Canadian Unlimited Liability Companies (ULC) – A Viable Vehicle for US Investors Expanding int
The fifth protocol of the Canada-US Tax Convention (the ‘Treaty’) introduced new anti-hybrid rules in Article IV(7) intended to deny Treaty benefits for amounts of income, profit or gains involving hybrid entities. The new rules generally operate to deem an amount of income, profit, or gain to not be paid to or derived by a resident of a contracting state in certain circumstances. Since the benefits of the Treaty are extended only to residents of the contracting states, the particular amount of income, profit, or gain will not have the benefit of any reduced rate of tax that would otherwise be available under the Treaty.
The Canadian provinces of Alberta, British Columbia and Nova Scotia allow for the creation of Unlimited Liability Companies (‘ULC’) under their respective statutes. A ULC is a hybrid entity as it is treated as a corporation for Canadian tax purposes and can be treated as a flow-through or disregarded entity for US tax purposes.
An ULC may be an attractive vehicle for a US investor expanding into Canada for reasons that may include:
- It avoids double taxation in the US, as unlike Canada, the US does not provide full integration between corporate and personal taxation that may arise in corporate structures
- It allows for losses to flow through to the shareholders to offset a US shareholder’s income
- It allows for investment in passive investments in Canada without triggering US anti-avoidance rules for foreign holding companies
- It provides flexibility to defer US income tax on the ULC’s income (Canadian tax rates are lower than US tax rates) by allowing US shareholders to elect to “check the box” to treat the ULC as a corporation for US income tax purposes so that the ULC income will not be taxed in the US until it is repatriated
- It has less stringent requirements to have Canadian directors
Since an ULC is considered an ordinary corporation for Canadian tax purposes, interest, dividends royalties and other payments from a Canadian ULC to a US shareholder are subject to 25% withholding tax under the Income Tax Act (Canada). The Treaty has historically reduced or eliminated such withholding taxes on many types of payments to US recipients, allowing ULCs to remain tax-efficient for US investors. Under the Treaty, the withholding rates on these types of payments range from 0% to 15%. Effective January 1, 2010, as a result of the ratification of the fifth protocol of the Treaty, treaty-reduced withholding rates on payments by a Canadian ULC to a US recipient, where the ULC is treated as a fiscally transparent entity for US tax purposes, are denied.
The denial of treaty benefits on payments of dividends, interest and other payments by ULCs to US investors would make ULCs tax inefficient vehicles for US investors. However, Canada Revenue Agency has published a series of advance income tax rulings and technical interpretations that accept the use of various repatriation strategies to avoid the application of the new anti-hybrid rule in certain situations. Canada Revenue Agency accepts these repatriation strategies only in certain circumstances. By way of example, a disregarded US Limited Liability Company (LLC) investing in an ULC can be tax inefficient, and even punitive in some situations, from a Canadian tax perspective.
With careful tax planning in the proper circumstances and in situations where the benefits of a ULC align with a US investor’s tax and business objectives, the ULC remains a useful alternative for structuring investment or expansion by US investors and businesses into Canada.
Maria Severino, CA, is a Tax Partner in the Toronto office of Collins Barrow.
Collins Barrow Can Help
We can assist US businesses expanding into Canada in determining Canadian tax reporting obligations as well as in developing and implementing effective tax planning structures and strategies.
Information is current to May 18, 2012. The information contained in this release is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation.