The Canada-United States Income Tax Convention 1980
(the "Treaty") was amended in 2008 to allow U.S. resident
members of a U.S. limited liability company ("LLC") that
is disregarded or treated as a partnership for U.S. tax purposes to
claim the benefit of the Treaty. Prior to this, it was the Canada
Revenue Agency's (the "CRA's") long-standing
administrative position that such LLCs were not entitled to the
benefits of the Treaty. On April 8, 2010, the Tax Court of Canada
held, in TD Securities (USA) LLC v. The Queen,
that an LLC could claim the benefit of the Treaty even before the
Treaty amendments were made. This is relevant both for
pre-amendment tax periods and on an ongoing basis given a recent
CRA technical interpretation suggesting that the Treaty amendments
are not adequate in some circumstances. This flash briefly reviews
the TD Securities decision and possible implications of
The TD Securities Case
In TD Securities, the taxpayer ("TD LLC") was
a Delaware LLC. In addition to carrying on business in the U.S., TD
LLC operated a branch in Canada through a Canadian permanent
establishment. TD LLC was subject to Canadian corporate income and
branch tax in respect of its Canadian operation. The Canadian
statutory branch tax rate is 25% and the question in this case was
whether TD LLC was entitled to the reduced 5% rate under the
To qualify for benefits under the Treaty, TD LLC needed to be a resident of the U.S. under the Treaty. This required, in part, that TD LLC be liable to tax in the U.S. TD LLC was a disregarded entity for U.S. federal income tax purposes and, as such, it was not itself subject to tax in the U.S. Rather, its income was included in the income of its sole member, a U.S. resident corporation.
The CRA's Position
It has been the CRA's long-standing position that a fiscally
transparent LLC (a LLC that is disregarded or treated as a
partnership for U.S. federal income tax purposes) is not entitled
to Treaty benefits because it is not itself liable to U.S. income
tax, and thus is not a U.S. resident for the purposes of the
Treaty. This contrasts with CRA's position that members of a
partnership may claim Treaty benefits for the partnership's
income because the partnership is not a separate person for these
purposes. The CRA concluded that, unlike a partnership, the LLC was
a person apart from its members, earning its own income, and this
prevented its U.S.-resident members from claiming Treaty benefits
themselves. The 2008 Treaty amendments were intended to overcome
The TD Securities case dealt with events prior to the Treaty amendments and, consistent with its position, the CRA argued that TD LLC was not entitled to benefits under the Treaty and was therefore subject to Canadian branch tax at a rate of 25%.
The Tax Court's Decision
After considering the treatment of income of a partnership under
tax treaties (including the OECD commentary in this regard) and the
CRA's administrative position that it would provide benefits
under the Treaty to tax exempt entities, partnerships, "S
corporations" and others, the Tax Court stated that it was not
intended that an entity whose income was comprehensively taxed in a
tax treaty country would be denied the benefit of the tax treaty
simply because its income was taxed at the level of the
shareholders, members or partners instead of at the entity level.
Where a U.S. corporation (a so-called "S corporation")
elects it is treated as a transparent entity for U.S. federal
income tax purposes and its income is taxed in the hands of its
shareholders. In allowing S corporations Treaty benefits, the CRA
has distinguished them from LLCs on the basis of fine statutory
differences in the U.S. Internal Revenue Code (the
The Tax Court concluded that TD LLC was liable to tax in the U.S. because all of its income was comprehensively taxed under the US Code, albeit not at the LLC entity level. On this basis, the Tax Court determined that TD LLC was a resident of the U.S. and entitled to the benefits of the Treaty, namely the reduced rate of branch tax.
Although the correctness of some of the statements by the Tax Court can be questioned, the Tax Court came to the correct conclusion when considered from a policy perspective.
Implications of the TD Securities Case
Subject to a possible appeal, the decision in TD Securities will provide relief for LLCs for periods prior to the effective date of the Treaty amendments. However, its scope is broader than this.
The 2008 Treaty amendments, pursuant to new Article IV(6), provide releif from the CRA's position that LLCs are not entitled to benefits under the Treaty. The share of an LLC's income that is attributable to members who are U.S. residents for Treaty purposes is entitled to benefits under the Treaty in qualifying circumstances.
However, in a recent technical interpretation, the CRA stated that Article IV(6) will not provide relief in all cases. In particular, the CRA stated that there are issues in the application of Article IV(6) to income for Canadian tax purposes that is treated differently or not recognized for U.S. tax purposes. With respect to income that is treated differently for U.S. tax purposes, the CRA stated that it is generally willing to consider that Article IV(6) applies; however, it will not extend this position for taxation years after 2009 to income that is not recognized for U.S. tax purposes.
For example, in our Flash entitled "CRA Provides Its Latest Views on Planning for Canada-U.S. Tax Treaty Changes and Other Issues", dated November 25, 2009 (available at http://www.dwpv.com/en/17620_24427.aspx ), we described a planning alternative to deal with the inappropriate application of the new anti-hybrid rules in the Treaty to the payment of a dividend by an unlimited liability company ("ULC") to its U.S. resident shareholders. The anti-hybrid rules can apply to a payment from an entity that is a corporation for Canadian tax purposes (a ULC) where the entity is disregarded for U.S. tax purposes and its being disregarded for U.S. tax purposes affects the U.S. tax treatment of the payment. The planning alternative involves effectively paying the dividend by first increasing the paid-up capital of the ULC shares and then reducing and paying out the paid-up capital. The paid-up capital increase is treated as a payment of a dividend for Canadian tax purposes. From a U.S. tax perspective, the increase in paid-up capital is disregarded and the distribution arises on the return of capital. Because the U.S. disregards the capital increase in all cases, this result is not affected by the ULC's transparent status, and the anti-hybrid rules do not apply. We noted in our prior Flash that other considerations would apply where the shareholder is an LLC. In that case, the CRA would take the position that Article IV(6) does not apply to the deemed dividend received by the LLC and would deny Treaty benefits. Although the correctness of the CRA's position is highly questionable (and the CRA itself has stated that there is substantial uncertainty in interpreting the scope and intended application of Article IV(6)), the LLC may now be able to claim benefits under the Treaty on the basis of the TD Securities decision where all the members of LLC are U.S. residents that are liable to tax in the U.S. (and the new limitation on benefits Article in the Treaty is not applicable to deny Treaty benefits).
Although the Treaty has been amended to accommodate LLCs, the TD Securities decision could still have important implications. However, the Tax Court was very careful to limit its comments to circumstances where all the members of the LLC are residents of the U.S. and it is unclear what the implications of the decision will be where any of the members of the LLC are not U.S. residents. Whether the CRA will appeal the Tax Court's decision to the Federal Court of Appeal remains to be seen.
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.