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.
Principal Issues: Whether there is a disposition of property for Canadian income tax purposes when a Delaware LLC is converted under Delaware laws to a Delaware limited partnership?
Position: Yes.
Reasons: A LLC and a limited partnership are separate and distinct entities with very different characteristics for Canadian commercial and common law purposes.
XXXXXXXXXX 2004-010469
S. Leung, CA
Attention: XXXXXXXXXX
August 14, 2008
Dear XXXXXXXXXX :
Re: Conversion of a Delaware Limited Liability Company ("DLLC")
into a Delaware Limited Partnership ("DLP")
We are writing in reply to your letter in which you requested a technical interpretation as to whether there is a disposition by the shareholders of a DLLC of their shares of the DLLC and a disposition by the DLLC of its underlying assets when the DLLC is converted under Delaware laws to a DLP. We apologize for the delay in replying.
You outlined the following hypothetical situation in your letter:
1. X is a DLLC governed by the Delaware Limited Liability Company Act ("LLCA");
2. X is converted to a DLP governed by the Delaware Revised Uniform Partnership Act ("DRUPA") and the Limited Partnership Act ("LPA") pursuant to Section 17-217 of the LPA, which provides for the conversion to have retroactive effect to the time of the formation of X (the "Conversion");
3. The shares of X (as a DLLC) are not exchanged on the conversion of X from a DLLC to a DLP but, rather, are converted to units of X (as a DLP), pursuant to Section 17-217 of the LPA, with retroactive effect to the time of the formation of X;
4. The shares/units of X are held by non-residents of Canada; and
5. X owns property, including taxable Canadian property (as defined in subsection 248(1) of the Income Tax Act (the "Act") at the time of the Conversion. The conversion of a DLLC to a DLP is covered by section 17-217 of the LPA
(Title 6, Subtitle II, Chapter 17 of the Delaware Code) and section 18-216 of the LLCA (Title 6, Subtitle II, Chapter 18 of the Delaware Code).
Pursuant to subsection 17-201(b) of the LPA, a limited partnership formed under the LPA shall be a separate legal entity, the existence of which as a separate legal entity shall continue until cancellation of the limited partnership's certificate of limited partnership.
Some of the relevant provisions of section 17-217 of the LPA are described below:
(a) As used in this section, the term "other entity" means a corporation, a statutory trust, a business trust, an association, a real estate investment trust, a common-law trust, or any other unincorporated business or entity, including a general partnership (including a limited liability partnership) or a foreign limited partnership (including a foreign limited liability limited partnership) or a limited liability company.
(b) Any other entity may convert to a domestic limited partnership (including a limited liability limited partnership) by complying with subsection (h) of this section and filing in the office of the Secretary of State in accordance with § 17-206 of this title...
(d) Upon the filing in the office of the Secretary of State of the certificate of conversion to limited partnership, the certificate of limited partnership and the statement of qualification (if applicable), or upon the future effective date or time of the certificate of conversion to limited partnership, the certificate of limited partnership and the statement of qualification (if applicable), the other entity shall be converted into a domestic limited partnership (including a limited liability limited partnership, if applicable) and the limited partnership shall thereafter be subject to all of the provisions of this chapter, except that notwithstanding § 17-201 of this title, the existence of the limited partnership shall be deemed to have commenced on the date the other entity commenced its existence in the jurisdiction in which the other entity was first created, formed, incorporated or otherwise came into being.
(e) The conversion of any other entity into a domestic limited partnership (including a limited liability limited partnership) shall not be deemed to affect any obligations or liabilities of the other entity incurred prior to its conversion to a domestic limited partnership, or the personal liability of any person incurred prior to such conversion.
(f) When any conversion shall have become effective under this section, for all purposes of the laws of the State of Delaware, all of the rights, privileges and powers of the other entity that has converted, and all property, real, personal and mixed, and all debts due to such other entity, as well as all other things and causes of action belonging to such other entity, shall remain vested in the domestic limited partnership to which such other entity has converted and shall be the property of such domestic limited partnership, and the title to any real property vested by deed or otherwise in such other entity shall not revert or be in any way impaired by reason of this chapter; but all rights of creditors and all liens upon any property of such other entity shall be preserved unimpaired, and all debts, liabilities and duties of the other entity that has converted shall remain attached to the domestic limited partnership to which such other entity has converted, and may be enforced against it to the same extent as if said debts, liabilities and duties had originally been incurred or contracted by it in its capacity as a domestic limited partnership. The rights, privileges, powers and interests in property of the other entity, as well as the debts, liabilities and duties of the other entity, shall not be deemed, as a consequence of the conversion, to have been transferred to the domestic limited partnership to which such other entity has converted for any purpose of the laws of the State of Delaware.
