11 January 2008 Roundtable, 2007-0259011C6 - 2007 TEI-Taxation of LLC under Protocol

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: 1) Will LLC's income from a business carried on in Canada but not through a permanent establishment be exempt in Canada? 2) Should LLC file the T2 to claim treaty exemption?

Position: 1) Yes 2) Yes

Reasons: 1) Under the conditions described in the response. 2) The LLC is a taxpayer for Canadian tax purposes.

Tax Executives Institute - Canada Revenue Agency Liaison Meeting
December 4, 2007
Question #23

Assume a U.S. limited liability company ("LLC") is 100% owned by a U.S. resident "C" corporation. The LLC has not elected to be treated as a corporation under the U.S. "check-the-box" regulations and, consequently, is treated as a disregarded entity for U.S. tax purposes. The LLC maintains a stock of goods in Canada for the purpose of storage, display or delivery, but otherwise does not have a place of business in Canada. Will the income earned by the LLC from its business be exempt from tax in Canada under the proposed 5th Protocol (the "Protocol") to the Canada-U.S. Income Tax Convention (the "Convention")? If so, should the LLC or the U.S. resident corporation file the T2 corporate income tax return to claim treaty exemption?

CRA Response

The Canada Revenue Agency ("CRA") has examined several state limited liability company statutes, but not all. We assume that the LLC in this example would constitute a corporation for Canadian income tax purposes.

By virtue of subparagraph 6(b) of Article V (Permanent Establishment) of the Convention, the term "permanent establishment" shall be deemed not to include a fixed place of business used solely for the maintenance of a stock of goods or merchandise belonging to the resident for the purpose of storage, display or delivery. Unless another article of the Convention applies, by virtue of paragraph 1 of Article VII (Business Profits) of the Convention, business profits of a resident of the U.S. shall be taxable only in the U.S. unless the resident carries on business in Canada through a permanent establishment situated in Canada.

Proposed paragraph 6 of Article IV (Residence) of the Convention (Article 2 of the Protocol) provides:

An amount of income, profit or gain shall be considered to be derived by a person who is a resident of a Contracting State where:

(a) The person is considered under the taxation law of that State to have derived the amount through an entity (other than an entity that is a resident of the other Contracting State); and

(b) By reason of the entity being treated as fiscally transparent under the laws of the first-mentioned State, the treatment of the amount under the taxation law of that State is the same as its treatment would be if that amount had been derived directly by that person.

Assuming U.S. tax law would in fact apply to consider the U.S. "C" corporation to have derived the business income through the LLC, and such income is treated for U.S. tax purposes as if it had been earned by the U.S. "C" corporation directly, we are of the view that, unless another article of the Convention applies, the business income earned in Canada by the LLC would be exempt from tax in Canada by virtue of Articles V and VII and proposed paragraph 6 of Article IV of the Convention.

Proposed paragraph 6 of Article IV of the Convention will have effect, in respect of taxes other than withholding taxes, for taxable years that begin after the calendar year in which the Protocol enters into force. However, if Canada and the U.S. notify each other in 2007 that the Protocol has been ratified, proposed paragraph 6 of Article IV will have effect for taxable years that begin in and after 2008.

Since the LLC is a corporation for Canadian income tax purposes, the LLC should file the T2 corporate income tax return, along with evidence that shows that the income earned by the LLC meets the requirements for treaty exemption under Articles V and VII and paragraph 6 of Article IV. While the LLC would be required to file a T2, please note that proposed paragraph 6 of Article IV (Residence) gives rise to certain administrative issues that have yet to be fully resolved and in respect of which the CRA needs more time to study.