21 May 2002 Internal T.I. 2002-0133747 - LLC Entitlement to Treaty Benefits

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues: (1) Is a U.S. LLC that is treated as a partnership for U.S. tax purposes and whose majority member is a political subdivision of the State of the U.S. a resident of the U.S. for purposes of the Canada-U.S. Income Tax Convention (the "Convention")?

(2) Is such a LLC's share of the gain realized by a U.S. limited partnership in which the LLC is a partner from the disposition of taxable Canadian property exempt from Canadian tax under Article XIII(4) of the Convention?

Position:   			(1) No; (2) No  	

Reasons: (1) The LLC is not a person liable to tax in the U.S. nor is it generally exempt from income taxation in the U.S. by reason of its nature as an "organization or other arrangement that is operated exclusively to administer or provide pension, retirement or employee benefits" within the meaning of Article IV(1) of the Convention.

(2) The LLC is not a resident of the U.S. for purposes of the Convention and is therefore not entitled to benefits thereunder.

May 21, 2002

	TORONTO NORTH TAX SERVICES OFFICE	HEADQUARTERS
	International Tax Directorate	Income Tax Rulings Directorate
	5001 Yonge Street	S.Wong
	North York ON  M2N 6P6	(613) 957-9231

Attention: Michael K. Yee, Regional Advisor
2002-013374

Article IV(1) and Article XIII(4) of the Canada-United States Income Tax Convention (1980) (the "Convention")

We are writing in reply to your e-mail correspondence of April 8, 2002 in which you requested our comments on the application of Article IV(1) and Article XIII(4) of the Convention to the situation described below. You have forwarded to us copies of certain correspondence between the Toronto Centre Tax Services Office and the taxpayer's representative.

The Situation

The facts, as described in your April 8, 2002 e-mail and based on a review of the correspondence between the Toronto Centre Tax Services Office and the taxpayer's representative are as follows:

1. XXXXXXXXXX (the "LP") is a U.S. limited partnership having XXXXXXXXXX limited partners and one general partner. On XXXXXXXXXX, LP disposed of its shares in XXXXXXXXXX ("Canco"). Canco is a corporation resident in Canada whose shares are not listed on a prescribed stock exchange and are therefore taxable Canadian property for purposes of the Income Tax Act (Canada) (the "Act"). For purposes of Article XIII of the Convention, the value of the shares of Canco is not derived principally from real property situated in Canada.

2. XXXXXXXXXX of the limited partners of LP are residents of the U.S. for purposes of the Convention. The other limited partner is XXXXXXXXXX (the "LLC"), a limited liability company formed under the laws of XXXXXXXXXX (specifically, XXXXXXXXXX).

3. LLC has been formed and is operated to administer and invest some of the investments of XXXXXXXXXX.

4. LLC holds a number of U.S. investments, including its investment in LP. LLC was formed by XXXXXXXXXX contributing the investment equity for a XXXXXXXXXX% interest in LLC.

XXXXXXXXXX (the "Manager") is a XXXXXXXXXX limited liability company responsible for managing LLC's investments. The members of the Manager are comprised of individuals and pension funds. XXXXXXXXXX% of the interests in the Manager is held by members (principally individual pension funds) that are exempt from U.S. income tax. The Manager is treated as a partnership for U.S. income tax purposes.

5. Pursuant to Section 115 of the U.S. Internal Revenue Code of 1986, as amended (the "IRC"), XXXXXXXXXX is not subject to U.S. income tax because it is a public agency which is a political subdivision of the State of XXXXXXXXXX.

6. We have assumed for purposes of our comments below that while XXXXXXXXXX is a political subdivision of the State of XXXXXXXXXX that is exempt from U.S. income tax, LLC is not considered to be a political subdivision or local authority of any State of the U.S. or any agency or instrumentality of such subdivision or authority.

