related to the taxpayer;
(iv) before the courts, or if a judgement has been issued, the time limit for appeal to a higher court has not expired; or
(v) the subject of a ruling previously considered by the Income Tax Rulings Directorate.
Definitions
In this letter, the following terms have the meaning specified below:
a) "Act" means the Income Tax Act, R.S.C. 1985 (5th Supp.) c.1, as amended to the date of this letter;
b) "Canco" means XXXXXXXXXX, a Taxable Canadian Corporation;
c) "Canco Debt" means the debt owed by Canco as described in paragraph 9 below;
d) "Capital Dividend" has, by virtue of subsection 248(1) of the Act, the meaning assigned by section 83 of the Act;
e) "Code" means the US Internal Revenue Code of 1986, as amended;
f) "Companies Act" means the XXXXXXXXXX;
g) "Fiscal Period" has the meaning assigned by subsection 249.1(1) of the Act;
h) "Individuals" means U.S. Resident individuals each of which is a Qualifying Person;
i) "Paid-Up Capital" has, by virtue of subsection 248(1) of the Act, the meaning assigned by subsection 89(1) of the Act;
j) "Qualifying Person" has the meaning ascribed to in paragraph 2 of Article XXIX A of the Treaty;
k) "Resident" has the meaning ascribed to in Article IV of the Treaty;
l) "S Corporation" means a corporation who has made a valid election under the Code to be taxed in accordance with Subchapter S of Chapter 1 of the Code;
m) "Taxable Canadian Corporation" has, by virtue of subsection 248(1) of the Act, the meaning assigned by subsection 89(1) of the Act;
n) "Treaty" means the Convention between Canada and the United States of America With Respect to Taxes on Income and Capital Signed on September 26, 1980 as Amended by the Protocols Signed on June 14, 1983, March 28, 1984, March 17, 1995, July 29, 1997 and September 21, 2007;
o) "United States" or "U.S." means the United States of America;
p) "USCo" means XXXXXXXXXX; and
q) "USCo2" means XXXXXXXXXX.
The rulings provided herein are based solely on the facts and proposed transactions described below. Any documents submitted with your request do not form part of the facts and proposed transactions and any references thereto are provided solely for the convenience of the reader.
Our understanding of the facts, proposed transactions and the purpose of the proposed transactions is as follows:
Facts
1. USCo is incorporated under the laws of the State of XXXXXXXXXX. All of the issued and outstanding shares of USCo are owned by the Individuals. USCo is a Resident of the U.S. and a Qualifying Person.
2. For the purposes of the Code, USCo is treated as an S Corporation. As a consequence, each of the shareholders of USCo (namely, the Individuals) will generally be required to include a proportionate share of each separately stated item of income, deduction, loss or credit of USCo and of any non-separately stated amount of income or loss of USCo in the computation of that shareholder's taxable income under the Code on an annual basis.
3. USCo2 is incorporated under the laws of the State of XXXXXXXXXX. All of the issued and outstanding shares of USCo2 are owned by the Individuals in the same proportion as their shareholding in USCo. USCo2 is a Resident of the U.S. and a Qualifying Person.
4. For the purposes of the Code, USCo2 is treated as an S Corporation. As a consequence, each of the shareholders of USCo2 (namely, the Individuals) will generally be required to include a proportionate share of each separately stated item of income, deduction, loss or credit of USCo2 and of any non-separately stated amount of income or loss of USCo2 in the computation of that shareholder's taxable income under the Code on an annual basis.
5. Canco is a Taxable Canadian Corporation incorporated as an unlimited liability company under the Companies Act. Canco has no subsidiaries. Canco invested CAN $XXXXXXXXXX to open a facility in XXXXXXXXXX ("Facility") from which, as of XXXXXXXXXX, it carries on the business of XXXXXXXXXX.
6. USCo and USCo2 own XXXXXXXXXX% and XXXXXXXXXX%, of the issued and outstanding common shares of Canco, respectively. Canco has not issued any other shares. Canco files its Canadian tax returns with the XXXXXXXXXX Tax Centre, and its Canadian income tax affairs are administered by the XXXXXXXXXX Tax Services Office.
7. For U.S. tax purposes, Canco has elected to be treated as a transparent entity (i.e., a partnership) under the U.S. entity classification rules described in the Code and files a US partnership return annually. As a consequence, for U.S. tax purposes, Canco's business income (including the earnings that are generated from the proceeds of the Canco Debt) will be included in the income of the Individuals in proportion to their respective interests in USCo and USCo2.
8. Canco anticipates significant earnings from its Canadian business operations during its fiscal period ending XXXXXXXXXX.
9. At the end of XXXXXXXXXX, USCo made a loan of approximately CAN$XXXXXXXXXX to Canco ("Canco Debt"). The Canco Debt is for a term of XXXXXXXXXX years and bears interest at the rate of XXXXXXXXXX%, per annum. The purpose of the Canco Debt was to allow Canco to purchase XXXXXXXXXX equipment and support Canco's start-up costs at the Facility.
10. USCo, USCo2 and Canco will each have a Fiscal Period that begins on XXXXXXXXXX and ends on XXXXXXXXXX.
Proposed Transactions
11. In accordance with the terms of the Canco Debt, Canco will make quarterly interest payments to USCo commencing on XXXXXXXXXX.
