2017-0724081C6 2017 CTF - Q11 - ULC-LLC structures & Treaty

Principal Issues: Are dividends paid by a ULC to its two LLC shareholders eligible for treaty benefits in order to reduce the rate of Canadian withholding tax?

Position: No.

Reasons: To the extent that, for U.S. income tax purposes, the ULC is considered to have made partnership distributions, it is our view that treaty benefits would not be available to reduce the rate of Canadian withholding tax applicable to payments of dividends by the ULC.

Author: Grondin, Yves
Section: Articles IV(1), IV(6), IV(7) and X(2) of the Canada-U.S. Treaty

2017 CTF Annual Conference
CRA Roundtable

Question 11: Treatment of LLC in ULC structures under the Canada-U.S. tax treaty

The CRA previously indicated that Article IV(6) of the Canada-U.S. Tax Treaty (the “Treaty”) does not treat a particular amount as being derived by a U.S. resident member of a U.S. LLC where that amount is disregarded under U.S. taxation laws.

Consider a Canadian ULC (“ULC”) with two shareholders, both limited liability companies created under the laws of Delaware (“LLC1” and “LLC2”, respectively).  LLC1 and LLC2 have their mind and management in the United States, are disregarded entities for U.S. tax purposes, and each owns 50% of the shares of ULC.

LLC1 is a wholly owned subsidiary of USCo1, and LLC2 is a wholly owned subsidiary of USCo2. Both USCo1 and USCo2 are U.S. residents for the purposes of the Treaty, qualifying persons for the purposes of Article XXIX-A and regarded entities for U.S. tax purposes. 

Can the CRA confirm whether dividends that ULC pays to LLC1 and LLC2 will be eligible for treaty benefits? Such dividends would not be disregarded payments for U.S. tax purposes, but would be treated as partnership distributions. 

CRA Response

Article IV(6) of the Treaty provides that an amount of income, profit or gain shall be considered to be derived by a person who is a resident of the U.S. (e.g., the members of an LLC) where the person is considered under the taxation law of the U.S. to have derived the amount through an entity (e.g. an LLC) and by reason of the entity being treated as fiscally transparent under the laws of the U.S., the treatment of the amount under U.S. taxation law is the same as its treatment would be if that amount had been derived directly by that person (e.g., the members of the LLC).

 We understand that, for U.S. federal income tax purposes, dividends paid by the ULC in the example provided above (which is treated as fiscally transparent under the laws of the U.S. but not as disregarded) should generally be considered as partnership distributions made by the ULC. As previously stated by the CRA at the Canadian Tax Foundation 2009 Round Table, with respect to an amount of income, profit or gain that is not “disregarded” under the taxation laws of the U.S. but is treated differently under those laws than under the taxation laws of Canada, the CRA is willing to consider, for the purposes of applying Article IV(6) of the Treaty, that the amount has been derived under the taxation laws of the U.S. Furthermore, pursuant to the Technical Explanation to the 2007 Protocol to the Treaty, where Article IV(6) applies to deem a U.S. resident to be considered to derive a Canadian-source dividend, such dividend is considered as being paid to that U.S. resident. As such, dividends paid by the ULC in the example provided above would be considered as being paid to USCo1 and USCo2.

Nevertheless, since the ULC is treated as fiscally transparent under the laws of the U.S., pursuant to Article IV(7)(b) of the Treaty, amounts of dividends paid by the ULC shall be considered not to be paid to or derived by a person who is a resident of the U.S. because, by reason of the ULC being treated as fiscally transparent under the laws of the U.S., the treatment of the amount under the taxation law of the U.S. (i.e. as a partnership distribution) is not the same as its treatment would be if the ULC were not treated as fiscally transparent under the laws of the U.S (i.e. as a dividend).

Therefore, pursuant to the application of Article IV(7)(b) of the Treaty, dividends paid by the ULC to LLC1 and LLC2 would be considered not to be paid to or derived by a U.S. resident. Therefore, the reduced treaty rate for dividends would not apply which results in the domestic Canadian withholding tax rate of 25% applying.

Yves Grondin
Nicolas Bilodeau
2017-072408
November 21, 2017

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