2017-0685651E5 Non-capital losses of LLC

Principal Issues: Whether the Canadian corporation requirement found in subsection 88(1.1) of the Act amounts to discrimination based on nationality or on a permanent establishment status contrary to Article XXV of the Canada-U.S. Income Tax Convention.

Position: No.

Reasons: For the reasons provided by the Tax Court of Canada and affirmed by the Federal Court of Appeal in Saipem UK Limited v. The Queen, 2011 TCC 25, affirmed in 2011 FCA 243.

Author: Eroff, Ina
Section: 87(2.1); 88(1.1); Article XXV of the Canada-U.S. Income Tax Convention

XXXXXXXXXX                                                                                                                        2017-068565
                                                                                                                                                Ina Eroff, B.C.L./LL.B.
May 25, 2017

Dear XXXXXXXXXX,

Re: Non-capital losses of LLC

We are replying to your facsimile in which you have requested our opinion on whether in the context of the hypothetical facts scenario you have outlined, the requirement found in subsection 88(1.1) of the Income Tax Act, R.S.C. 1985 (5th Suppl.) c.1, as amended (the “Act”) that both the parent corporation and the subsidiary corporation were Canadian corporations, amounts to discrimination based on nationality or against a permanent establishment contrary to Article XXV of the Convention between Canada and the United States of America with Respect to Taxes on Income and on Capital (the “Canada‑U.S. Treaty”).

Unless otherwise stated, all references to a statute are to the Act and all terms and conditions used herein that are defined in the Act have the meaning given in such definition unless otherwise indicated.

Hypothetical facts:

Parentco LLC is a limited liability company (“LLC”) resident in the United States. Parentco LLC does not carry on business in Canada within the meaning of subparagraph 115(1)(a)(ii).

Subco LLCs are single member LLCs resident in the United States that are wholly-owned by Parentco LLC. Each Subco LLC carries on business in Canada through a permanent establishment. Subco LLCs report their business income or loss derived through their permanent establishments in Canada pursuant to subparagraph 115(1)(a)(ii) and paragraph 115(1)(c). A number of Subco LLCs have non-capital losses within the meaning of subsections 111(8) and 111(9) that they are entitled to carry forward pursuant to subsection 111(1) and paragraph 115(1)(d).

To simplify the corporate structure, Subco LLCs will be wound-up into Parentco LLC. Subsequent to the wind-up, Parentco LLC will carry on the businesses of the predecessor Subco LLCs through permanent establishments in Canada.

Query:

Whether the non-capital losses of Subco LLCs can be utilized by Parentco LLC to reduce its business income derived through the permanent establishments situated in Canada notwithstanding that the conditions in subsection 88(1.1) are not satisfied on the basis that the requirement found in that subsection that both Parentco LLC and Subco LLC were Canadian corporations amounts to discrimination based on nationality or on a permanent establishment status contrary to Article XXV of the Canada – U.S. Treaty.

Would the response be different if Subco LLCs amalgamate with Parentco LLC instead of proceeding by way of a wind-up?

Our comments:

This technical interpretation provides general comments about the provisions of the Act and the Canada – U.S. 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.

The relevant portion of the definition of “Canadian corporation” set out in subsection 89(1) reads as follows: “Canadian corporation” at any time means a corporation that is resident in Canada at that time and was

(a)   incorporated in Canada, or

(b)   resident in Canada throughout the period that began on June 18, 1971 and that ends at that time 

The hypothetical transactions do not satisfy the requirement of subsection 88(1.1) that Parentco LLC and Subco LLCs were Canadian corporations. Based on the decision in Saipem UK Limited v. The Queen, 2011 TCC 25, affirmed in 2011 FCA 243 (“Saipem UK”), it is our view that this requirement does not violate either paragraph 1 or paragraph 5 of Article XXV of the Canada - U.S. Treaty. In particular, in Saipem UK, the Tax Court of Canada and the Federal Court of Appeal rejected the argument that this requirement in subsection 88(1.1) violated non-discrimination provisions in paragraphs 1 and 2 of Article 22 of the Convention between the Government of Canada and the Government of the United Kingdom of Great Britain and Northern Ireland for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and Capital Gains (the “Canada - U.K. Treaty”) which are in our view analogous to paragraphs 1 and 5 of Article XXV of the Canada - U.S. Treaty.