7. We have also assumed that the LLC is treated as a partnership for U.S. income tax purposes and is, by reason of it being so treated, not subject to U.S. income tax. Rather, the members of the LLC are subject to U.S. income tax on their share of the LLC's income. However, since XXXXXXXXXX is generally exempt from U.S. income tax, XXXXXXXXXX share (i.e., XXXXXXXXXX%) of the income of the LLC is exempt from U.S. income tax. The remaining XXXXXXXXXX% of the LLC's income is subject to U.S. income tax as income earned by the members of the Manager. As XXXXXXXXXX% of the interests in the Manager is held by members that are exempt from U.S. income tax, the total share of the LLC's income that is exempt from U.S. income tax as income of XXXXXXXXXX or as income of the tax-exempt members of the Manager is XXXXXXXXXX% (i.e., XXXXXXXXXX)

8. In a letter dated January 29, 2002 to the Toronto Centre Tax Services Office, the taxpayer's representative contended that by virtue of Article IV(1)(b)(i) of the Convention, the LLC should be considered to be a resident of the U.S. for purposes of the Convention and should be entitled to benefits thereunder because:

"1. XXXXXXXXXX

2. XXXXXXXXXX."

9. On March 28, 2002, the Toronto Centre Tax Services Office issued a certificate pursuant to subsection 116(5.2) of the Act (the "Certificate") indicating that the share of XXXXXXXXXX of the limited partners of the LP (i.e., the limited partners other than the LLC) in the LP's gain from the disposition of Canco shares (the "Gain") are exempt from tax under the Act by virtue of Article XIII (4) of the Convention. LLC's share of the Gain was excluded from the Certificate pending clarification of whether LLC is entitled to the benefits of Article XIII of the Convention.

Our Comments

In our view, the gain realized by the LP from the disposition of the shares of Canco will flow through to the partners of the LP. Accordingly, we will look through the LP to the partners of the LP to determine whether each partner's share of the Gain is exempt from Canadian income tax under Article XIII(4) of the Convention. In order for a partner's share of the Gain to be exempt from Canadian income tax under Article XIII(4) of the Convention: (i) the partner must be a resident of the U.S. for purposes of the Convention; and (ii) the value of the shares of Canco must not be derived principally from real property situated in Canada.

Requirement (ii) is satisfied in this case. Consistent with the Certificate issued to the taxpayer, requirement (i) is also satisfied with respect to the XXXXXXXXXX limited partners who are residents of the U.S. for purposes of the Convention. The issue is whether the LLC is a resident of the U.S. for purposes of the Convention.

It should be noted that the question of whether the members of the LLC are residents of the U.S. for purposes of the Convention is irrelevant for the purpose of determining whether the LLC's share of the Gain is exempt from Canadian income tax under the Convention. This is because, as we have stated at the 1997 Tax Executives Institute Conference Round Table in reply to Question XVII (see Document 9729780 dated November 14, 1997), where based on its attributes, a LLC is considered to be a corporation (as a LLC formed under the laws of XXXXXXXXXX is so considered - see Document 2001-0085845 dated January 29, 2002), the LLC is considered to have a legal personality and existence that is distinct from the persons who caused its creation or who own it. As a result, the Agency has no basis on which to look through to the residency of such persons for the purposes of providing relief under an income tax convention.

Thus, the fact that XXXXXXXXXX, the XXXXXXXXXX% member of the LLC is an instrumentality of the State of XXXXXXXXXX and "a trust, organization or other arrangement that is operated exclusively to administer or provide pension, retirement or employee benefits that was constituted in the U.S. and that is by reason of its nature as such, generally exempt from income taxation in the U.S." and may therefore be a resident of the U.S. pursuant to Article IV(1)(a) or (b)(i) of the Convention is not relevant for the purpose of determining whether the LLC's share of the Gain is exempt from Canadian income tax under the Convention. Rather, the issue is whether the LLC itself is a resident of the U.S. within the meaning of Article IV of the Convention.

The relevant portions of Article IV(1) of the Convention provides that:

"For the purposes of this Convention, the term "resident" of a Contracting State means any person that, under the laws of that State, is liable to tax therein by reason of that person's domicile, residence, citizenship, place of management, place of incorporation or any other criterion of a similar nature...The term "resident" of a Contracting State is understood to include:

(a) The Government of that State or a political subdivision or local authority thereof or any agency or instrumentality of any such government, subdivision or authority, and

(b) (i) A trust, organization or other arrangement that is operated exclusively to administer or provide pension, retirement or employee benefits; and

(ii) A not-for-profit organization

that was constituted in that State and that is, by reason of its nature as such, generally exempt from income taxation in that State."

As you know, it is our view that a U.S. LLC that is treated under U.S tax law as a partnership and which is therefore not liable to tax in the U.S. is not a resident of the U.S. for purposes of Article IV of the Convention (see, for example, Technical News Issue No. 16). Thus, the LLC would not be a resident of the U.S. for purposes of the Convention, unless it fits in the specific inclusions in the definition of "resident" in Article IV(1)(a) or (b) of the Convention. We have assumed that the LLC itself is not considered to be a political subdivision or local authority of any State of the U.S. or any agency or instrumentality of such subdivision or authority and therefore would not satisfy the requirements of Article IV(1)(a) of the Convention.

