Treatment of Hybrid Entities. 5th Taxation of Inbound Investment Course September 19 & 20, 2011 Kathleen S.M. Hanly and Kevin H.

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1 Treatment of Hybrid Entities 5th Taxation of Inbound Investment Course September 19 & 20, 2011 Kathleen S.M. Hanly and Kevin H. Yip

2 Topics Concepts: Fiscally transparent entity Hybrid entity Art. IV:6 and IV:7 of Canada-US Tax Treaty Same treatment concept in Art. IV:6 and IV:7 TD Securities case Canada Revenue Agency ( CRA ) statements, rulings and technical interpretations

3 Legend = corporation for Canadian and US tax purposes = corporation for Canadian tax purposes and disregarded entity for US tax purposes = points to recipient of payment = corporation for Canadian tax purposes and partnership for US tax purposes = ownership interest = partnership for Canadian tax purposes and corporation for US tax purposes

4 What is Fiscally Transparent Entity? Fiscally transparent entity ( FTE ) is entity taxed at beneficiary, member or participant level Technical Explanation to 5 th Protocol ( 5 th Protocol TE ) to Canada-US Tax Treaty ( Treaty ) comments on types of entities that are FTEs: For US tax purposes, FTE includes partnership, and LLC treated as partnership (multiple members) or disregarded (single member) for US tax purposes For Canadian tax purposes, FTE includes partnership Canada generally treats S corporation ( S Corp ) as entitled to benefits of Treaty in its own right and not as FTE, whereas US treats S Corp as FTE

5 What is Hybrid Entity? Entity that is fiscally transparent for US tax purposes but not for Canadian tax purposes, e.g.: Canadian unlimited liability company ( ULC ) US limited liability company ( LLC ) Entity that is fiscally transparent for Canadian tax purposes but not for US tax purposes, e.g.: Partnership formed under Canadian provincial law treated as Canadian corporation for US tax purposes For US tax purposes, entity may be treated as partnership, branch or corporation without regard to entity s classification under non-us laws For Canadian tax purposes, legal form and characteristics govern whether entity is treated as partnership or corporation

6 Treatment of FTEs Before and After 5 th Protocol To be entitled to Treaty benefits, US corporation generally must be US resident as defined in Art. IV (liable to tax in US by virtue of place of incorporation etc.) CRA until TD Securities case (discussed below) took position that neither LLC nor its members were eligible for Treaty benefits (for periods not governed by 5 th Protocol) Art. IV:6 now applies Treaty benefits to LLC on look-through basis based on Treaty entitlements of members, although anomalies continue to exist Art. IV:7 limits Treaty benefits in case of certain FTEs that are hybrid entities NOTE: Canada-US Treaty currently only treaty extending treaty benefits to hybrid entities

7 Art. IV:6 The Positive Rule Treaty Benefits for Amount Earned thru FTE Art. IV:6 states that an amount of income, profit or gain is considered to be derived by person who is resident of US where: (a) that person is considered under US taxation law to have derived that amount through an entity (other than Canadian resident), and (b) by reason of the entity being treated as fiscally transparent under US laws, the treatment of the amount under US taxation law is the same as its treatment would be if that amount had been derived directly by that person Note that person that qualifies under Art. IV:6 must also qualify under limitation on benefits provisions in Art. XXIXA of Treaty ( LOB )

8 Art. IV:6 Example from 5 th Protocol TE Dividend thru LLC USco assumed to be US resident and qualifying person under LOB USco considered to derive dividend paid by Canco to US LLC because US tax treatment of dividend same as would be if dividend received by USco directly from Canco 5th Protocol TE says USco will be considered beneficial owner of income for Treaty purposes (necessary for Treaty reductions in withholding rates) Treaty relief available 5% withholding tax see Art. X:2(a) look-through rule for 10% ownership test: US resident company considered to own shares owned by entity that is FTE for US tax purposes and not Canadian resident, in proportion to company s interest in FTE USco US LLC Canco Dividend UNITED STATES

9 Art. IV:6 Example from 5 th Protocol TE Dividend thru French FTE FTE Does Not Need to be US Entity: US resident earns Canadian source dividends through French FTE US tax treatment of dividend earned through French FTE same as treatment if earned directly US resident considered for Treaty purposes to derive dividend paid by Canco to French FTE, regardless of whether French FTE is regarded entity for Canadian and/or French tax purposes US Resident French FTE UNITED STATES FRANCE Dividend Canco

10 Art. IV:7(a) The First Negative Rule Earned thru non-fte for US Tax Purposes Art. IV:7(a) states that an amount of income, profit or gain is considered not to be paid to or derived by person who is resident of US where: (a) the person is considered under Canadian taxation law to have derived the amount through an entity that is not US resident, but (b) by reason of the entity not being treated as fiscally transparent under US laws, the treatment of the amount under US taxation law is not the same as its treatment would be if that amount had been derived directly by that person

