Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA. Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.
Principal Issues: Whether consequent to the decision of the U.K. Supreme Court in the case of Anson v. Commissioners for Her Majesty’s Revenue and Customs,  UKSC 44, an individual taxpayer who is a resident of Canada and a member of a U.S. limited liability company (LLC) is entitled to a foreign tax credit in Canada pursuant to paragraph 2 of Article XXIV of the Canada - U.S. Income Tax Convention for U.S. taxes paid in a taxation year on their share of the income of the LLC regardless of whether the LLC has made a distribution in that taxation year
Reasons: The CRA generally views income of a corporation, including an LLC, to belong to the corporation and the Anson decision has not changed that general view. The CRA considers the U.S. taxes paid by a member of a U.S. resident LLC on their share of the income of the LLC to be in respect of a U.S. source (i.e. the source being the member’s interest in the LLC). However, under the provisions of subsection 126(1) of the Act, an individual member must have U.S. source income (e.g. a dividend from an LLC) in the taxation year for which the tax is paid in order to compute a foreign tax credit. The relief from double taxation provided in paragraph 2 of Article XXIV of the Canada - U.S. Income Tax Convention is subject to the limitations imposed by subsection 126(1) of the Act.
Author: Eroff, Ina
Section: 20(11), 20(12), 126(1), 126(7); Article XXIV of the Canada-U.S. Income Tax Convention.
April 13, 2017
Re: Income of LLC
We are replying to your email in which you asked whether the decision of the U.K. Supreme Court (the “Court”) in the case of Anson v. Commissioners for Her Majesty’s Revenue and Customs,  UKSC 44 (“Anson”) is pertinent to the determination of whether paragraph 2 of Article XXIV of the Canada - U.S. Income Tax Convention (the “Treaty”) requires Canada to allow a deduction or credit contrary to the Income Tax Act, R.S.C. 1985 (5th Suppl.) c.1, (the “Act”) in order to avoid double taxation resulting from a timing mismatch in taxation of members of a U.S. limited liability company (“LLC”).
In particular, if an individual resident in Canada who is a member of an LLC that is resident in the United States for the purposes of the Act pays tax in the U.S. on his or her share of profit of the LLC for a particular taxation year but does not have U.S. source income on which Canadian tax is otherwise payable in that taxation year, no foreign tax credit is available under subsection 126(1) of the Act. Moreover, subsection 126(1) of the Act does not permit the foreign taxes paid for a particular taxation year to be carried forward to a subsequent taxation year when profits are distributed by the LLC to its members and the members have U.S. source income for the purposes of the Act. You are enquiring firstly, whether based on the Anson decision, the Canada Revenue Agency (the “CRA”) is prepared to accept that the member’s income from the LLC arises for the purposes of the Act as it is earned by the LLC rather than only once it is distributed by the LLC to its members, thus supporting the view that the U.S. taxes and the Canadian taxes are payable by the member in respect of the same profits, income or gains for the purposes of paragraph 2 of Article XXIV of the Treaty. Secondly, you request our view on whether notwithstanding any provisions of the Act, the member of the LLC can rely on paragraph 2 of Article XXIV of the Treaty to claim a foreign tax credit for the taxes paid to the U.S. on his or her share of the LLC’s income for the year when there is a distribution in respect of that income from the LLC regardless of whether the distribution takes place in the same taxation year when the income was earned by the LLC.
This technical interpretation provides general comments about the provisions of the Act and the Treaty. It does not confirm the income tax treatment of a particular situation but is intended to assist you in making that determination. The income tax treatment of transactions will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R7, Advance Income Tax Rulings and Technical Interpretations.
In Anson, the taxpayer, a U.K. resident and a member of a Delaware LLC that was treated as a partnership for U.S. tax purposes, claimed a foreign tax credit under Article 23(2)(a) of the U.K./U.S. Double Taxation Convention of December 31, 1975 and its successor, Article 24(4)(a) of the U.K./U.S. Double Taxation Convention of July 24, 2001 (together, the “Relevant Treaty”) for U.S. federal and state taxes paid on his share of the profits from the LLC against taxes he was liable to in the U.K. The issue before the Court was whether the U.K. taxes to which the taxpayer was liable were “computed by reference to the same profits or income”, within the meaning of the Relevant Treaty, as the profits or income by reference to which the U.S. taxes were computed.
The Court allowed the taxpayer’s appeal. The Court was ultimately of the view that whether or not the U.S. taxes and the U.K. taxes were computed by reference to the same “profits or income” or two different sources depended on whether the taxpayer’s income arose for purposes of U.K. law when the profits were earned by the LLC, or only when they were distributed by the LLC. The Court accepted the finding made by the First-Tier Tribunal (the “FTT”) that by virtue of the LLC agreement and the Delaware LLC Act, the members of the LLC were entitled to their shares of profits as they arose. The Court concluded that, as a matter of U.K. tax law, and based on the findings of the FTT, the taxpayer was liable to tax in the U.K. on his share of the LLC’s profits, which was the same income that had been taxed in the U.S.
