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.
Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.
Principal Issues: Various foreign affiliate issues concerning foreign taxes paid by members of U.S. LLCs.
Position: Various
Reasons:
982149
XXXXXXXXXX Olli Laurikainen
(613) 957-2116
Attention: XXXXXXXXXX
December 15, 1998
Dear Sirs:
Re: United States Limited Liability Companies
This is in reply to your letter dated August 6, 1998 requesting our views in connection with certain hypothetical foreign affiliate structures involving United States Limited Liability Companies (“LLCs”).
Scenario 1
1) US LLC-1 and US LLC-2 are corporations resident in the United States for the purposes of the Income Tax Act (the “Act”). US LLC-1 and US LLC-2 are treated as partnerships under the Internal Revenue Code (the “Code”) of the United States.
2) Four corporations resident in Canada which deal with each other at arm’s length (the “Cancos”) each own 25% of the shares of US LLC-1.
3) US LLC-1 owns 20% of the shares of US LLC-2. The remaining shares of US LLC-2 are owned by persons resident in the United States who deal with the Cancos at arm’s length.
4) US LLC-2 earns income from property as that term is defined in subsection 95(1) of the Act. Since the Code treats US LLC-1 and US LLC-2 as partnerships, each of the Cancos is taxable under the Code in respect of its share of the income of US LLC-1 which includes the income from property of US LLC-2.
5) From time to time US LLC-2 distributes its income (i.e. pays dividends) to its shareholders and US LLC-1 distributes the dividends it receives from US LLC-2 to the Cancos.
US LLC-2 is not a foreign affiliate or a controlled foreign affiliate of the Cancos as defined under subsection 95(1) of the Act. Therefore the property income earned by US LLC-2 will not be included in the income of the Cancos under subsection 91(1) of the Act as foreign accrual property income (“FAPI”). However, US LLC-1 is a controlled foreign affiliate of each of the Cancos and any dividends paid by US LLC-2 to US LLC-1 would be FAPI of US LLC-1. A portion of such FAPI would be included in the income of each of the Cancos and added pursuant to paragraph 92(1)(a) of the Act to the adjusted cost base of the shares of US LLC-1 held by the Cancos. Such FAPI would also be included in the taxable surplus of US LLC-1 vis-à-vis the Cancos.
Any US tax paid by the Cancos in respect of the income of US LLC-2 may in our view reasonably be regarded as having paid by the Cancos in respect of income (i.e. dividends) from a share of the capital stock of a foreign affiliate (i.e. US LLC-1). Accordingly, the US tax paid by the Cancos would be ineligible for any foreign tax credit under subsection 126(1) of the Act. Moreover the tax would not qualify for deduction under subsection 20(12) of the Act. However in our view a deduction in respect of such portion of the US tax that has been paid by, and which has not been refunded to, a particular Canco in respect of the income of US LLC-2 as can reasonably be viewed as applicable to a dividend received by it from the taxable surplus of US LLC-1 may be claimed under the provisions of paragraph 113(1)(c) of the Act. At that time, a further deduction under subsection 91(5) of the Act may be claimed by each Canco. The amount of any subsection 91(5) of the Act deduction claimed by a Canco is deducted from the ACB of the shares of US LLC-1 held by such Canco pursuant to paragraph 92(1)(b) of the Act.
A deduction under paragraph 113(1)(c) of the Act is available in respect of US taxes paid only to the extent that the taxes have not been subsequently refunded (e.g. as a result of the carry-back of an operating loss of a subsequent taxation year). In the event that a deduction has been claimed by a Canco in a taxation year and the related tax is refunded in a subsequent taxation year, Canco would be required to amend its Canadian tax return for the taxation year in which the deduction was claimed and delete the deduction.
Scenario 2
The facts are the same in Scenario 1 except that US LLC-1 is not a US limited liability company and therefore the comments below we will refer to it as Usco. Usco is treated under the Code as a corporation.
Since Usco is a corporation for the purposes of the Code, it rather than the Cancos will be liable for US tax in respect of its share of the income of US LLC-2. Since the US tax is paid by a foreign affiliate, paragraph 113(1)(c) of the Act is not applicable to such tax and the issue becomes whether or not the tax qualifies as foreign accrual tax for the purposes of subsection 91(4) and as underlying foreign tax for the purposes of the Regulations to the Act supporting paragraph 113(1)(b) of the Act.
Foreign Accrual Tax
The provisions of subsection 95(1) define “foreign accrual tax” (FAT) applicable to any amount included in computing a taxpayer’s income by virtue of subsection 91(1) for a taxation year in respect of a particular affiliate of the taxpayer as:
(a) the portion of any income or profits tax that was paid by
(i) the particular affiliate, or
(ii) any other foreign affiliate of the taxpayer in respect of a dividend received from the particular affiliate.
and that may reasonably be regarded as applicable to that amount...”.
