2016-0669761C6 2016 CTF - Q11 - Computation of Earnings for LLCs

Principal Issues: 1) Whether it continues to be the CRA's position that a disregarded U.S. LLC computes its “earnings” pursuant to subparagraph (a)(i) of the definition of “earnings” in subsection 5907(1) of the Regulations in light of the introduction of subsection 5907(2.03) of the Regulations; (2) Whether the answer would change if the LLC had one or more members which were not regarded U.S.-resident corporations

Position: (1) Upon the introduction of subsection 5907(2.03) of the Regulations, “earnings” of a disregarded LLC should be computed pursuant to subparagraph (a)(iii) of the definition of “earnings” in subsection 5907(1) of the Regulations; (2) Provided that the LLC is treated as a disregarded entity for U.S. purposes, the answer would not change. However, if the LLC is treated as a partnership for U.S. purposes, the LLC should compute its “earnings” pursuant to subparagraph (a)(i) of the definition of “earnings” in subsection 5907(1) of the Regulations.

Reasons: See response below

Author: Tu, Grace
Section: Definition of “earnings” under subsection 5907(1) of the Regulations, subsection 5907(2.03) of the Regulations

2016 Canadian Tax Foundation Annual Conference
CRA Roundtable

Question 11 - Computation of Earnings for a Disregarded U.S. Limited Liability Company

In its response to Question 9 posed at the 2011 IFA Conference, the CRA indicated that a disregarded U.S. limited liability company (LLC) that is a foreign affiliate of a Canadian taxpayer and that has a single member which is a regarded U.S. corporation should compute its “earnings” in accordance with subparagraph (a)(i) of the definition of “earnings” in subsection 5907(1) of the Regulations. Despite the fact that such an LLC would not itself be required to compute its profits pursuant to U.S. tax law, and that such a computation would only be made for purposes of computing the member’s tax liability, the CRA considered this to be sufficient to bring the scenario within the scope of the above-mentioned provision. The CRA further stated the following:

“If the CRA encounters a Canadian corporation that has attempted to inflate the surplus balances of a foreign affiliate that is a US limited liability company by computing its “earnings” in accordance with the Act and ignoring discretionary deductions, the CRA may challenge the taxpayer's filing position…”

a)    In light of subsection 5907(2.03) of the Regulations, which was enacted in 2013 and which requires an affiliate that computes its “earnings” in accordance with Canadian tax law to claim all discretionary deductions to the maximum extent possible, does the position set out above still accurately reflect the CRA’s view? That is, is it still the CRA’s view that a disregarded LLC that is resident and carrying on an active business in the United States should compute its “earnings” under the U.S. rules? 

b)    Would the answer change if the LLC had one or more members which were not regarded U.S. resident corporations?

CRA Response

a)    The view of the CRA regarding the interpretation of the definition of “earnings” in subsection 5907(1) of the Regulations (hereinafter referred to as the “Earnings Definition”) has changed as a result of the context provided by subsection 5907(2.03) of the Regulations.  The CRA is now of the view that the “earnings” from a U.S. active business of a U.S.-resident, single member LLC that is disregarded for U.S. tax purposes and that is a foreign affiliate of a corporation resident in Canada should be computed in accordance with subparagraph (a)(iii) of the Earnings Definition.  The change in the CRA’s position is effective for the first taxation year of the LLC for which subsection 5907(2.03) has effect, that year being the LLC’s first taxation year ending after August 19, 2011.

The CRA recognizes that subsection 5907(2.03) does not contemplate a scenario where the “earnings” of a foreign affiliate are computed under subparagraph (a)(i) of the Earnings Definition in one taxation year and under subparagraph (a)(iii) of the Earnings Definition the next taxation year. However, for the purposes of such a transition, the CRA is prepared to accept that paragraph 5907(2.03)(b) applies under this scenario and that the deductions claimed in preceding taxation years in computing the LLC’s “earnings” under subparagraph (a)(i) of the Earnings Definition were “deductions…actually claimed under the Act”. 

b)    The CRA’s position is the same where the LLC is treated as a disregarded entity for U.S. tax purposes, regardless of the status of its member for U.S. tax purposes. However, the CRA’s position differs for a U.S.-resident LLC that has two or more members and that is treated as a partnership for U.S. tax purposes. If such LLC carries on an active business in the U.S and is required for U.S. tax purposes to compute its income to determine the partners’ distributive shares, it is the CRA’s view that the LLC must compute its “earnings” under subparagraph (a)(i) of the Earnings Definition in accordance with the income tax laws of the U.S.

Grace Tu
Vitaliy Anissimov
2016-066976
November 29, 2016

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