The April 8, 2010 decision of the Tax Court of Canada in TD Securities (USA) LLC v. R. (2008-2314(IT)G) has reversed a long-standing position of the Canada Revenue Agency (CRA) that US limited liability companies (LLCs) are not entitled to the benefits of the Canada-US Income Tax Convention (Treaty) before the recent amendments made in the Fifth Protocol to the Treaty. While we expect the case will be appealed, US LLCs that have not claimed the benefit of the Treaty for past years may wish in the meantime to file amended returns for branch tax or capital gains tax or to file claims for refunds of withholding tax on dividends, interest, royalties and management fees for past years. Applications for refunds of amounts withheld must be made no later than two years after the calendar year in which the amount was withheld and remitted.
TD Securities (USA) LLC (TD LLC) is a Delaware LLC, the sole member of which is TD Holdings II Inc. (Holdings), a Delaware corporation indirectly wholly owned by The Toronto-Dominion Bank, a Canadian chartered bank. TD LLC is a US broker-dealer that has a Canadian branch in Canada to serve its US customers. TD LLC is a disregarded entity for US tax purposes such that its income is included in that of its sole member, Holdings.
The Canadian branch profits of TD LLC for 2005 and 2006 were reported by TD LLC in its Canadian tax returns. Under Part XIV of the Income Tax Act (Canada), an additional 25 per cent "branch tax" is imposed on non-residents carrying on business in Canada, subject to reduction under an applicable treaty. TD LLC claimed the reduced rate of five per cent on its Canadian branch profits on the basis that the Treaty applied. Holdings also included the Canadian branch profits of TD LLC in its income under the US Code.
The CRA argued that, although an LLC is a person, it is not liable to tax in the US, such that it could not meet the definition of "resident" in Article IV of the Treaty (i.e., "any person that, under the laws of that State, is liable to tax therein by reason of that person's domicile, residence, citizenship, place of management, place of incorporation or any other criterion of a similar nature"). Accordingly, TD LLC was not entitled to the benefits of the reduced rate of branch tax under the Treaty.
The Tax Court of Canada held that TD LLC was entitled to the benefits of the Treaty, as the evidence was overwhelming that the "object and purpose" of the Treaty would be frustrated if the Canadian-sourced income of TD LLC that is fully taxed in the US in the hands of its member does not enjoy the benefits of the Treaty. As stated by Boyle, J.:
"It makes little sense to think that treaty entitlement should be affected by a US LLC's exercise of its right under the US Code to elect to have its income taxed in its hands or flowed through and taxed in the hands of its US-resident members."
This was stated to be consistent with the OECD Model Treaty and related reports and commentaries, in particular those dealing with partnerships. It was also consistent with the CRA's position that the Treaty applied to not-for-profit entities and government entities, notwithstanding that they are not generally liable to tax under the US Code, and "S" corporations, notwithstanding that their income is flowed through to their shareholders. Further, it was consistent with the CRA's position that the Treaty applied to foreign partnerships, notwithstanding that their income is flowed through to partners, and treaty benefits determined and enjoyed at the partner level. In the Court's view, the treatment of foreign partnerships and LLCs should be analogous. Finally, the Fifth Protocol, although not treating an LLC as a resident yet applying the Treaty as if the LLC were a resident, was further evidence that the Treaty prior to the Fifth Protocol should extend to LLCs.
It will be interesting to see how the CRA will interpret the Fifth Protocol in light of this case and the difficult interpretative issues that the Fifth Protocol provisions dealing with LLCs and other fiscally transparent entities already present and that we have discussed in earlier Notes.1, 2 The February 10, 2010 CRA Technical Interpretation 2009-0345351C6, which contains the official answer to a CRA Round Table question at the Canadian Tax Foundation's 2009 annual conference on the application of the Fifth Protocol to LLCs, may require reconsideration — in particular in respect of interest and dividends paid to a US LLC before 2010. It is also interesting to consider whether the result in the case would have been different if TD LLC had two members, one of which was not resident in a treaty country.
A similar reversal recently occurred in the February 22, 2010 decision of the UK First-Tier Tribunal in Mr. Swift v. Commissioners,  UKFTT 88 (TC). In this case, a UK resident who was a member of a US LLC was held to be entitled to claim a UK foreign tax credit for the US federal and state taxes on his share of the profits of the LLC against his UK tax on the distributions from the LLC. The UK tax authority's long-standing position had been that the LLC is a corporate entity that paid the equivalent of a dividend to its members (i.e., not fiscally transparent) so that the UK resident had not been taxed on the same income in the UK for which relief from double taxation would be available with a foreign tax credit.
In both recent cases dealing with the treatment of LLCs, the decisions were expressly stated to be limited to the particular facts and circumstances; however, practically they have wider potential application.