13 May 2002 External T.I. 2002-0136855 - Tower Struture

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: Whether foreign income taxes are deductible under subsection 20(12) or creditable under section 126 of the Income Tax Act in a tower structure situation?

Position: No.

Reasons: Because these taxes can reasonably be regarded as having been paid by the Canadian parent company in respect of income from a share of the capital stock of a foreign affiliate of the parent company.

IFA Conference - CCRA Roundtable
Responses Prepared by ITR Directorate
May 13, 2002

Question 5. Tower Structure

Canadian multinational corporations frequently in the past financed U.S. subsidiaries through structures taking advantage of the hybrid status of limited liability companies. Until U.S. domestic law changes rendered such structures less attractive, the Canadian parent company would benefit from a reduced treaty withholding rate on the interest paid by the U.S. subsidiary and such interest would then be distributed as dividends out of the exempt surplus of the LLC, and not subject to tax in Canada. With the demise of this U.S. withholding tax relief, a number of more complex structures have been suggested for such financings. What experience has Rulings had to date with these structures?

CCRA's Response

The Income Tax Rulings Directorate was recently asked by one of our local tax services office to comment on foreign tax credit issues with respect to an outbound financing arrangement using the following structure:

A Canadian parent company ("Parentco") together with its wholly-owned Canadian subsidiary formed a U.S. partnership ("LP") which elects to be taxed in the U.S. as a domestic corporation. Parentco contributed equity as well as loaned money to LP. LP invested all its funds in the share capital of a Nova Scotia unlimited liability company ("ULC") which is treated as a partnership for U.S. tax purposes. ULC in turn invested the funds in the share capital of a U.S. limited liability company ("LLC") which is also treated as a partnership for U.S. tax purposes. LLC loaned the funds to a U.S. operating company which is owned solely by Parentco.

There are many issues involved in this kind of tower structure. One of the issues is whether the U.S. income tax paid by LP on its profits and the U.S. withholding tax paid by Parentco on the interest received from LP are deductible under subsection 20(12) or creditable under section 126 of the Income Tax Act ("Act").

The above-noted tower structure appears to aim at getting around the U.S. domestic rule of prohibiting a non-resident of the U.S. to take advantage of the favorable treaty rate on income flowing through a U.S. LLC from a U.S. operating company while such income is not taxed in Canada. It appears that the taxpayers used this structure mainly for tax purposes. In essence, after cutting through all the corporate and partnership tiers, it is Parentco which owns 100% of the U.S. operating company and which loaned money to that U.S. company for use in the latter's operations. While interest paid by the U.S. operating company directly to Parentco is subject to tax in Canada in the hands of Parentco and the U.S. withholding tax on such interest is deductible or creditable, this tower structure provides a way that such interest is first converted into a dividend out of exempt surplus of LLC to ULC and then to a tax deductible dividend from ULC to Parentco through LP, without incurring any Canadian income tax. While we have been provided limited information on this structure, our initial reaction is that the U.S. taxes paid by LP and Parentco are neither deductible under subsection 20(12) nor creditable under section 126 of the Act because these taxes can reasonably be regarded as having been paid by Parentco in respect of income from a share of the capital stock of a foreign affiliate of Parentco.

As these outbound financing tower structures are complicated and raise many issues, it is strongly recommended that Canadian corporations consider an advance income tax ruling before implementing such an arrangement.

Presenter: Jim Wilson
Prepared by: Simon Leung
Phone number: 946-3252
Division: Income Tax Rulings Directorate