2017-0691201C6 IFA 2017 Q.9: Computation of Earnings for LLCs

Principal Issues: Whether the CRA would reconsider the position announced at the 2016 CTF Conference that earnings of disregarded LLCs must be computed under the rules in subparagraph (a)(iii) of the definition of “earnings” in Regulation 5907(1), rather than the rules under subparagraph (a)(i) of that definition, starting from the taxation years of the LLCs ending after August 19, 2011.

Position: Relief provided.

Reasons: See below

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

2017 International Fiscal Association Conference
CRA Roundtable

Question 9 - Computation of Earnings for a Disregarded U.S. LLC

At the November 2016 Canadian Tax Foundation annual conference in Calgary (“2016 Annual Conference”), in its response to Question 11, the CRA stated it had changed its position regarding the computation of earnings of a disregarded U.S. limited liability company (“LLC”) that carries on an active business. The CRA’s previous position (“2009 Position”), which was reaffirmed in its response to Question 9 at the 2011 IFA Conference, was that such an LLC should compute its earnings in accordance with subparagraph (a)(i) of the definition of “earnings” (“Earnings Definition”) in subsection 5907(1) of the Income Tax Regulations (“Regulations”). The CRA’s revised position, expressed at the 2016 Annual Conference (“2016 Position”), is that in light of the introduction of subsection 5907(2.03) of the Regulations, such an LLC should compute its earnings in accordance with subparagraph (a)(iii) of the Earnings Definition. The CRA stated that this change in position applies retroactively to the LLC’s first taxation year ending after August 19, 2011, which is the effective date of subsection 5907(2.03) of the Regulations.

The change in the CRA’s position described above can have a material retroactive impact on the computation of a foreign affiliate’s earnings for surplus purposes. Over the past few years, up until the 2016 Position was announced, many transactions could have taken place that would have affected, or would have relied on, such computations, including distributions, liquidations, and sales or acquisitions of shares.

Given the potentially adverse consequences associated with the change in the CRA’s administrative position for the computation of an LLC’s earnings, would the CRA be willing to consider the following:

a)    For taxation years of the LLC beginning prior to November 29, 2016, the taxpayer may choose whether to compute the LLC’s earnings in accordance with either the 2009 Position or the 2016 Position.

b)    To the extent of any dividends received by a Canadian taxpayer on or before November 29, 2016, or any other transactions completed prior to November 29, 2016 that relied on the computation of the LLC’s earnings based on the 2009 Position, the computation of the LLC’s earnings may be based on the 2009 Position.

CRA Response

Since the 2016 Position was published, the CRA has listened to taxpayers’ concerns regarding the retroactive effect of the change in position with respect to the calculation of earnings of disregarded U.S. LLCs. The CRA appreciates that where taxpayers have completed certain transactions and relied on the computation of earnings in accordance with the 2009 Position, the retroactive effect of the 2016 Position may result in adverse tax consequences that could not have been foreseen by the taxpayers. We also appreciate that some taxpayers may have incurred compliance costs in relation to the calculations of earnings and surplus of disregarded U.S. LLCs based on the 2009 Position, prior to the announcement of the 2016 Position.

For these reasons, if a taxpayer uses the 2009 Position to calculate the earnings of a foreign affiliate that is a disregarded U.S. LLC for the LLC’s taxation years ended on or before November 29, 2016 (i.e. on or before the day the 2016 Position was announced), the CRA is prepared to accept that calculation, provided that the taxpayer and all taxpayers related to the taxpayer use the 2009 Position to calculate the earnings of all of their foreign affiliates that are disregarded U.S. LLCs for all taxation years of these LLCs that ended on or before November 29, 2016.  Alternatively, such taxpayers can choose to compute the earnings of all of their foreign affiliates that are disregarded U.S. LLCs in accordance with the 2016 Position for all taxation years of these LLCs that ended after August 19, 2011.

The CRA is of the view that the earnings of a disregarded U.S. LLC for any taxation year that ends after November 29, 2016, should be computed in accordance with the 2016 Position.

Grace Tu
Olli Laurikainen
2017-069120
April 26, 2017

Response prepared in collaboration with:

Mark Turnbull
International Tax Division
International, Large Business and Investigations Branch

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