Canada: Canada Revenue Agency Accepting Certain Refund Claims by U.S. LLCs

In a recently released published statement, the Canada Revenue Agency (CRA) indicated that, based on the decision of the Tax Court of Canada in TD Securities (USA) LLC v. The Queen,1 it will allow requests for refunds of excess income or withholding tax paid under the Income Tax Act (Canada) (the Act) by certain U.S. limited liability companies (LLCs). While it is helpful that the CRA is partially accepting the decision of the Tax Court, the CRA appears to be attempting to limit its application in a manner that is not consistent with the context or purpose of the Treaty.

In TD Securities, the Tax Court held that a U.S. LLC was "liable to tax" in, and therefore a resident of, the United States for purposes of Treaty. The Court concluded that the taxpayer in that case was a U.S. resident since the United States retained and exercised the jurisdiction to tax the worldwide income of the taxpayer (including its Canadian branch income) on a comprehensive basis, notwithstanding that such taxation occurred at the level of its U.S. resident member. The taxpayer was represented by Osler's Al Meghji, Patrick Marley and Pooja Samtani.

The case overturned the long-established position of the CRA that LLCs that are fiscally transparent for U.S. tax purposes cannot be U.S. residents for treaty purposes prior to the Fifth Protocol (which did not apply to the taxation years at issue). The Crown did not appeal the decision of the Tax Court to the Federal Court of Appeal. For a discussion of the decision, see our Osler Update of April 15, 2010.

The CRA commented on the impact of TD Securities at the Canadian Petroleum Tax Society 2010 Annual Conference. In a published statement released on July 7, 2010,2 the CRA adopted the position that, notwithstanding the contrary finding in TD Securities, it remains of the view that "an LLC that is fiscally transparent under the taxation laws of the United States is not a resident of the United States for purposes of the Treaty."

Refund Claims for Periods Prior to the Fifth Protocol

Although the CRA considers LLCs that are fiscally transparent for U.S. tax purposes not to be Treaty residents, the CRA stated that it will accept a claim for Treaty benefits made by an LLC, in respect of a taxation year to which Article IV(6) of the Treaty (introduced by the Fifth Protocol) does not apply, provided that:

  • the LLC can demonstrate that it was wholly-owned, throughout the relevant taxation year, by one or more persons who were residents of the United States for Treaty purposes; and
  • a notice of objection for the relevant taxation year is filed within the prescribed time period, or where the CRA has confirmed an assessment to which the LLC has objected, the LLC appeals the assessment within the prescribed time period, and the LLC is not otherwise precluded from raising the claim in the notice of appeal.

Where such relief is made available, the CRA expects that there will be corresponding adjustments to any foreign tax credits claimed in the United States that relate to the refunded Canadian taxes.

With respect to taxes withheld at source (under Part XIII of the Act), the CRA indicated that refunds may be available for amounts paid or credited by a Canadian resident to an LLC prior to the application of the Fifth Protocol (i.e., before February 1, 2009), if the refund application is made prior to the expiry of the limitation period specified in subsection 227(6) (i.e., no later than two years after the calendar year in which the amount is paid). The CRA also indicated that it will refund the excess tax only if "the item of income, in its entirety, was fully and comprehensively taxed in the United States in the hands of one or more persons who were U.S. Treaty residents."

Where a taxpayer has been assessed for failure to deduct or withhold tax under Part XIII of the Act on an amount paid or credited to an LLC, the CRA indicated that it will reassess the taxpayer to reduce the amount owing to reflect the application of the Treaty if:

  • the amount paid or credited, in its entirety, was fully and comprehensively taxed in the United States in the hands of one or more persons who were residents of the United States under the Treaty; and
  • the taxpayer has filed a valid objection to the assessment, or the CRA has confirmed an assessment to which the taxpayer has objected, and the taxpayer appeals the assessment, within the prescribed time period.

Impact of the Fifth Protocol

With respect to an amount of income, profit or gain arising in circumstances where Article IV(6) of the Treaty is applicable,3 the position of the CRA is that Article IV(6) establishes "the parameters under which the benefits of the Treaty may be claimed by a fiscally transparent LLC." Accordingly, in these circumstances, Treaty benefits claimed by an LLC will be recognized by the CRA only if the amount is considered to be derived, pursuant to Article IV(6) of the Treaty, by a person who is a resident of the United States and that person is a "qualifying person" or is entitled, with respect to the amount, to the benefits of the Treaty pursuant to paragraph 3, 4 or 6 of Article XXIX A.

Comments

Despite the CRA's recent view, the Tax Court held that the LLC in TD Securities was itself liable to tax and entitled to Treaty benefits. Such LLCs should be entitled to apply for refunds within the rules of the Act. Also, the CRA appears to be attempting to limit Treaty benefits to situations where the LLC's income has been fully and comprehensively taxed in the United States. However, Treaty benefits should be available based on being "liable to tax" in the United States – which may arise where the U.S. has the jurisdiction to tax the income on a comprehensive basis – even if it does not in fact actually tax that income (including, for example, where the entity realizes net losses). The position that liability to tax requires actual taxation is inconsistent with pronouncements of the Supreme Court of Canada,4 the published positions of the CRA and the Internal Revenue Service,5 as well the OECD Commentary on Article IV(1) of the Treaty and other various sources. Also, it is not clear why the CRA is attempting to limit refund claims for withholding taxes to a two year period. Article XXVI(2) of the Treaty provides that a request for relief from taxation not in accordance with the Treaty (such as withholding tax imposed at the rate of 25% instead of Treaty reduced rates) may be made within six years after the end of the relevant taxation year. The CRA has generally acknowledged that the six year rule in Article XXVI overrides the two year limitation period under subsection 227(6).6

In its published view, the CRA has adopted a restrictive view of TD Securities and has indicated that it will provide the relief contemplated by this decision in very limited circumstances. Despite this approach, taxpayers in circumstances that do not fit the terms outlined by the CRA should consider applying for a refund or a remission order, especially if they had ordered their tax affairs in good faith reliance on the CRA's long-standing administrative position that was subsequently overturned.

With respect to the impact of the Fifth Protocol, the CRA's view suggests that Article IV(6) sets certain parameters or limits on the ability to claim Treaty benefits. However, it is clear from the context of that provision, and the accompanying U.S. Technical Explanation, that Article IV(6) was intended to be a relieving rule – reversing the prior position of the CRA that sought to deny treaty benefits to many LLCs. The text of Article IV(6), like the rest of the Treaty, should be interpreted together with its context and purpose in determining whether Treaty benefits are available.

Footnotes

1. 2010 TCC 186.

2. CRA Document No. 2010-0369271C6, Canada-US Tax Convention - Treatment of LLCs (July 7, 2010).

3. Article IV(6) is in effect for taxes withheld at source in respect of amounts paid or credited on or after February 1, 2009 and for other amounts, for taxation years beginning after December 31, 2008.

4. Her Majesty The Queen v. Crown Forest Industries, 95 DTC 5389 (SCC).

5. See Income Tax Technical News No. 35 (February 26, 2007) and IRS - Revenue Ruling 2000-59.

6. Information Circular 71-17R5, Guidance on Competent Authority Assistance Under Canada's Tax Conventions (January 1, 2005) at para. 71.

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