FROM PRINCIPLES TO PLANNING

International Tax Treaties - CanadaFROM PRINCIPLES TO PLANNING

International Tax Treaties

Knox Teague, Dixon Hughes Goodman LLPWilliam Inchoco, WeiserMazars LLP

Mark Pearlman, MNP LLP

The U.S. - Canada Treaty

Mark Pearlman, MNP LLP

5th Protocol to the U.S.-Canada TreatyDiscussion TopicsLLC’s• Prior to 5th Protocol• Article IV(6)• Payments to LLC’s• Article IV(7)

The U.S. – Canada Treaty

LLC’s•Canada doesn’t have the concept•Only Flow through entities for Canadian purposes• Partnership• Trusts•LLC treated as a Corporation by Canada

The U.S. – Canada Treaty

LLC’sPrior to 5th Protocol• CRA’s position

“As you know, it is our view that a U.S. LLC that is treated under U.S tax law as a partnership and which is therefore not liable to tax in the U.S. is not a resident of the U.S. for purposes of Article IV of the Convention (see, for example, Technical News Issue No. 16). Thus, the LLC would not be a resident of the U.S. for purposes of the Convention, unless it fits in the specific inclusions in the definition of "resident" in Article IV(1)(a) or (b) of the Convention. We have assumed that the LLC itself is not considered to be a political subdivision or local authority of any State of the U.S. or any agency or instrumentality of such subdivision or authority and therefore would not satisfy the requirements of Article IV(1)(a) of the Convention.” 1

1. Technical Interpretation 2002-0133747

The U.S. – Canada Treaty

LLC’s•Previous Position • Based on “resident of a Contracting State”

• (Article IV (I))

• Resident of Contracting State is liable to pay tax because:• Domicile• Resident • Citizenship• Management

•LLC fiscally transparent in U.S. so not itself subject to U.S. tax.•Previously no treaty protection

The U.S. – Canada Treaty

Article IV (6)5th Protocol deals with this through Article IV. (Paragraph 6 & 7)Amounts considered derived by a U.S. member of an LLC who is a resident of the U.S. where: • U.S. Law considers that the member derived it from the LLC (because

it’s transparent) and

• The treatment of the amount under U.S. law is the same as it would be if the amount was derived directly by the member

The U.S. – Canada Treaty

Article IV (6)•Canada continues to regard the LLC as a corporation and view it as a taxpayer.

•LLC now benefits from treaty reductions to extent that the members are U.S. Treaty residents.

•Treaty benefits not applicable to LLC members who are non-U.S. residents.

•Article IV(6) applies to all fiscally transparent entities in the country of residence of the taxpayer.

•Examples include:

• LLC

• Grantor Trust

• Partnerships

The U.S. – Canada Treaty

Article IV (6) Same Treatment

• Need to have the same treatment as would have if amount derived directly

• Technical Explanation says that for U.S. purposes it is determined by Code Section 894 & Treasury Regulation Section 1.894-1(d)(3)(iii).

• Reported currently regardless of whether or not paid.

• No similar provision in Canada’s domestic law.

• CRA noted it will use comparable principals

• Said will be considered the same if

1. Timing of recognition

2. Character

3. Quantum

of the amount are the same

The U.S. – Canada Treaty

Article IV (6) ExampleTechnical Explanation provides some examples

U.S.Resident

French

Canada

Corp in France & Canada

100%Disregarded in U.S.

Dividend

The U.S. – Canada Treaty

•Canada sees this as a dividend to a French company •Look to Canada/France Treaty

Article IV (6)•Canada pays Dividend• Treaty applies • Ultimate recipient receives the income through a U.S. entity that is

fiscally transparent• The treatment is the same for the ultimate recipient whether the

payment flows through the transparent entity or not

The U.S. – Canada Treaty

U.S.Resident

U.S. LLC

Canada

Dividend

Article IV (6)Deems the payment as amounts derived by MEMBERS of the LLC

LLC is the taxpayer for Canadian purposes (viewed as a corporation)

Because of this paragraph members of the LLC may now be treaty protected on many payments that were previously not covered

