2018-0749481C6 IFA 2018 Q.8: Update on Entity Classification

Principal Issues: (1) Update on the administrative relief regarding certain Delaware and Florida LLPs/LLLPs announced at the IFA 2017; (2) update on the CRA Delaware & Florida LLPs/LLLPs Working Group deliberations; and (3) update on new entities or arrangements that were considered by the CRA?

Position: (1) & (2) General comments; as a result of the compliance study of the CRA Delaware & Florida LLPs/LLLPs Working Group, the grandfathering administrative practice was introduced to address the main concerns brought to the attention of the CRA. As such, it is anticipated that the working group will conclude its compliance study in the near future. (3) We recently reached the conclusion that a specific French “Société de Libre Partenariat” would not be considered to be a partnership for Canadian income tax purposes.

Reasons: (1) & (2) This approach facilitates compliance and administration; (3) application of the “two-step” approach for entity classification.

Author: Roulier, Yannick
Section: 150, 152(4)(a), 248(1) "corporation"

IFA 2018 International Tax Conference
Canada Revenue Agency Roundtable

Question 8 - Update on Entity Classification

At this conference last year, the Canada Revenue Agency (“CRA”) announced that the CRA Delaware & Florida LLPs/LLLPs Working Group (footnote 1) (the “Working Group”) formed to study compliance issues related to Delaware and Florida limited liability partnerships (“LLPs”) and limited liability limited partnerships (“LLLPs”) had decided to build on a prospective approach previously announced by allowing any such entities formed before April 26, 2017, to file as a partnership for all prior and future tax years, provided certain conditions were not met. The CRA indicated that Delaware and Florida LLPs and LLLPs formed after April 25, 2017 will be assessed as corporations for all purposes of Canadian income tax law. The CRA also stated that the Working Group was continuing its study of compliance issues.

Can the CRA provide us: (a) with the current status of the Working Group’s study of compliance issues relating to Delaware and Florida LLPs and LLLPs, and (b) with an update on any new entities or arrangements that have recently been considered?

CRA Response

a)    The CRA’s position expressed at the CRA Roundtable of the 2016 annual meeting of the International Fiscal Association - Canadian chapter (“IFA”) held on May 26, 2016 (footnote 2) (the “IFA 2016 Pronouncement”) regarding the treatment of Delaware and Florida LLPs and LLLPs was that these types of entities should generally be treated as corporations for the purposes of Canadian income tax law.

At the 2016 Canadian Tax Foundation annual conference, the CRA announced that it had established the Working Group to study transitional and compliance issues related to Delaware and Florida LLPs and LLLPs arising from its prior announcement that it would generally consider such entities to be corporations for Canadian tax purposes.

As a result of the Working Group’s review, the CRA announced at the CRA Roundtable of the 2017 annual meeting of the IFA held on April 26, 2017 (footnote 3) (the “IFA 2017 Pronouncement”) that it would offer administrative grandfathering. The CRA’s administrative practice allows any Delaware and Florida LLPs and LLLPs formed before April 26, 2017 to file as a partnership for all prior and future taxation years, provided none of the following conditions apply:

*     one or more members of the entity and/or the entity itself take inconsistent positions from one taxation year to another, or for the same taxation year, between partnership and corporate treatment;

*     there is a significant change in the membership and/or the activities of the entity; or

*     the entity is being used to facilitate abusive tax avoidance.

Where any of these conditions is met in respect of any such entity formed before April 26, 2017, the CRA may issue assessments to the members and/or the entity, for one or more taxation years, on the basis that the entity is a corporation.

The Working Group has received further submissions following the IFA 2017 Pronouncement and would like to clarify the conditions related to the grandfathering administrative practice and other related items. We believe this information addresses the issues raised in the submissions received with respect to the administrative practice.

Additional clarification with respect to the administrative practice

The following information provides clarification on the application of the administrative practice.

1.    Regarding the first condition of the administrative practice, the following examples will generally not, in and of themselves, be considered by the CRA as “inconsistent positions”:

a.    The “protective filing” of T1134s and / or T106s, in respect of Delaware and Florida LLPs or LLLPs, based on the IFA 2016 Pronouncement.

b.    Delaware and Florida LLPs and LLLPs that have been assigned a Business Number by the CRA, further to a request made based on the IFA 2016 Pronouncement.

c.    The filing of a T2 corporate tax return in respect of a Delaware and Florida LLP or LLLP based on the IFA 2016 Pronouncement.

