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 any or all of subsections 20(11), 20(12), and 126(1) can apply to allow/restrict a Canadian resident shareholder of a U.S. LLC to deduct in computing its income and/or obtain a foreign tax credit in a particular year in respect of U.S. income tax paid by the individual on its portion of the income of the LLC for that year where in that year the LLC paid no dividends and the individual disposed of its shares of the LLC.
Position: (i) Subsection 20(11) should not apply; (ii) subsections 20(12) and 126(1) could have application.
Reasons: (i) Subsection 20(11) should not apply since in the particular year the individual would not have included in its income any income from the LLC shares; (ii) in respect of subsections 126(1) and 20(12), the U.S. tax paid by the individual should be "non-business income tax" under subsection 126(7) and should be “in respect of that income” for purposes of subsection 20(12).
February 3, 2016
This letter is in response to your e-mail of September 19, 2014, wherein you asked for our views on, in summary, the possible application, in a particular taxation year, of subsections 20(11), 20(12) and 126(1) of the Income Tax Act (the “Act”) in respect of U.S. income taxes paid for that year by an individual resident in Canada who is a member of a limited liability company (“LLC”) where, in that year, no dividends are paid by LLC and the individual realises a capital gain as a result of the liquidation and dissolution of LLC. The assumed facts are described more fully below.
This technical interpretation provides general comments about the provisions of the Act and related legislation (where referenced). It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer 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 Rulings and Technical Interpretations however, we offer the following general comments, which may be of assistance to you.
(a) Assumed Facts
The assumed facts are as follows:
(i) Mr. A is a resident and citizen of Canada, and is one of a number of members of LLC;
(ii) LLC is organized under the laws of the U.S., and is respected as a “corporation” for purposes of the Act and a “partnership” for purposes of U.S. federal income tax;
(iii) LLC carries on an active business in the U.S.;
(iv) Mr. A is subject to U.S. federal income tax on his portion of LLC’s income;
(v) For purposes of the Act, LLC is not resident in Canada and is not a “controlled foreign affiliate” of Mr. A;
(vi) Mr. A’s adjusted cost base of his membership interest (shares) in LLC is $500;
(vii) LLC has a December 31 taxation year end;
(viii) No actual dividends were paid by LLC in its 2013 and 2014 taxation years;
(ix) In each of 2013 and 2014, Mr. A’s share of LLC’s income was $1000, and Mr. A’s U.S. individual income tax paid each year in respect of that income is $400;
(x) LLC is liquidated and dissolved in 2014, and as result of that liquidation and dissolution (“L&D”), LLC distributes all of its property pro rata to all of its members;
(xi) The fair market value of LLC’s property distributed to Mr. A in the course of the L&D of LLC is $2500;
(xii) Mr. A’s membership interest in LLC is capital property;
(xiii) For purposes of the Act, in each of 2013 and 2014, Mr. A has significant taxable income, but has no income from sources in the U.S. other than income possibly arising from the L&D of LLC in 2014;
(xiv) For each of 2013 and 2014, Mr. A’s marginal tax rate in Canada is 50%.
Collectively, these assumed facts are referred to herein as the “Described Case”.
(b) Specific Questions
The specific questions you raised in respect of the Described Case were the following:
(1) would all or a portion of the $2500 received by Mr. A in 2014 on the L&D of LLC be deemed to be a dividend?
(2) absent subsections 20(11) and (12), would the $400 of US tax paid by Mr. A in respect of his share of LLC’s income for each of 2013 and 2014 be a “non-business-income tax” as defined in subsection 126(7)?
(3) would subsections 20(11) and/or 20(12) apply in computing Mr. A’s income for his 2013 and/or 2014 taxation years?
(4) would the “source” rule in subparagraph 3(b) of Article XXIV of the Canada-U.S. Tax Convention (“the US treaty”) preclude the taxable capital gain arising from the L&D being US-source income for purposes of subsection 126(1)?
(5) if the US tax paid by Mr. A is a “non-business income tax”, and the taxable capital gain is US-source income for purposes of subsection 126(1), would Mr. A be entitled to a foreign tax credit in 2014 under subsection 126(1)?
(c) Comments on the specific questions raised in your email
With respect to question (1), the rules in either subsection 69(5) or subsection 88(3) of the Act would apply in respect of property distributed by LLC to the members (as members) in the course of the L&D of LLC. Neither of these subsections provide for a deemed dividend arising as a result of a L&D. In addition, the deemed dividend rule in subsection 84(2) of the Act does not apply since LLC is not a corporation resident in Canada. If the LLC was a foreign affiliate of Mr. A, he could not make a subsection 93(1) election (to cause a deemed dividend) in respect of his gain on the disposition of his LLC shares. Furthermore, if LLC was a foreign affiliate of Mr. A the deemed dividend rules in subsection 90(2) of the Act would not apply since these rules do not apply to a distribution made in the course of a L&D of a corporation. As such, no portion of the $2500 distributed to Mr. A in the course of the L&D of LLC would be deemed to be a dividend. All of the $2500 would be proceeds of disposition in respect of the disposition of the LLC shares, in which case Mr. A will have a resulting taxable capital gain of $1000 in 2014 in respect of that disposition.
