Pure flow-through structure for designation of foreign business income (p 15)
An alternative to this structure [Canadian LP atop US LP atop US private REIT] is… a pure flow-through structure. [fn 71: …[S]ee R&R Real Estate Investment Trust. … Circular of Westcap Investments Corp.," July 18, 2014… .] In this structure, the Blocker LP is considered to indirectly carry on business in the U.S. and accordingly is subject to U.S. corporate income tax, plus U.S. branch tax (because it has elected to be treated as a foreign corporation for U.S. tax purposes).
From a Canadian tax perspective, the trust is generally considered to carry on the business it indirectly carries on through its subsidiary partnerships, including for purposes of the definition business income tax" in subsection 126(7)….Provided the necessary designations are made under subsection 104(22), the unit-holders of the trust will each be considered to have paid their pro rata share of such tax and will be eligible to claim foreign tax credits under subsection 126(2). Because the income retains its character as business income by virtue of paragraph 96(l)(f) and subsection 104(22), subsection 20(11) does not apply to limit individuals to a 15% credit. [fn 73: A similar flow-through approach could be used with respect to income from property that would be considered to be income from real or immovable property for purposes of the Act.]
In order to achieve this full flow-through treatment, it is critical that there are no entities in the structure that would be regarded as corporations for Canadian tax purposes (other than corporate general partners having nominal economic interests)….
113(1)(c) deduction where LLC dividends paid after Cdn corporate member pays tax on LLC FAPI (p. 26)
If the LLC is a foreign affiliate earning FAPI…U.S. tax paid by the Canadian corporation in respect of the LLC's income will not qualify as UFT, as the definition of UFT - even as amended by Bill C-43 - only applies to taxes paid by a foreign affiliate of the taxpayer, not by the taxpayer itself. [fn 115: … 9703535…] Accordingly, no deduction will be available under paragraph 113(l)(b) in respect of distributions paid out of the LLC's taxable surplus. However, the CRA considers the U.S. tax paid for a year in respect of an LLC's income to be in respect of dividends derived from the shares of the LLC, even if the LLC does not pay dividends in the year for which the U.S. tax is paid. Accordingly, when the LLC pays a taxable surplus dividend, relief from double tax is available in the form of a deduction under paragraph 113(l)(c). [fn 116: … 9703535…9821495…2013-0480321C6 [above]…]
…[A] timing issue remains in this latter context if the LLC is a controlled foreign affiliate and is not able to distribute all of its income each year, as the applicable share of the LLC's FAPI will be required to be included in the member's income in the taxation year in which it is received, without an offsetting deduction for FAT.
Pooling of high and low state tax rates (p. 4)
Because the foreign tax credit is computed on a country-by-country pooling basis, where a taxpayer's income from a source in a particular foreign country is subject to a higher foreign tax rate than the corresponding Canadian rate (or higher aggregate foreign taxes applicable to the taxpayer's income from a business carried on in that jurisdiction), the unused excess can be used to subsidize Canadian tax otherwise payable on other business or non-business income from that country, as the case may be, that is subject-to a lower foreign tax rate….
Creditability where domestic Treaty override (p.9)
Where the source state's domestic law expressly provides for taxation in contravention of a treaty, the treaty crediting mechanism would likely not apply (assuming the relevant treaty rule follows the OECD Model, which provides for a credit in respect of tax imposed "in accordance with the treaty"). One could argue that the domestic law credit under section 126 should apply in these circumstances, as a payment of tax in excess of the amount permitted under a treaty should not fail to qualify as a "tax" under general principles where the source state's domestic law imposes the tax under a treaty override. [fn 49: …[S]ee Abraham Leitner and Jon Northup, "The US Inversion Rules and Their Impact on Cross-Border Offerings," 2013 Conference Report… 21: 1-35.] The CRA appears to have accepted this premise in the context of U.S. alternative minimum tax imposed in contravention of the U.S. Treaty, to the extent such tax relates to foreign source income. [fn 50: … 2003-0019751E5… .] Arguably, this analysis could also be applied where foreign tax is imposed in contravention of a treaty under a domestic anti-treaty shopping rule.
Reduction of Canadian taxes otherwise payable by losses (p.22:5)
Determining worldwide income involves many nuances that affect CTOP and therefore the foreign tax credit that may be claimed. For example, net operating losses claimed in a year will reduce CTOP but will not affect the taxpayer's worldwide income, with the result that the foreign tax credit may be less than the amount of foreign tax paid even if the foreign tax rate is less than the applicable marginal Canadian rate.
