11 February 2010 Roundtable, 2009-0345351C6 - Canada-United States Tax Convention (1980)

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 a fiscally transparent entity, such as a United States LLC, is eligible to claim benefits under Article X or XI of the Convention on behalf of its member(s) in respect of Canadian-source dividends or interest paid to the LLC in circumstances where the amount paid is disregarded under the taxation laws of the United States or where the treatment of the amount under the taxation laws of the United States differs from its treatment under the taxation laws of Canada

Position: See response

Canadian Tax Foundation - 2009 Round Table

Question 4(d) re: Application of Article IV(6)

Before the Fifth Protocol was signed by Canada and the United States (US) in the fall of 2007, it was widely expected that a rule would be introduced to provide treaty benefits to US-owned LLCs. With this expectation in mind, some US parties have structured their investments in Canada through a LLC owning a Canadian ULC. As expected, Article IV(6) did address the LLC issue. What was certainly not expected is that treaty benefits would be denied pursuant to Article IV(7)(b) with respect to most payments made by a Canadian ULC after 2009.

In the CRA's opinion, would treaty benefits be available with respect to a payment of interest or dividends by a Canadian ULC to a LLC before January 1, 2010? Similarly, would treaty benefits be available with respect to an amount paid by a Canadian corporation (other than a corporation that is disregarded under the taxation laws of the US) to a LLC after 2009 if the amount is not disregarded but the treatment of the amount under the taxation laws of the US differs from the treatment of that amount under the taxation laws of Canada? This could occur, for example, if the corporation pays a cash dividend on shares held by the LLC and all or a portion of that dividend is treated as a return of capital under the taxation laws of the US.

CRA Response

Article IV(6) of the Canada-United States Tax Convention (1980) ("Treaty") is effective, in respect of taxes withheld at source, for amounts paid or credited on or after February 1, 2009. An amount paid or credited to a fiscally transparent US LLC by a Canadian ULC after January 31, 2009 may be eligible for treaty-reduced rates if the amount is considered, by Article IV(6) of the Treaty, to be derived by a person who is a resident of the US. In this respect, Article IV(6) applies if, pursuant to Article IV(6)(a), the person is considered to have derived the amount under the taxation laws of the US through the LLC and the amount meets the requirement in Article IV(6)(b) (i.e. by reason of the fiscal transparency of the LLC, the treatment of the amount under the taxation laws of the US is the same as its treatment would be if the person derived the amount directly). As noted in the question, treaty-reduced rates may not be available in respect of an amount paid by an ULC after 2009 because of Article IV(7)(b) of the Treaty.

Where an US LLC that is fiscally transparent under the taxation laws of the US holds all of the shares of a Canadian ULC and the ULC is a disregarded entity under those laws, it is our understanding that an amount paid to the LLC by the ULC (e.g. interest or dividends) would not be recognized as an item of income in the hands of the member(s) of the LLC nor would it have any other US tax consequences. However, we also understand that the member(s) of the LLC would be required to include, on a current basis, their share of the earnings of the ULC in the computation of their US taxable income. In this respect, it has been argued that where the earnings of the ULC are considered, under the taxation laws of the US, to be derived by the member(s) of the LLC, a cross-border remittance, such as a dividend, that is paid out of those earnings by the ULC to the LLC should also be considered to be derived by the member(s) of the LLC. On the other hand, the amount paid would, under the taxation laws of Canada, be distinct from the underlying earnings of the ULC and would not, in itself, be recognized under the taxation laws of the US (i.e. the payment is "disregarded").

The CRA believes that the better view is that Article IV(6) does not apply to treat a particular amount of Canadian-source income, profit or gain as being derived by the US resident member(s) of a LLC if that amount is "disregarded" under the taxation laws of the US. However, the CRA recognizes that there is substantial uncertainty regarding the scope and intended application of Article IV(6) of the Treaty, particularly as it applies to an amount of income, profit, or gain that is subject to different tax treatment under the taxation laws of the US than under the taxation laws of Canada. Given this uncertainty, the CRA will not take the position that an amount that was paid or credited before 2010 by a Canadian corporation to a fiscally transparent LLC was not "derived" by the member(s) of the LLC within the meaning of Article IV(6)(a) of the Treaty. However, the CRA will not accept a claim for treaty benefits made by a LLC to the extent that the claim relates to a "disregarded" amount that is paid or credited after 2009.

With respect to an amount of income, profit or gain that is not "disregarded" under the taxation laws of the US but is treated differently under those laws than under the taxation laws of Canada, the CRA is willing to consider, for the purposes of applying Article IV(6), that the amount has been derived under the taxation laws of the US. For example, assume that a fiscally transparent single-member LLC holds shares of a Canadian corporation that is not disregarded under the taxation laws of the US. Assume also that the corporation redeems some of the shares held by the LLC. In this situation, the CRA is willing to consider, for the purposes of applying Article IV(6), any Canadian-source deemed dividend which arises on the redemption of the shares to be derived by the US-resident member of the LLC even though the amount paid by the corporation to redeem the shares may be treated, under the taxation laws of the US, as proceeds of disposition or a return of capital. In addition, if the Canadian corporation pays a cash dividend to the LLC, the CRA is willing to consider, for the purposes of applying Article IV(6), that the Canadian-source dividend has been derived by the US-resident member of the LLC even though, under the taxation laws of the US, the dividend may be treated partly as a dividend and partly as a return of capital.