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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
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