Treaty status of LLCs.

• Author: O'Connell, Frank J., Jr.
• Position: Limited liability companies

In International Technical Assistance (ITA) 200019042, the IRS stated that a single-member limited liability company (SMLLC) that is a disregarded entity for U.S. tax purposes could not be certified as a U.S. resident. This issue is relevant when LLCs seek to reap the benefits of U.S. income tax treaties. The income tax treaties to which the U.S. is a party provide, inter alia, reduced withholding rates and other benefits to U.S. residents and residents of the other country that is a party to the treaty. The recent ITA highlights the often-uncertain treaty status of LLCs under U.S. bilateral income tax treaties. This item considers the Canadian and Mexican treaty treatment of U.S. LLCs.

Bilateral Treaty with Canada

In Income Tax Rulings and Interpretations Directorate, Internal Memo 971312 (May 20, 1997), the Canada Customs and Revenue Agency (CCRA) (formerly Revenue Canada) stated that it would not extend the benefits of the Canada-U.S. income tax treaty to U.S. LLCs or their members for Canadian-source income. In the absence of treaty benefits, Canadian-source income, including interest, dividends or management fees, would be subject to tax in Canada at the nontreaty rate of 25%. In contrast, for a corporation that is a U.S. resident for treaty purposes, Canadian-source interest income would be taxed at only 10% and Canadian-source dividend income at either 5% or 15% (depending on the degree and identity of ownership in the paying corporation). Under the treaty, management fees would generally be exempt from tax.

Given the fact that Canada does not treat a U.S. LLC as a U.S. resident for treaty purposes, such an entity may not be a suitable vehicle for U.S. residents to derive income from Canadian sources, unless all Canadian taxes will be recovered through foreign tax credits in the U.S.

However, Canada and the U.S. are in the process of negotiations for a Fifth Protocol to the U.S.-Canada income tax treaty, and there have been indications that the proper treatment of U.S. LLCs might be included in these negotiations.

Bilateral Treaty with Mexico

Unlike the Canadian position on the treatment of U.S. LLCs, under which treaty benefits are not available to LLCs or their members, Mexico treats U.S. LLCs as separate legal entities that would qualify for treaty benefits, provided there is proper certification. As such, if an LLC treated as a disregarded entity for U.S. purposes receives a payment from a Mexican resident, the Mexican tax...