(g) Unless otherwise agreed, for all purposes of the laws of the State of Delaware, the converting other entity shall not be required to wind up its affairs or pay its liabilities and distribute its assets, and the conversion shall not be deemed to constitute a dissolution of such other entity. When an other entity has been converted to a limited partnership pursuant to this section, for all purposes of the laws of the State of Delaware, the limited partnership shall be deemed to be the same entity as the converting other entity and the conversion shall constitute a continuation of the existence of the converting other entity in the form of a domestic limited partnership.
(i) In connection with a conversion hereunder, rights or securities of, or interests in, the other entity which is to be converted to a domestic limited partnership may be exchanged for or converted into cash, property, rights or securities of, or interests in, such domestic limited partnership or, in addition to or in lieu thereof, may be exchanged for or converted into cash, property, rights or securities of, or interests in, another domestic limited partnership or other entity or may be cancelled.
Some of the relevant provisions of section 18-216 of the LLCA are described below:
(a) Upon compliance with this section, a domestic limited liability company may convert to a corporation, a statutory trust, a business trust, an association, a real estate investment trust, a common-law trust or any other unincorporated business or entity, including a partnership (whether general (including a limited liability partnership) or limited (including a limited liability limited partnership)) or a foreign limited liability company.
(c) Unless otherwise agreed, the conversion of a domestic limited liability company to another entity or business form pursuant to this section shall not require such limited liability company to wind up its affairs under § 18-803 of this title or pay its liabilities and distribute its assets under § 18-804 of this title, and the conversion shall not constitute a dissolution of such limited liability company. When a limited liability company has converted to another entity or business form pursuant to this section, for all purposes of the laws of the State of Delaware, the other entity or business form shall be deemed to be the same entity as the converting limited liability company and the conversion shall constitute a continuation of the existence of the limited liability company in the form of such other entity or business form.
(d) In connection with a conversion of a domestic limited liability company to another entity or business form pursuant to this section, rights or securities of or interests in the domestic limited liability company which is to be converted may be exchanged for or converted into cash, property, rights or securities of or interests in the entity or business form into which the domestic limited liability company is being converted or, in addition to or in lieu thereof, may be exchanged for or converted into cash, property, rights or securities of or interests in another entity or business form or may be cancelled.
(h) When any conversion shall have become effective under this section, for all purposes of the laws of the State of Delaware, all of the rights, privileges and powers of the limited liability company that has converted, and all property, real, personal and mixed, and all debts due to such limited liability company, as well as all other things and causes of action belonging to such limited liability company, shall remain vested in the other entity or business form to which such limited liability company has converted and shall be the property of such other entity or business form, and the title to any real property vested by deed or otherwise in such limited liability company shall not revert or be in any way impaired by reason of this chapter; but all rights of creditors and all liens upon any property of such limited liability company shall be preserved unimpaired, and all debts, liabilities and duties of the limited liability company that has converted shall remain attached to the other entity or business form to which such limited liability company has converted, and may be enforced against it to the same extent as if said debts, liabilities and duties had originally been incurred or contracted by it in its capacity as such other entity or business form. The rights, privileges, powers and interests in property of the limited liability company that has converted, as well as the debts, liabilities and duties of such limited liability company, shall not be deemed, as a consequence of the conversion, to have been transferred to the other entity or business form to which such limited liability company has converted for any purpose of the laws of the State of Delaware.
Based on the above provisions of the Delaware Code and the analysis of certain documents published by the Canada Revenue Agency (the "CRA") that you mentioned in your letter, you are of the view that a disposition of neither the shares in X of the shareholders of X nor the underlying property of X would have occurred on the Conversion.
Our Comments
The situation outlined in your letter appears to relate to an actual situation involving identifiable taxpayers. If that is the case, the applicable Tax Services Office should be consulted with respect to the income tax liabilities of such taxpayers. However, we can offer the following general comments.
