CRA confirms that Treaty benefits could be created for a s. 216 structure by creating partnerships for US purposes

A US corporate REIT that is a qualifying person under the Canada-US Treaty owns US LLC 1, which owns US LLC 2 which, like US LLC 1, is disregarded for US purposes, and is a s. 216 taxpayer. Interest on an unsecured loan from LLC 1 to LLC 2 is now subject to Part XIII tax as a result of the introduction of s. 212(13.2)(b). CRA confirmed that no Treaty relief would be available under Art. XI given that LLC 1 does not qualify as a Treaty resident from the Canadian perspective and given that Art. IV(6) could not apply because the interest is disregarded for US purposes.

CRA further agreed that two alternative modifications to this structure would generate an exemption for the interest under Art. XI of the Treaty.

In Scenario 1, the REIT forms a taxable REIT subsidiary (TRS) that is a US resident and a qualifying person for Treaty purposes, and TRS and LLC 1 form US LP in which they have respective interests of 0.1% and 99.9%, respectively, and the loan to LLC 2 is made by US LP rather than LLC 1.

CRA indicated that TRS would be entitled to the Treaty benefit respecting its share of the interest income received by US LP and that the REIT would get the benefit of Art. IV(6) respecting its share of such interest income given inter alia that the U.S. income tax treatment of the interest received by US LP and indirectly allocated to REIT is the same as the U.S. income tax treatment that would apply had the REIT derived the amount directly from US LP.

Scenario 2 is similar to Scenario 1 except that TRS, which is held by the REIT, subscribes for a 0.1% membership interest in LLC 2 so that for US purposes, LLC 2 is a partnership between it and the REIT and, as in the base case, the loan is made by LLC 1 to LLC 2. CRA indicated that, again, Art. IV(6) would apply given inter alia that the U.S. income tax treatment of interest income to REIT is the same as the U.S. income tax treatment would be had REIT received the interest income directly from LLC 2.

Neal Armstrong. Summary of 17 May 2023 IFA Roundtable, Q.6 under Treaties – Income Tax Conventions – Art. 4.