2.    Regarding the second condition of the administrative practice, a non-arm’s length (“NAL”) change (e.g. a transfer of membership between NAL parties or the issuance of additional memberships to NAL parties) will not be considered a “significant change”.

3.    If one or more of the conditions in respect of the administrative practice are first met in a given year that ends after the IFA 2017 Pronouncement, the CRA may issue assessments or reassessments to the particular entity and/or any member of the entity in respect of one or more taxation years, on the basis that the entity is a corporation.

4.    The fact that a particular entity had initially been set up as a limited liability company and subsequently converted, before April 26, 2017, to a Delaware or Florida LLP or LLLP would not, in and of itself, prevent such entity from taking advantage of the administrative practice allowing the grandfathering of the partnership status of the entity.

5.    In accordance with the IFA 2017 Pronouncement, to the extent LLPs or LLLPs of other jurisdictions of the U.S. have similar attributes to those of Florida and Delaware and the CRA views them as corporations for the purposes of Canadian income tax law, the CRA’s administrative practice outlined above will be applied to them as well, provided the entities were formed before April 26, 2017.

Working Group additional work

The Working Group received many submissions and would like to thank the tax community for this valuable input. As a result, the grandfathering administrative practice was introduced and is now clarified as noted above. As the administrative practice addresses the concerns raised regarding these types of entities, it is anticipated that the Working Group will conclude its compliance study in the near future.

b)    In terms of new developments on any new entities or arrangements that have recently been considered, the Income Tax Rulings Directorate (“ITRD”) was recently asked to rule that a specific “Société de Libre Partenariat” (“SLP”), governed by the laws of France was a partnership for Canadian income tax purposes. The entity was to be created as a French SLP – which is a “Fonds Professionnel Spécialisé” – established as a “société en commandite simple” (“SECS”). A SECS is considered to be a “société commerciale” under French law, as is also the case for a “société en nom collectif”, “société à responsabilité limitée” and a “société par actions”.

Based on the information provided by the requestor, in ITRD’s view, a SLP established as a SECS generally possesses certain characteristics of both a corporation and a limited partnership as these exist under Canadian law. The main characteristics of this entity considered in the analysis included the following:

*     the existence of a separate legal personality that is recognized under the law of the relevant foreign jurisdiction – meaning the entity’s full legal capacity to acquire and own property, to sue and be sued, to carry on its own activities and to incur liabilities of its own;

*     the limitation of liability afforded to all of its “limited members”;

*     the unlimited liability of the “general member”; and

*     the computation of earnings at the entity level, with a distribution mechanism akin to the declaration and payment of a dividend.

Based on ITRD’s understanding of the facts submitted by the requestor, which included certain provisions of the foreign legislation and the entity’s constating documents, the combination of these four general characteristics – in the particular context of the foreign legislation and applicable agreement – sets the specific SLP apart from general partnerships and limited partnerships that exist under Canadian law. The existence of a separate legal personality alone is generally not sufficient to distinguish certain foreign partnerships from Canadian partnerships. However, in our view, the absence of legal authority to support an effective entitlement to share profits and losses earned through the entity along with the other corporate like characteristics noted above, were sufficiently important in this case to conclude that this entity should not be treated as a partnership for Canadian tax purposes.

Based on ITRD’s conclusion, the requestor decided to withdraw its rulings request.

It should be noted that the classification of a particular entity remains a question of fact to be determined on a case-by-case basis. Taxpayers may wish to request an advance income tax ruling from the ITRD if they are contemplating transactions involving foreign entities whose Canadian income tax status may be unclear.

Yannick Roulier / Nicolas Bilodeau
2018-074948
May 16, 2018

Response prepared in collaboration with:
The CRA Delaware & Florida LLPs/LLLPs Working Group
International Tax Division
International, Large Business and Investigations Branch

FOOTNOTES
Note to reader:  Because of our system requirements, the footnotes contained in the original document are shown below instead:

1 The Working Group is led by members of the audit branch, specifically the International Tax Division of the International and Large Business Directorate of the International, Large Business and Investigations Branch.
2 See document 2016-0642051C6.
3 See document 2017-0691131C6.

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