Determination of partner's share of partnership tax (p.9)
[T]he suggestion [1.39 of S 5-F2-C1] that a taxpayer's share of taxes paid by a partnership should be the same as its share of partnership income (a pre-tax computation) raises concerns in the context of withholding taxes deducted from payments to a partnership where the amount withheld is determined based on the withholding rate that would apply to each partner….The authors understand from informal discussions with the CRA that this statement in the Folio was not intended to require a pro rata redistribution of foreign withholding taxes…
Non-deductibility on general principles (p.6)
Subsections 20(11) and 20(12) specifically override the limitation in paragraph 18(l)(a) which would normally preclude the deduction of taxes paid, on the basis that taxes paid are typically viewed as an expense incurred as a result of earning income, rather than for the purpose of earning income. [fn 36: See…[IRC] v. Dowdall, O'Mahoney & Co., [1952] AC 401…cited in 4145356 Canada Ltd v. R., 2011 TCC 220 at para 62… .]
Picayune deduction where active LLC only distributes amount equalling Cdn member's US tax liability (p.25)
An individual investing directly in an LLC will not recognize any foreign source income from the LLC for Canadian tax purposes until the LLC pays dividends unless the LLC earns FAPI and is a controlled foreign affiliate of the individual….
The CRA takes the position that the full amount of U.S. taxes paid in the year should be used in the 20(11) formula in this instance, regardless of whether the LLC has distributed all or only a portion of its income for the year. [fn 111: … 9641375…1999-0010305.] The result of this position is that the 20(11) deduction may be based on an effective tax rate that exceeds the actual U.S. tax rate imposed on the LLC's income. For example, where the LLC earns income from an active business or is not a controlled foreign affiliate of the taxpayer, and if a taxpayer's share of the LLC's income for a taxation year is $10,000 and the taxpayer pays $4,000 of U.S. taxes for that year (based on an assumed U.S. tax rate of 40%), and if the LLC only distributes an amount for the year sufficient to cover that tax, the taxpayer's income for the year would be limited to $4,000 and the 20(11) deduction would be calculated as follows:
U.S. tax paid - (15% x Canadian income inclusion from the LLC shares)
= $4,000 - (15% x $4,000)
=$3,400
This would leave only $600 of U.S. taxes eligible for a foreign tax credit. [fn 112: By virtue of paragraph (b) of the definition of non-business income tax in subsection 126(7). See similar sample calculation in 1999-0010305... . Note that the ability to claim the amount eligible for a foreign tax credit would also be impacted by the taxpayer's Canadian tax otherwise payable, taking into account the impact of the 20(11) deduction... .] Under this formula, the less of its income an LLC distributes each year, the more its Canadian members will be limited to a foreign tax deduction in respect of the U.S. taxes paid – (oddly) unless the LLC distributes none of its income in which case the full amount of U.S. taxes would potentially be ( creditable (provided the taxpayer has other U.S. source income to support the credit)….
Re-sourcing of capital gains and derivative gains (p.7)
A common scenario in which a treaty re-sourcing rule may apply is where a Canadian resident realizes a capital gain from a disposition of foreign-company shares that is taxable in the company's state of residence under a treaty….
Re-sourcing under Canada - U.S. Income Tax Convention (the "U.S. Treaty") may also be relevant in the context of payments by Canadian residents under derivative instruments (which would generally be sourced to Canada under Canadian principles) where such payments are subject to U.S. withholding under the recently enacted "dividend equivalent payment" rules in section 871(m) of the Internal Revenue Code (the "Code"). [fn 48: … OECD Commentary… states that the state of residence should grant a credit in situations where a payment is characterized differently for purposes of an applicable treaty under source state and residence state law. …]
Creditability where domestic Treaty override (p.9)
Where the source state's domestic law expressly provides for taxation in contravention of a treaty, the treaty crediting mechanism would likely not apply (assuming the relevant treaty rule follows the OECD Model, which provides for a credit in respect of tax imposed "in accordance with the treaty"). One could argue that the domestic law credit under section 126 should apply in these circumstances, as a payment of tax in excess of the amount permitted under a treaty should not fail to qualify as a "tax" under general principles where the source state's domestic law imposes the tax under a treaty override. [fn 49: …[S]ee Abraham Leitner and Jon Northup, "The US Inversion Rules and Their Impact on Cross-Border Offerings," 2013 Conference Report… 21: 1-35.] The CRA appears to have accepted this premise in the context of U.S. alternative minimum tax imposed in contravention of the U.S. Treaty, to the extent such tax relates to foreign source income. [fn 50: … 2003-0019751E5… .] Arguably, this analysis could also be applied where foreign tax is imposed in contravention of a treaty under a domestic anti-treaty shopping rule.
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