Paragraph 1 of Article XXV of the Canada - U.S. Treaty prohibits discrimination based on nationality between nationals of the contracting states that are in the same circumstances. The Court in Saipem UK concludes that the kind of discrimination contemplated in the analogous paragraph 1 of Article 22 of the Canada - U.K. Treaty has to be based only on the place of incorporation, while different treatment based on residence does not offend that provision because nationals of one state that are non-residents of the other state are not “in the same circumstances” as resident nationals of that other state.

Paragraph 5 of Article XXV of the Canada - U.S. Treaty provides that the taxation on a permanent establishment which a resident of one state has in the other contracting state shall not be less favourably levied in the other state than the taxation levied on residents of that other state carrying on the same activities. The Court in Saipem UK cites the Commentary by the Organization for Economic Cooperation and Development (the “OECD Commentary”) on non-discrimination provisions in Article 24 of the Model Convention with respect to Taxes on Income and on Capital (the “Model Tax Convention”).  The OECD Commentary provides that paragraph 3 of Article 24 of the Model Tax Convention, which is in our view analogous to paragraph 5 of Article XXV of the Canada – U.S. Treaty and paragraph 2 of Article 22 of the Canada – U.K. Treaty is designed to prevent discrimination based on the actual situs of an enterprise in the country and not on its nationality. Paragraph 41 of the OECD Commentary on paragraph 3 of Article 24 provides:

“[…] the equal treatment principle of paragraph 3 only applies to the taxation of the permanent establishment’s own activities. That principle, therefore, is restricted to a comparison between the rules governing the taxation of the permanent establishment’s own activities and those applicable to similar business activities carried on by an independent resident enterprise. It does not extend to rules that take account of the relationship between an enterprise and other enterprises (e.g. rules that allow consolidation, transfer of losses or tax-free transfers of property between companies under common ownership) since the latter rules do not focus on the taxation of an enterprise’s own business activities similar to those of the permanent establishment but, instead, on the taxation of a resident enterprise as part of a group of associated enterprises.”

As such, a rule that effectively allows for the transfer of losses between companies under common ownership does not in our view come within the protection against discrimination found in paragraph 5 of Article XXV of the Canada - U.S. Treaty.

In addition, subsection 88(1.1) requires not only that the parent be a Canadian corporation but that the subsidiary be a Canadian corporation as well. A Canadian corporation that winds up a subsidiary that is not a Canadian corporation is not entitled to use losses of the subsidiary. On this basis, by not being able to deduct losses incurred by Subco LLCs Parentco LLC is not being treated less favorably than a Canadian enterprise carrying on the same activities. As a result, the Canadian corporation requirement in subsection 88(1.1) does not in our view amount to discrimination against a permanent establishment contrary to paragraph 5 of Article XXV of the Canada - U.S. Treaty.

If Parentco LLC were to amalgamate with Subco LLCs, the transactions would not satisfy the requirements of subsection 87(2.1) since for the purposes of that provision, subsection 87(1) defines an amalgamation as a merger of two or more corporations each of which was, immediately before the merger, a taxable Canadian corporation. For the reasons outlined above and in accordance with the decision in Saipem UK, this requirement for the application of subsection 87(2.1) does not in our view violate the non-discrimination provisions in paragraphs 1 and 5 of Article XXV of the Canada - U.S. Treaty.

We hope this information is of assistance to you.

Yours truly,

Olli Laurikainen, CPA, CA
Section Manager
For Division Director
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

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