CRA requirement for disregarded LLCs to now compute their surplus under the ITA engenders complications

At the annual 2016 CTF annual conference, CRA announced that, retroactive to all FA taxation years ending after August 19, 2011, a disregarded US LLC must apply ITA rules to its surplus computations rather than using the local tax law (under the Code) – and that if this entails a switch from using US tax law, CRA would treat deductions claimed under the Code as if they had been claimed under the ITA. Issues raised by this change include:

• In the situation where the Act provides a larger deduction than the Code for the previous year, does the shortfall leads to a retroactive downward adjustment to earnings computed on ITA principles given that Reg. 5907(2.03)(b) deems maximum deductions to have been claimed in prior taxation years?
• The requirement to shift to Canadian tax law retroactive to 2011 could mean that once the surplus has been recomputed, it will now be retroactively considered that dividends were paid in excess of available exempt surplus.
• Using Canadian tax law may trigger early recognition of income or gain for surplus purposes but without corresponding US tax; and subsequent US tax may be paid by a different FA and now be ignored in computing the first FA's surplus.

Neal Armstrong. Summary of Paul Barnicke and Melanie Huynh, "Earnings of Disregarded US LLC," Canadian Tax Highlights, Vol. 25, No. 2, February 2017, p. 5 under Reg. 5907(1) – earnings – (a)(iii).