11 Art. IV:7(a) Example from 5 th Protocol TE Reverse Hybrid CAN LP is FTE for Canadian tax purposes but viewed as corporation for US tax purposes USco viewed for Canadian tax purposes as deriving dividend paid by Canco, whereas for US tax purposes CAN LP viewed as deriving dividend USco therefore not considered to derive dividend for Treaty purposes by virtue of Art. IV:7(a) and denied Treaty reduction of withholding tax rate Same result with Foreign LP rather than CAN LP that is non- FTE for US purposes Comment: These reverse hybrid structures are often used for inbound to Canada private equity investments. Such investments are often routed through Luxembourg to avoid application of Art. IV:7(a). USco < 100% CAN LP Canco UNITED STATES Dividend

12 Art. IV:7(b) The Second Negative Rule Earned thru FTE for US Tax Purposes Art. IV:7(b) states that an amount of income, profit or gain is considered not to be paid to or derived by person who is US resident where (a) the person is considered under Canadian tax law to have received the amount from an entity that is Canadian resident, but (b) by reason of the entity being treated as fiscally transparent under US laws, the treatment of the amount under US tax law is not the same as its treatment would be if that entity were not treated as fiscally transparent under US laws

13 Art. IV:7(b) Example from 5 th Protocol TE ULC: US Branch Income ULC is fiscally transparent for US tax purposes but viewed as corporation for Canadian tax purposes USco viewed as receiving dividend, interest or royalty paid by Canco for Canadian tax purposes, whereas payment disregarded for US tax purposes if ULC were not FTE, US tax treatment would be different USco therefore not considered to derive amount for Treaty purposes by virtue of Art. IV:7(b) and denied Treaty reduction of withholding tax rate USco 100% ULC Dividend, interest or royalty UNITED STATES

14 Art. IV:7(b) Example from 5 th Protocol TE ULC Partnership Distribution ULC is partnership for US tax purposes but corporation for Canadian tax purposes USco viewed for Canadian tax purposes as receiving dividend paid by ULC, whereas ULC viewed for US tax purposes as making partnership distribution if ULC not FTE, US tax treatment would be different USco therefore not considered to derive dividend for Treaty purposes by virtue of Art. IV:7(b) and denied Treaty reduction of withholding tax rate USco ULC < 100% Dividend UNITED STATES

15 Same Treatment: Canadian Source Income, Profit or Gain Derived by US Resident Art. IV:6: Compare US tax treatment of amount derived through FTE to US tax treatment if derived directly Art. IV:7(a): Compare US tax treatment of amount derived through entity that is FTE for Canadian purposes and non-fte for US tax purposes to US tax treatment if derived directly Art. IV:7(b): Compare US tax treatment of amount derived through Canadian resident entity that is FTE for US tax purposes to US tax treatment if Canadian resident were not FTE for US tax purposes

16 What is Same Treatment? What is same treatment? CRA Doc No I7 (Nov 13, 2009) considers same treatment test in context of 12 examples, and looks at: Character of amount Timing of recognition of amount Quantum of amount Examples are summarized on next slides

17 Art. IV:6 Single Member LLC Receives Part XIII Amounts from Canco Ex. 1 USco USco and US Sub are assumed to be US residents and qualifying persons in all examples, and Canco is assumed to be a non-fte for US tax purposes 100% For US tax purposes, treatment in terms of quantum, character and timing of dividend, interest, and royalty earned through US LLC is same as if earned directly from Canco Art. IV:6 applies Treaty benefits Dividend, interest or royalty US LLC UNITED STATES Canco

18 Art. IV:6 Dual-Member LLC Receives Part XIII Amounts from Canco Ex. 2 Same facts as Ex. 1 except US LLC has two members, USco and US Sub US LLC treated as partnership for US tax purposes USco and US Sub derive their proportionate share of dividends, interest or royalties received by US LLC; same US tax treatment if received directly Art. IV:6 applies Treaty benefits Dividend, interest or royalty USco 90% US LLC Canco 100% US Sub 10% UNITED STATES

19 Art. IV:6 Single Member LLC Sells Canco Shares Ex. 3 Same facts as Ex. 1 except US LLC disposes of Canco shares For US tax purposes, USco considered to have derived gain on disposition of Canco shares Art. IV:6 applies and Art. XIII determines extent to which Canada can tax gain on disposition Comment: Note that this example assumed Canco shares were taxable Canadian property ( TCP ) but that their value was not derived principally from real property in Canada. The recent Income Tax Act ( ITA ) changes to the TCP definition mean that, in many cases, shares of a Canadian resident corporation will not be TCP and it will not be necessary to rely on the Treaty. USco 100% US LLC Canco UNITED STATES Sale of Canco

