20 March 2015 External T.I. 2014-0535971E5 - Meaning of "paid-up capital" in subsection 90(3)

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. Meaning of "paid-up capital" in subsection 90(3) in respect of distributions from a US Limited Liability Company ("LLC") to its Canadian resident member. 2. Whether paid-up capital would be computed differently if the US LLC was previously not a foreign affiliate.

Position: 1. The meaning assigned by subsection 89(1) which would rely upon the relevant foreign law. 2. No.

Reasons: The definition in subsection 89(1) applies to the entire Act by virtue of subsection 248(1).

XXXXXXXXXX
2014-053597
Judy Ho

March 20, 2015

Dear XXXXXXXXXX:

Re: Paid-up Capital of a LLC for the purposes of subsection 90(3)

We are writing in response to your email dated June 10, 2014 in which you requested our view as to how the paid-up capital of a limited liability corporation governed under the laws of the United States (the "US LLC") should be computed for purposes of subsection 90(3) of the Income Tax Act, R.S.C. 1985 c.1 (5th Supp.) (the "Act"). We also acknowledge the additional information provided to us in your emails and phone calls, the last of which was dated March 2, 2015.

In your emails you described a specific scenario which appeared to be an actual fact situation relating to proposed if not completed transactions. This technical interpretation provides general comments about the provisions of the Act and related legislation. It does not confirm the income tax treatment of a particular situation but is intended to assist you in making that determination. The income tax treatment of transactions will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R6, Advance Income Tax Ruling.

For the purposes of this technical interpretation we will provide general comments about the provisions of the Act by responding to the following questions:

1. What is the meaning of "paid-up capital" as that term is used in subsection 90(3) of the Act in respect of distributions from the US LLC to its Canadian resident member?
2. Would the paid-up capital be computed differently if the US LLC was previously not a foreign affiliate?

Our comments

Paid-up Capital of the US LLC for the purposes of subsection 90(3)

Subsection 90(3) allows a taxpayer to elect to treat a distribution from a foreign affiliate as a "qualifying return of capital", provided certain conditions are met. Since one of the conditions for making the election is the existence of a "reduction of the paid-up capital of the affiliate", it is necessary to determine the paid-up capital of the affiliate and whether there has been a reduction of the paid-up capital.

Although it is generally understood that a US LLC's equity is not divided into shares under the relevant foreign law under which the US LLC was created , subsection 93.2(2) deems the equity interests in a non-resident corporation without share capital (such as the US LLC) to be capital stock of the corporation. As such, the paid-up capital of the US LLC in respect of its shares is, in our view, to be computed pursuant to the definition of "paid-up capital" in subsection 89(1).

Subsection 89(1) provides that the paid-up capital in respect of a share of any class of the capital stock of a corporation is to be computed without reference to the provisions of the Act, except for the provisions listed in that definition. Moreover, paragraph 2 of IT 463R2 – Paid-up Capital states that paid-up capital is "based on the relevant corporate law rather than tax law. The amount calculated under corporate law is usually referred to as the "stated capital" of the class of shares."

In the case of the US LLC, the relevant jurisdiction's laws under which the US LLC was created and the US LLC's constating documents would be the starting point for determining the paid-up capital of the US LLC for Canadian income tax purposes. We would note that although subsections 90(3) and 93.2(2) are relatively new provisions to the Act, the question of what constitutes a reduction of paid-up capital of a foreign entity is not novel, as it has historically been relevant for the purposes of subparagraph 53(2)(b)(ii) in respect of amounts received by a taxpayer after 1971.

The scenario you described in your emails contained details regarding the annual incomes earned, and distributions made, by the US LLC. However, it did not address the concept of stated capital, if any, in the specific jurisdiction's laws under which the US LLC was created or the US LLC's constating documents (such as the LLC agreement). As noted above, this would be the starting point for determining the paid-up capital, if any, of the US LLC for Canadian income tax purposes. To the extent those laws and constating documents do not provide for stated capital akin to that which is provided for under Canadian domestic corporate law but, rather, provide for an attribute that is akin to a partner's capital account, the US LLC would not, in our view, have stated capital for the purposes of subsection 89(1). As such, it would not have paid-up capital for the purposes of subsection 90(3) or paragraph 53(2)(b).

Paid-up Capital Where the US LLC was not Previously a Foreign Affiliate

The paid-up capital of the US LLC should be computed pursuant to subsection 89(1), regardless of whether it is a foreign affiliate of the unit holder. Subsection 89(1) defines the paid-up capital "of a class of shares of the capital stock of the corporation" and does not specify whether the corporation is a foreign affiliate.

We trust our comments will be of assistance.

Yours truly,

Lori M. Carruthers CPA, CA
Section Manager
for Division Director
International Division
Income Tax Rulings Directorate
Legislative Policy Regulatory Affairs Branch