In the above scenario, the FAPI included in income by a Canco is in respect of the dividend income of Usco from US LLC-2. Prior to the payment of any dividends by US LLC-2 any US tax paid by Usco in respect of the income of US LLC-2 cannot be regarded as applicable to any income inclusion by a Canco under subsection 91(1) of the Act. When such dividends are paid, the dividends as explained in our comments in reference to Scenario 1 above, would be included in the foreign accrual property income of Usco and in the income of the Cancos pursuant to subsection 91(1) of the Act. At such time, it may be reasonable to regard all or a portion of the taxes paid by (and not refunded to) Usco in respect of the income of US-LLC-2 from which the dividends were paid by US-LLC-2 as applicable to the amount included in income by the Cancos for the purposes of the FAT definition set out above. Provided the requirements of subsection 91(4) were otherwise satisfied, each Canco would then be entitled to a deduction in respect of a portion of such FAT in computing its income. The determination of what portion of the foreign tax paid by a foreign affiliate qualifies as FAT in the above circumstances, must necessarily be made on a case by case basis.
Underlying Foreign Tax
The relevant portion of the definition of “underlying foreign tax” (“UFT”) in subsection 5907(1) of the Act is subparagraph (ii) of the description of A. That subparagraph refers to
“the portion of any income or profits tax paid to the government of a country by the subject affiliate that can reasonably be regarded as having been paid in respect of taxable earnings of the affiliate for a taxation year ending in the period”
That provision does not refer to when the tax was paid. It merely requires that it has been paid and can reasonably be regarded as having been paid in respect of the taxable earnings of the affiliate. Therefore it is our view that to the extent that it can be established that the tax is applicable to the income of US LLC-2 which was used by it to pay dividends to Usco, it may be included in the UFT of Usco vis-à-vis the Cancos.
Therefore each Canco is entitled to claim deductions in respect of such UFT under paragraph 113(1)(b) of the Act as applicable. An additional deduction may be available under subsection 91(5) of the Act, however the total deducted under the two provisions may not exceed the amount of the dividend. Paragraph 113(1)(c) of the Act may also provide for a deduction if the dividend received by Canco was subject to US withholding tax.
Scenario 3
1) Canco is a corporation resident in Canada.
2) Canco owns a 25% interest in a limited partnership (“LP”).
3) LP’s only activity is the holding of 20% of the shares of a United States limited liability company (“LLC”).
4) The remaining shares of LLC are held by persons not resident in Canada who deal at arm’s length with LP.
5) LLC is a corporation resident in the United States for the purposes of the Act and is treated as a partnership for the purposes of the Code.
6) All the income of LLC is income from property.
7) Canco is liable for US tax on its share of the income of LP which includes LP’s share of the income of the LLC.
In the above circumstances, the income of Canco from LP will be determined pursuant to the provisions of subsection 96(1) of the Act. Under subsection 96(1) of the Act the income of Canco will be determined as if LP were a separate person resident in Canada. As a result, LLC will be viewed as a foreign affiliate of LP for the purposes of determining Canco’s income from LP. As LP only owns a 20% interest in LLC and the other shares of LLC are held by non-resident persons who deal at arm’s length with LP, LLC will not be a controlled foreign affiliate of LP. Accordingly the FAPI provisions of the Act have no application in these circumstances. Moreover, the foreign affiliate provisions set out in section 113 of the Act are applicable only where a corporation resident in Canada has received a dividend from a foreign affiliate. Since LP is not a corporation, the provisions of section 113 of the Act have no application here.
Canco would be taxable in Canada on its share of any dividend income derived by LP from LLC. Such income would be sourced to the United States. Therefore to the extent that Canco has paid US tax in a taxation year in which it includes US source dividend income from LP in its income for tax purposes, it may be entitled to a foreign tax credit under subsection 126(1) of the Act. A deduction may also be available under subsection 20(12) of the Act in a taxation year where the full amount of the foreign tax cannot be claimed as a foreign tax credit.
Scenario 4
1) Canco owns 90% of the shares of a limited liability company (“LLC”) which is treated under the Code as a partnership.
2) LLC is a corporation resident in the United States for the purposes of the Act.
3) All of the income of LLC is from an active business carried on by it in the United States for the purposes of section 5907 of the Regulations.
You request our comments regarding the effect of the US tax paid by Canco in respect of the income of LLC on the exempt surplus balance of LLC vis-à-vis Canco.
It is our view that the exempt surplus of LLC vis-à-vis Canco would not be reduced by US tax paid by Canco. We also note that the tax paid by Canco would be considered to be paid in respect of income from a share of the capital stock of a foreign affiliate and is therefore not eligible for deduction from tax under subsection 126(1) of the Act or for a deduction in computing income under subsection 20(12) of the Act.
The foregoing comments are given in accordance with the practice referred to in paragraph 22 of information Circular 70-6R3 and are not binding on Revenue Canada.
We trust this is the information you require.
Yours truly,
for Director
Reorganizations and International Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch
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