Canadian company formed by U.S. S corporation will be considered a partnership.

• Author: Zink, Bill

The IRS recently approved a format for doing business in Canada that allows a U.S. company to claim Canadian losses on its U.S. return. Further, if this format is used in a joint venture format with a Canadian local company, it permits maximum use of foreign tax credits. The facts of recently issued Letter Ruling 9538020 are as follows:

[] X was incorporated in 1962 and elected S status in 1987.

[] Y was incorporated in 1994 and immediately elected S status.

[] X and Y have identical ownership.

[] On Nov. 1, 1994, X and Y formed Z as a company of unlimited liability under the Nova Scotia Companies Act.

[] X owed 79% of Z and Y owned the remaining 21

[] Y planned to transfer a portion of its interest in Z to X so that X would own more than 80% of Z, but that Y would at all times own at least 1% of Z The before/after ownership structure is depicted in the chart on page 74.

In reviewing Z's status for U.S. Federal income tax purposes, the Service reviewed the Nova Scotia Companies Act, particularly as to continuity of life, centralization of management, limited liability, and the free transferability of interests.

In terms of liability, the IRS noted that under Section 135 of the Nova Scotia Companies Act, during a windup, the members of an unlimited company were liable to contribute to the company's assets an amount sufficient for the payment of its liabilities together with the expense of winding up.

Z's memorandum of association stated that Z was an unlimited liability company; therefore, Z's members were liable to contribute an unlimited amount to pay Z's liability when Z was wound up. Thus, Z did not have limited liability.

In terms of free transferability of interests, the Service noted that Section 32 of the Nova Scotia Companies Act provided that the ownership interest of any member in a company is transferable in the manner provided by the company's articles. Z's articles of association specifically prohibited any transfer of ownership interest in the company without the prior written consent of all the owners. Further, Z's owners were only allowed to...