As was noted by the CRA in response to Question 7 at the 2015 CTF Conference, although foreign countries’ court cases generally have no precedential value under Canadian law, we do consider them, especially when our laws are rooted in similar legal systems. With the Anson case, we find both the reasons in the U.K. Supreme Court case as well as the Court of Appeal case to be of interest. However, it is our view that the overall conclusions in Anson are not relevant for the determination of how an LLC’s income is treated under the Act. We are maintaining our position that LLCs would generally be considered to be corporations for the purposes of the Act, based on the application of our usual two-step approach. Consequently, for the purposes of the Act, any profits earned by an LLC generally belong to the LLC as a separate legal entity until they are distributed to the members.
In view of our conclusion below that the right of a taxpayer to claim a foreign tax credit is limited to circumstances provided in subsection 126(1) of the Act, it is not necessary to consider whether the profits, income or gains arising in the U.S. on which income taxes are paid or accrued to the U.S. may nevertheless be the same profits, income or gains in respect of which the Canadian taxes are payable for the purposes of subparagraph (a) of paragraph 2 of Article XXIV of the Treaty.
Subparagraph (a) of paragraph 2 of Article XXIV of the Treaty provides that in order to avoid double taxation, income tax paid or accrued to the U.S. on profits, income or gains arising in the U.S. shall be deducted from any Canadian tax payable in respect of such profits, income or gains. The application of this provision of the Treaty is expressly subject to the provisions of the law of Canada regarding the deduction from tax payable in Canada of tax paid in a territory outside Canada and to any subsequent modification of those provisions (which shall not affect the general principle of Article XXIV of the Treaty). In our view this means that a Canadian resident is subject to the limitations on claiming a foreign tax credit found in the Canadian legislation, and more specifically in section 126 of the Act, including a timing restriction on when a foreign tax credit may be claimed.
This approach is consistent with the commentary provided by the Organization for Economic Co-operation and Development (“OECD”) on Article 23B of the OECD Model Tax Convention on Income and on Capital, 2014 (the “Model Tax Convention”), which requires the state of residence to provide relief from double taxation by granting a tax credit for the taxes levied by the state of source on profits earned in that state. In particular, the OECD states that it is preferable for the credit method in Article 23B not to propose an express and uniform solution in the Model Tax Convention, but to leave each state free to apply its own legislation and technique. The OECD expressly contemplates that states may impose timing restrictions on claiming foreign tax credits. In paragraph 32.8, section F “Timing Mismatch” of the commentary on Article 23 B of the Model Tax Convention it is stated:
[…] Some States, however, do not follow the wording of Article 23 A or 23 B in their bilateral conventions and link the relief of double taxation that they give under tax conventions to what is provided under their domestic laws. These countries, however, would be expected to seek other ways (the mutual agreement procedure, for example) to relieve the double taxation which might otherwise arise in cases where the State of source levies tax in a different taxation year.
In the case of Canada, such “other ways … to relieve the double taxation” include deductions allowed under subsections 20(11) and 20(12) of the Act. As such, in our view, the limits imposed by subsection 126(1) of the Act on claiming a foreign tax credit are in accordance with the OECD guidelines and do not affect the general principle of Article XXIV of the Treaty.
We hope this information is of assistance to you.
For Division Director
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
All rights reserved. Permission is granted to electronically copy and to print in hard copy for internal use only. No part of this information may be reproduced, modified, transmitted or redistributed in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, or stored in a retrieval system for any purpose other than noted above (including sales), without the prior written permission of Canada Revenue Agency, Ottawa, Ontario K1A 0L5.
© Her Majesty the Queen in Right of Canada, 2017
Tous droits réservés. Il est permis de copier sous forme électronique ou d'imprimer pour un usage interne seulement. Toutefois, il est interdit de reproduire, de modifier, de transmettre ou de redistributer de l'information, sous quelque forme ou par quelque moyen que ce soit, de facon électronique, méchanique, photocopies ou autre, ou par stockage dans des systèmes d'extraction ou pour tout usage autre que ceux susmentionnés (incluant pour fin commerciale), sans l'autorisation écrite préalable de l'Agence du revenu du Canada, Ottawa, Ontario K1A 0L5.
© Sa Majesté la Reine du Chef du Canada, 2017
For additional commentary on Technical Interpretations, court cases, government releases, and conference materials in a single practical document specifically geared toward owner-managed businesses, see Video Tax News Monthly Tax Update newsletter.
This effective summary and flagging tool is the most efficient way to ensure that you, your firm, and clients are fully supported and armed for whatever challenges are thrown your way.
Packages start at $399/year.