Investing in Canada through an LLC.

• Author: Bakale, Anthony S.
• Position: Limited liability company

The use of a limited liability company (LLC) in the United States for domestic purposes provides a number of benefits. For instance, an LLC provides the legal protection offered to a corporate body while, for U.S. tax purposes, still being able to retain the flowthrough of profits and losses to the LLC's members. The benefit of the flowthrough of profits and losses stems from the lack of integration that exists in the United States between the corporate tax system and the individual tax system. That is, profits earned in a corporation and subsequently passed through as dividends to the shareholder may create a higher U.S. income tax burden than if the income had been taxed only at the shareholder level.

The Code allows an LLC to elect to be treated as either a corporation subject to U.S. federal income taxes like any other U.S. domestic corporation, a partnership, or, in the case of single-member LLCs, a disregarded entity. The election to be treated as a partnership or to be a disregarded entity provides for the flowthrough of profits and losses to the members and is the focus of this item.

A U.S. corporation can obtain similar results by electing to be an S corporation, which is treated as a flowthrough entity the income of which is generally taxed at the shareholder level.

Under its own Income Tax Act (ITA), Canada has viewed both an LLC and an S corporation as corporations, notwithstanding that their profits and losses flow through to their shareholders or members. However, when applying the provisions of the Canada-U.S. Income Tax Convention (the treaty), the Canada Revenue Agency (CRA) has viewed an LLC as not meeting the definition of a resident of the United States for purposes of the treaty while at the same time viewing an S corporation as being a U.S. resident for purposes of the treaty. Of course, because an LLC has not been given the status of a resident of the United States, it has in the past been disallowed the benefits of the treaty.

In TD Securities (US

1. LLC vs. The Queen, 2010 D.T.C. 1137 (Can. Tax Ct.), acase decided in April 2010, the Tax Court of Canada (Tax Court) had the opportunity to review the CRA's position on the residency of an LLC for purposes of the treaty. The Tax Court decided in favor of the taxpayer, TD Securities (USA) LLC (TD LLC), by concluding that it was a resident for purposes of the treaty and therefore allowed the benefits of the treaty where applicable. This item examines the Tax Court's opinion as well as how it will affect the amendments under the Fifth Protocol to the Canada-U.S. treaty.

   The CRA has not appealed the TD Securities decision, although it may be too early to determine to what extent it will accept the court's opinion in the future. The CRA has a history of limiting the benefits of a court decision to the facts of a particular case, and therefore it may decide not to apply the court's holding to other cases.

   CRA's Previous View of the Residency of an LLC Under the Treaty

   As stated, prior to ratification of the treaty, the CRA had taken the position that an LLC was not a resident of Canada for purposes of the treaty. The position was founded on the point that an "LLC which is treated as a partnership under the Internal Revenue Code of the United States does not qualify as a resident of the United States for the purposes of the Treaty under Article IV thereof, for the reason that such LLC is not subject to tax in the United States" (sec CRA Document No. 9729780). This technical interpretation attempts to reconcile the positions taken by the CRA with respect to residency status for treaty purposes of an LLC and an S corporation. In actuality, the original opinions date back to earlier years. Furthermore, the CRA states that it will not allow for the lookthrough to the members of the LLC in considering whether the members may benefit from treaty exemption.

   Fundamentally, the CRA based its position on a risk assessment rather than reason, in this author's opinion. More specifically, the CRA stated that "if a LLC was granted the benefits of the Treaty, it would be possible for Canadian resident members to avoid both U.S. and Canadian tax on income from a business carried on in Canada by the LLC if the LLC did not have a permanent establishment in Canada" (CRA Document No. 9729780).

   Unlike the position for an LLC, the CRA arrived at the opposite conclusion about an S corporation. In the CRA's analysis, the view was that even if profits and losses flowed to the shareholders of the S corporation under the Code, because the shareholders of an S corporation were...