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: The application of Article X(6) of the Canada-US Treaty to certain US entities carrying on business in Canada through a permanent establishment.
Position: Question of fact.
Reasons: See our comments.
XXXXXXXXXX
2009-033995
A. Seidel, CMA
(613) 957-2058
October 26, 2010
Dear XXXXXXXXXX :
Re: Canadian Branch Tax - Post Fifth Protocol
This is in response to your September 2, 2009 letter in which your requested our comments with respect to the application of Article X(6) of the Canada-United States Tax Convention (1980) (the "Treaty") to certain U.S. entities that carry on business in Canada through a permanent establishment ("PE") subsequent to the Fifth Protocol.
You describe the following three situations in your letter:
(1) A corporation formed in the U.S. carries on business in Canada through a PE. For U.S. income tax purposes, the corporation has elected to be taxed under Subchapter S of Chapter 1 of the Internal Revenue Code (an "S Corporation"). Accordingly, the corporation's income (loss) is divided among and passed through to its shareholders who report such income (loss) on their own income tax returns.
(2) A corporation that is a resident of the U.S. is a member of a limited partnership that carries on business in Canada through a PE. The limited partnership is a partnership for Canadian income tax purposes, however, for U.S. income tax purposes, the limited partnership has elected to be treated as a corporation such that the income earned by the limited partnership is taxed at the partnership level in the U.S.
(3) A corporation formed in the U.S. as a limited liability company ("LLC") carries on business in Canada through a PE. For U.S. income tax purposes, the LLC is treated as a flow-through entity and its income is taxed in the hands of its members. For Canadian income tax purposes, the LLC is a corporation.
In each of the situations described above, we are assuming that the income was earned in a taxation year beginning after 2008.
It is not this Directorate's practice to comment on transactions involving specific taxpayers other than in the form of an advance income tax ruling. For more information about how to obtain a ruling, please refer to Information Circular 70-6R5, "Advance Income Tax Ruling", dated May 17, 2002. This Information Circular and other Canada Revenue Agency ("CRA") publications can be accessed on the CRA website at http://www.cra-arc.gc.ca. We are, however, prepared to provide the following general comments.
Our Comments
A non-resident corporation computes its "branch tax" in accordance with the rules in section 219 of the Income Tax Act (the "Act"). The imposition of tax under section 219 is subject to any overriding provision in a bilateral income tax treaty that may exempt or limit the rate of this tax.
Paragraph 6 of Article X of the Treaty confirms that Canada has a right to impose the branch tax on a non-resident corporation that carries on business in Canada through a PE. However, a non-resident corporation that is eligible for benefits under the Treaty is, pursuant to Article X(6) of the Treaty, entitled to an exemption on the first $500,000 of cumulative earnings attributable to its Canadian PE. In addition, Article X(6) restricts the rate of tax that can be imposed on earnings in excess of the $500,000 cumulative earnings exemption to 5%.
S Corporations
Although the earnings of an S Corporation that are attributable to a PE in Canada may be considered to be derived by the shareholders of the S Corporation, the CRA's current practice is to treat the S Corporation as a resident of the U.S. for purposes of the Treaty. As a result, provided that an S Corporation is a "qualifying person" or otherwise eligible for benefits under paragraph 3 or 6 of Article XXIX-A of the Treaty, we will extend the benefits of Article X(6) to the S Corporation.
Limited Partnerships
The Act provides that the income of a partner is to be computed at the partnership level as if the partnership were a separate person resident in Canada. However, the income is not taxed at the partnership level but is taxed in the hands of the partners as if the partners had derived the income directly (i.e., the income retains its original character and source).
Thus, a non-resident corporation that is a member of a partnership that carries on business in Canada through a PE is subject to tax in Canada on any income that it earns as a member of the partnership and is subject to the branch tax. The non-resident corporation may qualify for relief under Article X(6) of the Treaty where it is a "qualifying person" or otherwise eligible for benefits under paragraph 3 or 6 of Article XXIX-A of the Treaty.
Limited Liability Companies (LLCs)
Article IV(6) of the Treaty states:
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.
It is our understanding that, for U.S. tax purposes, an LLC that is wholly-owned by one person and has not elected to be taxed as a corporation, is disregarded for U.S. tax purposes while an LLC with more than one member that has not elected to be taxed as a corporation, is treated as a partnership. In either case, the CRA does not consider the LLC to be a resident of the U.S. under the Treaty. However, the LLC may claim treaty benefits on behalf of its members in respect to items of income, profit or gain that the member is considered to have derived pursuant to Article IV(6) of the Treaty.
Treaty benefits under Article X(6) claimed by an LLC with respect to an amount of income or profit attributable to a Canadian PE will be recognized by the CRA only if the amount is considered to be derived, pursuant to Article IV(6), by a corporation that is a resident of the U.S. and a "qualifying person" or is entitled, with respect to the amount, to the benefits of the Treaty pursuant to paragraph 3 or 6 of Article XXIX-A.
Yours truly,
Daryl Boychuk
Manager, International Tax I
International & Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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