To determine whether a disposition of property has occurred on a conversion from one type of entity into another type of entity, we need to examine many factors including, among other things, the classification of the relevant entities for Canadian commercial and tax purposes, the provisions of the Act (particularly the definition of "disposition" in subsection 248(1) of the Act) and the common law principles that govern the conversion. The CRA follows the two-step approach described below to determine the status of an entity for Canadian tax purposes:
1) Determine the characteristics of the foreign business association under foreign commercial law and the agreements (such as articles of incorporation) and contracts between the parties that govern it. The most important attributes are the nature of the relationship between the various parties and the rights and obligations of the parties under the applicable laws and agreements; and
2) Compare these characteristics with those of recognized categories of business associations under Canadian commercial law in order to classify the foreign business association under one of those categories.
With regard to the classification of a DLP, it has been the CRA's long-standing position that, notwithstanding subsection 17-201(b) of the LPA which provides that a limited partnership is a separate legal entity, an entity formed under the DRUPA (Title 6, Subtitle II, Chapter 15 of the Delaware Code) or the LPA closely resembles a Canadian partnership under Canadian common law, with the effect that an entity governed by the DRUPA or the LPA would be treated as a partnership for Canadian income tax purposes. Accordingly, a DLP is considered a partnership for purposes of the Act and a "flow through" entity. As such, property held by a DLP is considered to be held in common by its owners, with each owner holding an undivided interest in each of the underlying partnership property. This is different from the property held by a DLLC which is classified as a corporation for Canadian income tax purposes. In the latter case, the underlying property held by a DLLC is considered to be owned by the DLLC and not by its shareholders.
Based on the treatment of partnership property under common law in Canada as noted above, notwithstanding the provisions of Delaware laws that deem the converted DLP to be the same entity as the converting DLLC and provide a continuation of the existence of a converting DLLC in the form of the converted DLP for all purposes of the laws of the State of Delaware, it is reasonable to consider for Canadian tax purposes that the shareholders of X have disposed of their shares in X and have acquired partnership interests in the DLP because the rights held in the entity are not the same after the Conversion. Before the Conversion, the shareholders of the entity are only entitled to dividends that are declared by X whereas after the Conversion they are entitled to share in the profits of the DLP. Moreover, the Conversion, viewed from a Canadian tax perspective, results in a fundamental change in the nature and character of the entity being converted: a corporate entity the income of which is subject to tax in its own hands is converted into a non-corporate entity (a partnership) the income of which is subject to tax in the hands of the partners. Commercially, X is governed by the LLCA prior to the Conversion while the DLP will be governed by the LPA after the Conversion. Administratively, before the Conversion there is an elected board of directors responsible for the management of X. After the Conversion the general partner of the DLP is responsible for the management of the partnership. Financially, currently the shareholders of X only have limited liability, but after the Conversion the general partner of the DLP has unlimited liability.
In addition, as noted above, under subsection 17-217(i) of the LPA and subsection 18-216(d) of the LLCA, the rights or securities of or interests in the DLLC which is to be converted may be exchanged for or converted into cash, property, rights or securities or interests in the DLP into which the DLLC is being converted or in another entity or business form or may be cancelled. This suggests a disposition of the shares in X on the Conversion as those shares could be cancelled or exchanged or converted into other property. Consequently, it could not be said that a share in X is the same property as a partnership interest in the DLP for Canadian tax purposes.
The property of X will be vested in the hands of the DLP after the Conversion. As a DLLC and a DLP are not the same type of entities for Canadian tax purposes, the property of X will be considered to be transferred by X to the DLP on the Conversion. Hence, there will be a disposition of the property of X at the time of the Conversion.
Conclusion
Based on the above, it is our opinion that there is a disposition of property on the Conversion of X to the DLP. As a result, the underlying assets of X and the shares in X would be considered to have been disposed of respectively by X and the shareholders of X on the Conversion for the purposes of the Act.
As stated in paragraph 22 of Information Circular 70-6R5 dated May 17, 2002, the opinions expressed in this letter are not rulings and are consequently not binding on the Canada Revenue Agency.
Yours truly,
Olli Laurikainen, CA
Section Manager
for Division Director
International and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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