12. Before the end of its XXXXXXXXXX Fiscal Year, Canco, in lieu of declaring and paying a cash dividend, will:
a. increase, in accordance with the provisions of the Companies Act, the Paid-Up Capital in respect of its shares held by USCo and USCo2 by an amount equal to the amount of cash that it wishes to distribute to USCo and USCo2;
b. following the transaction described in paragraph 12(a) above, Canco will reduce the Paid-Up Capital in respect of its shares held by USCo and USCo2, in accordance with the provisions of the Companies Act, by an amount equal to the amount of increase described in paragraph 12(a) above; and
c. distribute an amount in cash, as a return of Paid-Up Capital on its shares held by USCo and USCo2, equal to the amount of the reduction referred to in paragraph 12(b) above.
Additional Information
13. Notwithstanding that the proposed transaction referred to in paragraph 12(a) above would, pursuant to subsection 84(1) of the Act, result in a deemed payment of a dividend on the shares of Canco, no amount of income, profit or gain will arise or will be recognized under the Code as a result of that transaction. Similarly, no amount of income, profit or gain would arise or be recognized in the U.S. as a result of that transaction if Canco were not treated as fiscally transparent under the Code.
14. Canco will not elect, in accordance with subsection 83(2) of the Act, to deem any portion of the dividend that it will be deemed to have paid by virtue of subsection 84(1) of the Act, to be a Capital Dividend.
15. The proposed transaction described in paragraph 12(a) above will not affect the tax treatment in the U.S. of any subsequent distribution on the Canco shares, including the return of Paid-Up Capital referred to in paragraph 12(c) above.
16. For U.S. federal income tax purposes, the payment of interest by Canco to USCo on the Canco Debt as described in paragraph 11 above, will be treated as a payment of interest made by a partnership (Canco) to one of its partners (USCo) and will not be disregarded; the interest receivable on the Canco Debt will be included in the income of the Individuals in the computation of their taxable income under the Code, in proportion to their interests in USCo, to the extent that such interest accrues in a particular taxable year.
17. If Canco was not a fiscally transparent entity for U.S. tax purposes, the interest on the Canco Debt would be included in the income of the Individuals as described in paragraph 16 above.
18. For the purposes of the Code, the interest payable by Canco in respect of the Canco Debt will be deductible by USCo and USCo2 in the computation of their income in proportion to their respective interests in Canco. As a result of USCo and USCo2 each being treated as an "S" Corporation for purposes of the Code, the interest payable by Canco will be deductible by the Individuals in the computation of their income under the Code, in proportion to their respective interests in USCo and USCo2.
Purpose of the Proposed Transactions
19. The purpose of the Proposed Transactions described in paragraph 12 above is to distribute current year earnings from Canco's Canadian business operations to USCo and USCo2 in a manner that avoids the application of subparagraph 7(b) of Article IV of the Treaty.
Rulings Given
Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and the purpose of the proposed transactions, and provided further that the proposed transactions are completed in the manner described above, our rulings are as follows:
A. To the extent that Canco is deemed to have paid, and USCo and USCo2 are deemed to have received, a dividend pursuant to subsection 84(1) of the Act on the increase of Paid-Up Capital referred to in paragraph 12(a) above, that dividend will be a taxable dividend for purposes of paragraph 212(2)(a) of the Act.
B. The dividend referred to in ruling A above will be considered to be income described in the definition of "dividends" in paragraph 3 of Article X of the Treaty.
C. The dividend referred to in ruling A above will be subject to withholding tax under Part XIII of the Act at a rate of 5% pursuant to paragraph 2(a) of Article X of the Treaty.
D. Subparagraph 7(b) of Article IV of the Treaty will not apply to the dividend referred to in ruling A above.
E. Subparagraph 7(b) of Article IV of the Treaty will not apply to treat the payment of interest on the Canco Debt referred to in paragraph 11 above as not having been paid to or derived by USCo.
F. Subsection 245(2) of the Act will not apply to re-determine the tax consequences confirmed in the rulings given above.
The above-noted rulings are based on the Act and the Treaty in their present form and do not take into account any proposed amendments which, if enacted, could have an effect on the rulings provided herein.
The rulings are based solely on the facts and proposed transactions described above and are subject to the limitation and qualifications set forth in Information Circular 70-6R5 issued on May 17, 2002. The rulings are binding on the Canada Revenue Agency provided that the proposed transactions are completed before XXXXXXXXXX.
Caveats
Except as expressly stated, this advance income tax ruling does not imply acceptance, approval or confirmation of any other income tax implications of the facts or proposed transactions described herein. For greater certainty, the Canada Revenue Agency has not confirmed or made a determination in respect of:
a) whether USCo is a Qualifying Person;
b) whether USCo2 is a Qualifying Person;
c) whether Canco is fiscally transparent under the Code;
d) whether the deemed dividend referred to in paragraph 12(a) above is disregarded under the Code or would be disregarded if Canco were not fiscally transparent under the Code;
e) the determination of any Paid-Up Capital of any share or class of shares under the Companies Act or the Act;
f) whether the interest on the Canco Debt is deductible by Canco in the computation of its income under the Act;
g) whether the interest on the Canco Debt qualifies for relief from tax under Part XIII of the Act pursuant to the provisions of Article XI of the Treaty; or
any tax consequences relating to the facts and proposed transactions described herein other than those specifically described in the rulings given above.
Yours truly,
XXXXXXXXXX
For Director
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