With respect to question (2), the business carried by LLC, as well as the income earned by LLC, would for purposes of the Act be respected as being the business (and the income) of LLC and not a business carried on, or the income of, the members of the LLC. As such, the $400 of US tax paid by Mr. A in each of 2013 and 2014 on his share of LLC’s income for those years should be viewed as “non-business-income tax” paid by Mr. A for the particular year, subject to the rules in subsections 20(11) and (12) – i.e. the answer to your question (2) is “yes”.
With respect to question (3), this question deals with the possible application, in the Described Case, of subsections 20(11) and 20(12) in each of 2013 and 2014. Our comments are as follows:
- In essence, for purposes of subsections 20(11) and (12), when a taxpayer resident in Canada is a member of an LLC, CRA views the US tax paid by the taxpayer, for a particular year of the taxpayer, on its portion of the taxable income of the LLC for a taxation year of the LLC that ends in the particular year, as being a foreign tax paid by the taxpayer in respect of an amount (e.g. a dividend on a share) that is or will be included in computing the taxpayer’s income from the shares of the LLC (footnote 1);
- * As a result of paragraph 20(11)(a), subsection 20(11) only applies if an individual has, in a particular taxation year, included in its income an amount that is “income from a property” and that income is income from a source outside Canada. “Income from property” does not include a taxable capital gain. In the Described Case, the “property” referred to in subsection 20(11) is the shares of LLC owned by Mr. A, and in 2013 or 2014 Mr. A does not include in his income any income from those shares, in which case no amount would be determined under subsection 20(11) in either 2013 or 2014;
- In a particular taxation year, the amount of a foreign tax credit that a taxpayer may claim under subsection 126(1) in respect of the amount of non-business income tax paid to a particular foreign country for that year, depends (in part) on the amount of the taxpayer’s income for that year that is sourced in that country. For purposes of subsection 126(1), a taxpayer’s income sourced in a particular foreign country for a particular year would include the taxpayer’s taxable capital gains for that year that are sourced in that country. CRA’s views as to the geographic source of a capital gain are set out in IT Folio S5-F2-C1, and reference should be made to these views. See also discussion below of issue (4).
- For purposes of the foreign tax credit rules in subsection 126(1), there is no carryover permitted for the amount of a taxpayer’s non-business income tax paid for a particular taxation year that is in excess of the amount of the foreign tax credit claimed in that year. Consequently, subsection 20(12) permits a taxpayer to deduct in computing its income from a property (being the shares of LLC in the Described Case) for a particular taxation year an amount up to the non-business income tax paid by the taxpayer “in respect of that income”, even if the deduction results in the taxpayer having a loss from the particular property for that year. In the Described Case, CRA would consider the US income tax paid by Mr. A on his portion of LLC’s income to be, for purposes of subsection 20(12), a tax “in respect of that income”, even if the income of the LLC is not FAPI and even if no distributions are received from the LLC (see Technical Interpretation 2013-048037). As such, since Mr. A has no foreign source income in 2013 and thus would not be entitled to a foreign tax credit in 2013 under subsection 126(1), it would generally be expected that in 2013 Mr. A would claim under subsection 20(12) the $400 of US tax that he paid in respect of his share of LLC’s income for that year, resulting in Mr. A having in 2013 a loss from property (being the shares of LLC) of $400.
With respect to question (4), reference is made to subparagraph 3(b) of Article XXIV of the US treaty. You advised that this paragraph would source Mr. A’s capital gain from the disposition of the LLC shares as being in Canada. As noted, CRA’s views as to the geographic source of a capital gain are set out in IT Folio S5-F2-C1. Subparagraph 3(b) of Article XXIV only applies for purposes of Article XXIV, and that Article contains rules designed to avoid double taxation. In our view, the provisions of an income tax treaty are generally not to be applied so as to result in more burdensome Canadian income tax being imposed on a taxpayer resident in Canada than the tax that would otherwise be imposed on the taxpayer under the Act (determined without reference to the treaty). The rules in subparagraph 3(b) of Article XXIV would not necessarily preclude Mr. A’s gain on the disposition of his LLC shares being sourced in the U.S. for purposes of the Act.
For reasons noted above, and subject to the comments noted above, with respect to question (5), if Mr. A’s capital gain on the disposition of his LLC shares is a US source capital gain under IT Folio S5-F2-C1, subsection 126(1) could apply to allow Mr. A a foreign tax credit of up to $400 in 2014. Mr. A could under subsection 20(12) opt to claim, in his 2014 Canadian income tax return, an amount of up to $400. Any amount actually claimed by Mr. A in 2014 under subsection 20(12) would reduce the amount of his “non-business income tax” for 2014 for purposes of subsection 126(1).
We trust our comments are of assistance. We apologize for our delay in responding to your email.
Olli Laurikainen, CPA CA
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:
1 For the sake of completeness, it is noted that with respect to the treatment of the U.S. tax paid or payable in respect of an LLC’s taxable income by a direct or indirect member that is a foreign affiliate of a taxpayer, specific rules are now provided in the “foreign accrual tax” definition in subsection 95(1) and in the foreign affiliate surplus computation rules (e.g. regulation 5907(1.092)).
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