FTC problem for undistributed LLC income (p. 12)
Assume that a Canadian-resident individual is a member of an LLC that carries on a trade or business in the United States. The LLC is treated as a partnership in the United States, and a 39 percent US withholding tax applies to income allocable to an individual who is resident abroad. The Canadian resident's eligibility for a foreign tax credit or deduction for the US withholding is limited to his foreign-source income. Thus, if the LLC does not distribute income to the Canadian individual in the same calendar year that the US tax liability arises, foreign taxes and foreign income may be mismatched and double taxation may arise. Moreover, only 15 percent of the US withholding tax is creditable; because the balance is only deductible, there is always some double taxation regardless of the level of foreign-source income.
High US branch tax if use LLC (p.11)
Assume that a Canco expands into the United States and forms an LLC to be the US opco. For Canadian tax purposes, the LLC is regarded as a controlled FA. For US tax purposes, the LLC is disregarded, and the Canco is subject to US corporate tax and to a 30 percent US branch tax. The branch tax reduction in treaty article X does not apply, both because of US domestic law and because of article IV(7)(a). Alternatively, if the Canco carried on business directly in the United States, the US branch tax will be reduced to 5 percent and may apply after a $500,000 threshold is exceeded.
Relief under U.S. Treaty, Art. IV(6) for US residents only (p.11)
Article IV(6) provides relief from Canadian withholding tax for US residents only. Assume that a US resident and a UK resident form an LLC to license computer software to Canadian clients. Under article XII of the Canada-US treaty, Canadian withholding tax does not apply to licence payments for computer software made to a US resident. Under the Canada-UK treaty, a similar payment made directly by a Canadian resident to a UK resident is also exempt from Canadian withholding tax. However, if the payment is made to the LLC, the pro rata portion allocable to the US resident is Canadian withholding-tax-exempt, but the portion allocable to the UK resident is subject to 25 percent Canadian withholding tax. The UK resident is penalized for investing through an LLC rather than directly from the United Kingdom.
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