The U.S. – Canada Treaty

Passive Income•Prior to 5th Protocol 25% withholding on passive income and management payments made to LLC

•Now rates will be lowered for U.S. resident if fall under IV(6)

•If the LLC member is a U.S. C or S Corp then withholding on• Dividends 5% (own at least 10% of common shares)• Interest 0%• Management fees 0%• Royalties 10%

The U.S. – Canada Treaty

Disposition of Canadian PropertyNow treaty protected if sold by LLC

If > 50% value Canadian real property pay tax in Canada (Same as all entities)

The U.S. – Canada Treaty

Business Income•Canadian Rules

• Taxable if carrying on Business in Canada

• Deemed carrying on Business in Canada if offer anything for sale through an agent regardless of where the contract is completed

• If treaty protected then to be taxable need to be carrying on business through a P.E.

The U.S. – Canada Treaty

Business Income (cont’d)Pre 5th Protocol, LLC often caught if sold into Canada with no P.E.

Now look through LLC to members to determine status under the treaty

If U.S. residents are the only members of LLC then covered under the treaty

If others not eligible for treaty protection are members of the LLC then only portion of income related to U.S. resident is exempt

The U.S. – Canada Treaty

• Non U.S. resident members not entitled to treaty relief

U.S. Resident

LLC

U.KResident

Canadian Corporation

15% withholding tax on portion to U.S.25% withholding tax on portion to U.K.

Should consider Luxemburg or Dutch intermediary

50 50

Dividend

Non-U.S. Members of LLC’s

The U.S. – Canada Treaty

LLC Operating in Canada as a Branch Treaty provides for reduced rate of Branch tax to 5% for treaty protected Corporation

U.S. C Corp

LLC

Branch tax at 5% for U.S. C. Corp & U.S. S Corp

Branch tax at 25% for Cayman Corp & U.S. Individual

Operates through P.E. in Canada

25 25

CaymanCorp

U.S. S Corp

U.S. Resident

Individual

25 25

The U.S. – Canada Treaty

Article IV (7) – Anti-Hybrid Rule Applies when the Flow through entity is in one country and the owner of the entity is in the other

Could apply to Canadian members of LLC’s or U.S Entities owning Canadian disregarded entities

If applies amounts received are deemed not to be from an entity resident in a treaty country so no treaty benefits

Will not get treaty protection if payment from disregarded entity in one country to recipient in the other country will have a different tax treatment than if they entity making the payment was not disregarded

The U.S. – Canada Treaty

LLC

No treaty protection – Not the same treatment• Position is that IV(7)(b) overrides IV(6)

ULC

Example

The U.S. – Canada Treaty

Deemed Dividend Solution

• No treaty protection if ULC disregarded – Not the same treatment

ULC

C CorpS Corp

The U.S. – Canada Treaty

Deemed Dividend Solution (cont’d)

• Convert Retained Earnings to PUC• Deemed Dividend for Canadian• No impact for U.S. if ULC disregarded or not • 5% withholding on conversion• Reduction of PUC a non taxable event for Canadian purposes• If LLC is Parent then rate on conversion depends on members

ULC

C Corpor

S Corp

The U.S. – Canada Treaty

Interest Solution• Interest – C Corp

• Loan between grandparent ULC gets treaty protection if grandparent is a C Corp

C Corp

C Corp

ULC

The U.S. – Canada Treaty

Interest Solution (cont’d)

• ULC considered as a Partnership for U.S. purposes• Interest payments gets treaty protection because retains character as interest

S Corp 1

ULC

The U.S. – Canada Treaty

Loan

S Corp 2

Interest

U.S. Entity

Luxembourg SARL

Cdn ULC

Dividend Withholding 0%

Dividend Withholding 5%

Luxembourg Intermediary

The U.S. – Canada Treaty

To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed herein.

IRS Circular 230 Disclosure

Questions?

Contact Information

Knox Teague, Dixon Hughes Goodman LLPknox.teague@dhgllp.com

William Inchoco, WeizerMazars LLP

Mark Pearlman, MNP LLPmark.pearlman@mnp.ca