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Canadian tax treatment of U.S. LLC.

Revenue Canada takes die position that U.S. limited liability companies (LLCs) structured to be treated as partnerships for U.S. tax purposes are not U.S. residents under the Canada-U.S. income tax treaty. As a result, a U.S. LLC doing business in Canada or receiving income from Canada is not eligible for treaty relief, even if all its members are U.S. residents. The Competent Authorities of Canada and the U.S. are working to resolve this issue.

Article IV (Residence) of the treaty defines "resident of a Contracting State" to mean "any person that, under the laws of that State, is liable to tax therein by reason of that person's domicile, residence, place of management, place of incorporation . ..." (Emphasis added.) In the case of a partnership, Revenue Canada looks through the partnership and determines treaty benefits based on the status of the individual partners. Revenue Canada takes the position that a U.S. LLC is to be treated as a corporation rather than a partnership for Canadian tax purposes. Revenue Canada's position is that LLCs that have been structured for U.S. tax purposes to qualify as partnerships, rather than corporations, are not to be treated as US. residents for purposes of the treaty because, as a passthrough entity, the LLC is not liable for tax in the US. Therefore, Revenue Canada does not look through the LLC and grant treaty benefits based on the residency of its members.

Revenue Canada takes a different position for U.S. S corporations. It treats a U.S. S corporation as a U.S. resident for treaty purposes because the S corporation is not taxable in the U.S. as the result of an election by its shareholders. Also, an S corporation may be subject to U.S. tax if certain conditions are not met and on certain types of income. Revenue Canada says a U.S. LLC may be contrasted to an S corporation because an LLC is not taxable for U.S. income tax purposes by reason of its structure, rather than by reason of an election.

Revenue Canada's position on LLCs is a concern principally when an LLC does business in Canada through a branch, offers anything for sale in Canada or receives income from a Canadian resident subject to Canadian withholding tax. Without treaty protection, the following Canadian tax results occur:

* A Canadian branch of an LLC is required to pay branch tax at the 25% domestic rate and is not eligible for the exemption on the first $500,000 of branch profits.

* An LLC that offers anything for sale in Canada, through an agent or otherwise, is deemed to be doing business in Canada and is subject to Canadian tax even though it does not have a permanent establishment in Canada.

* An LLC receiving income from Canada that is subject to withholding tax, such as dividends, rent, royalties and interest, is subject to the 25% domestic rate of withholding tax rather than the treaty-reduced rates.

US. Treasury officials have initiated discussions with the Canadian Department of Finance on this issue.
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Title Annotation:limited liability company
Author:Williamson, W. Gordon
Publication:The Tax Adviser
Date:Nov 1, 1996
Previous Article:Investment-adjustment regulations may significantly affect 1995 and later years' E & P determinations.
Next Article:Generation-skipping transfer tax rules affect nonresident aliens.

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