With respect to Article IV(1)(b) of the Convention, while it is arguable that the LLC is an "organization or other arrangement" and "is operated exclusively to administer or provide pension, retirement or employee benefits", we are of the view that it is not "by reason of its nature as such, generally exempt from income taxation in the U.S.". Even though the LLC is not liable to tax in the U.S., the reason why it is not liable to U.S. income tax is by reason of it being treated as a partnership for U.S. income tax purposes, rather than by reason of its nature as an "organization or other arrangement that is operated exclusively to administer or provide pension, retirement or employee benefits".

This conclusion is consistent with the wording and meaning of Article IV(1)(b) as intended by the parties to the Convention. Article IV(1)(b) was added to the Convention by the Third Protocol to the Convention. The technical explanation to the Third Protocol clearly states that the amendments were made to clarify the residence article, consistent with the past practice of the contracting states. Thus, Article IV(1)(b) of the Convention is intended to apply to "trusts, organizations or other arrangements that are operated exclusively to administer or provide pension, retirement or employee benefits; and not-for-profit organizations that were constituted in a Contracting State and that are, by reason of its nature as such, generally exempt from income taxation in that State" that were already accepted as residents of that State prior to the Third Protocol. The rationale for this practice, as stated in paragraph 8.2 of the Commentary to the OECD Model Tax Convention on Income and on Capital as well as in Document 9822230 dated September 23, 1998 and Document HBW4125J1 dated March 6, 1990, is that these "trust, organizations or other arrangements" are exempt from income tax in a Contracting State only if they meet all the requirements for exemption specified in the domestic legislation which entitle them to a specific exemption from tax and are therefore effectively subject to the tax laws of the Contracting State.

Based on the above-noted background to Article IV(1)(b) of the Convention, we are of the view that Article IV(1)(b) is intended to apply only to "trusts, organizations or other arrangements" that are exempt from income tax in that State only because of their nature as "trusts, organizations or other arrangements that are operated exclusively to administer or provide pension, retirement or employee benefits; or not-for-profit organizations". That is, that provision is intended to apply only to such trusts, organizations or other arrangements that would be liable to tax in that State if they do not meet the requirements under the domestic legislation which entitles them to a specific exemption from tax as "trusts, organizations or other arrangements that are operated exclusively to administer or provide pension, retirement or employee benefits; or not-for-profit organizations".

In the present case, the correspondence from the taxpayer's representative does not indicate whether the LLC is not subject to U.S. income tax other than by reason of it being treated as a partnership for U.S. income tax purposes. Even if there is a specific exemption under the IRC that would also apply to exempt the LLC from U.S. income tax and which application depends on the LLC's nature as an "organization or other arrangement that is operated exclusively to administer or provide pension, retirement or employee benefits" (which we assume is not the case here), it can still be argued that the LLC is not the type of organization or other arrangement intended to be covered by Article IV(1)(b) of the Convention. This is because even if the LLC does not meet the requirements of such a specific exemption, the LLC would presumably still not be liable to U.S. income tax by reason of it being treated as a partnership for U.S. income tax purposes.

For the following two reasons, we would also note that the fact that approximately XXXXXXXXXX% of the LLC's income is exempt from U.S. income tax does not affect the position that Article IV(1)(b) does not apply to the LLC. Firstly, it is XXXXXXXXXX and certain members of the Manager, and not the LLC, that are exempt from U.S. income tax on such income. Secondly, such income is exempt from U.S. income tax by reason of the nature of XXXXXXXXXX, the majority member of the LLC and the nature of certain members of the Manager as tax-exempts under the IRC, rather than by reason of the nature of the LLC itself as "an organization or other arrangement that is operated exclusively to administer or provide pension, retirement or employee benefits".

Based on all of the foregoing, in our view, the LLC is not a resident of the U.S. for purposes of the Convention. As a result, the LLC's share of the Gain is not exempt from Canadian income tax under Article XIII(4) of the Convention.

We trust that our comments have been helpful.

For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Customs and Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the electronic library version, or they may request a severed copy using the Privacy Act criteria, which does not remove client identity. Requests for this latter version should be made by you to Mrs. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.

Yours truly,

Jim Wilson
Section Manager
For Director
International and Trust Division
Income Tax Rulings Directorate
Policy and Legislation Branch
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