Canada: The Downside Of Tax Efficiency

Tax Benefits of Using an LLP

Until recently, band-owned businesses in British Columbia tended to be structured in one of three forms:

  1. owned directly by the band (also known as a band proprietorship);
  2. as a company (often called an economic development corporation); or
  3. as a limited partnership.

Deciding between these options was generally a matter of balancing administrative simplicity, liability and tax efficiency.

Recent tax guidance in British Columbia has suggested that a fourth type of ownership, the limited liability partnership ("LLP"), can be very efficient from a taxation perspective. When used correctly, LLPs can result in significant savings on provincial sales taxes (such as PST and fuel tax) for businesses owned wholly or in part by Indian bands. These savings are generally not available to corporations or limited partnerships.

Many bands are now rushing to convert their existing businesses into LLPs in order to recognize savings on provincial sales taxes.

But Wait – There are Downsides to LLPs

Tax efficiency is not the only consideration. Choosing the correct corporate vehicle for a band-owned business requires an analysis of a number of factors, including administrative simplicity, tax efficiency and liability.

In many instances, LLPs do not offer the same degree of liability protection as corporations or limited partnerships. If you rush into an LLP for tax reasons, you may be putting your band's assets at risk – including money earmarked for things like education, health and social development.

Here are some of the LLP liability traps you need to keep an eye out for:

Liability for Negligent and Wrongful acts

A limited liability partner may be personally liable for negligent or wrongful acts if the partner knew of the act and did not take reasonable steps to prevent it. In many cases, this means the band could be on the hook for the business' negligent or wrongful acts.

Consider the example of an LLP with two owners: an established business and a band. Let's say that these two owners open a gravel pit business, and the band is concerned about retaining some control over the business, so it appoints a band representative to jointly manage the business on a management committee. The business is not as profitable as planned, so the management committee decides to defer some maintenance on a piece of equipment for a few months until revenue from a large contract comes in.

If the equipment malfunctions due to the deferred maintenance, an employee was injured, and the employee sued on the basis that it was negligent to defer the equipment maintenance, the band could potentially be liable for the damages.

Director-Like Liability

Most business people are aware of the potential liabilities that come with being a director of a company. The same liabilities also attach to partners in a LLP, and include:

Liability for unpaid wages and taxes

Under the British Columbia Employment Standards Act, a director of a corporation can be liable for unpaid wages to employees. Additionally, many tax laws (both federal and provincial) impose liability on directors for unpaid tax obligations. This can include unpaid source deductions (such as employee income tax, CPP, EI), withholding taxes or GST. If a band is a partner in an LLP, it faces these same liabilities.

Liability for environmental damage or contamination

Under federal and provincial statutes, directors of a corporation are potentially liable for certain environmental impacts. For example, if a business causes environmental damage by polluting fish habitat or contaminating land, the directors could be liable under the Fisheries Act or the Environmental Management Act. Moreover, under provincial environmental legislation, if a company simply acquired an already contaminated piece of land, the directors could be considered "responsible persons" and liable for costs of remediation.

Think of a gas station run by a band-owned LLP. Many gas stations are on land that has been contaminated by hydrocarbons as a result of decades of operation. If the gas station is owned or operated by a band-owned LLP, the band itself could be liable for the costs of remediation – which could be in the millions of dollars.

Should Bands Avoid Using LLPS?

Despite these liability drawbacks, there can be major advantages to using LLPs, especially for businesses that rely heavily on goods that attract PST or fuel tax. Sometimes it will make sense for a band-owned business to take advantage of these tax savings. However, it is critical to consider the liability trade-off for tax savings: prudent leaders and EDOs will ensure that they understand the liability risk, and make an informed decision about whether the tax benefits outweigh the risks.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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