20 Art. IV:7(a) Reverse Hybrid Receives Part XIII Amounts from Canco Ex. 4 USco and US Sub have elected for US tax purposes to treat CAN LP as foreign corporation; CAN LP therefore not FTE for US tax purposes Dividends, interest and royalties received by CAN LP not considered to be received by USco and US Sub for US tax purposes; subject to US anti-deferral rules, USco and US Sub do not include amounts in income in respect of CAN LP earnings until CAN LP makes distribution to partners; distribution treated as dividend for US tax purposes If election had not been made, USco and US Sub would have been required to include payments from Canco in income for US tax purposes; US tax treatment different if amounts derived directly Art. IV:7(a) applies no Treaty benefits USco 90% 10% CAN LP Canco 100% US Sub UNITED STATES Dividend, interest or royalty

21 Art. IV:7(a) Reverse Hybrid Sells Canco Shares Ex. 5 Same facts as Ex. 4 except CAN LP disposes of Canco shares and realizes gain Assume Canco shares are TCP but value not derived principally from Canadian real property For US tax purposes, CAN LP considered to have disposed of shares and USco and US Sub do not have gain included in income If election had not been made, USco and US Sub would have been required to include gain in income for US tax purposes as if they had realized gain directly; US tax treatment different Art. IV:7(a) applies; Art. XIII does not apply USco 90% 10% CAN LP Canco 100% US Sub UNITED STATES Sale of Canco

22 Art. IV:7(a) Reverse Hybrid Carries on Business in Canada Ex. 6 Same facts as Ex. 4 and 5 except CAN LP carries on business in Canada rather than holding Canco shares USco 100% For Canadian tax purposes, each US partner of CAN LP is considered to earn its proportionate share of partnership s income, which is included in such partner s income in partner s taxation year in which CAN LP fiscal year ends For US tax purposes, US partners taxed on dividend basis and only when CAN LP income distributed If election had not been made, US partners would have been taxed in US on current basis on their respective share of partnership income; different treatment if derived directly Art. IV:7(a) applies to deny Treaty benefits; no permanent establishment ( PE ) threshold or branch tax reduction 90% 10% CAN LP Carries on Business in Canada/no PE US Sub UNITED STATES

23 Art. IV:7(b) USco Receives Interest from ULC Ex. 7 USco makes loan to ULC, its 100% subsidiary ULC is FTE for US tax purposes; USco considered to carry on ULC business as branch for US tax purposes and includes Canadian branch income in its income for US tax purposes Loan and interest thereon disregarded for US tax purposes If ULC were not FTE, USco would recognize interest income on accrual basis for US tax purposes; different tax treatment if ULC not FTE Art. IV:7(b) applies no Treaty benefits USco ULC 100% Interest UNITED STATES

24 Art. IV:7(b) USco Receives Interest from Partnership ULC Ex. 8 Same as Ex. 7 with USco making loan to ULC except here ULC has two shareholders ULC treated as FTE partnership for US tax purposes USco and US Sub allocated income and expenses of partnership on proportionate basis for US tax purposes (such items may be netted before allocated) USco is considered to earn interest income on loan for US tax purposes; if ULC were not FTE, for US tax purposes USco would still realize interest income but neither partner would incur share of ULC interest expense US tax treatment of interest received on loan same regardless of whether ULC is FTE Art. IV:7(b) does not apply Treaty benefits USco Interest 90% 10% ULC 100% US Sub UNITED STATES

25 Art. IV:7(b): USco Indirect Parent Receives Interest from ULC Ex. 9 USco wholly-owns US Sub and US Sub, in turn, wholly owns ULC USco considered for US tax purposes to receive interest from US Sub and includes interest in income on accrual basis; if ULC were not FTE, USco would include interest from ULC in income on accrual basis Interest 100% USco CONSOLIDATED REPORTING In US consolidated return US Sub s interest expense is offset by USco s interest income; if ULC were not FTE, there would be no offset because ULC not in consolidated return and payor would be ULC; nevertheless, in both FTE and non-fte scenario, USco required for US tax purposes to include amount in income equal to interest income on loan to ULC; timing, character and quantum same Art. IV:7(b) does not apply Treaty benefits US Sub 100% ULC UNITED STATES

26 Art. IV:7(b) USco Sells ULC Shares Ex. 10 Same facts as Ex. 7 except USco sells shares of ULC to arm s length purchaser and realizes capital gain USco considered to have sold ULC assets for US tax purposes; if ULC were not FTE, USco would be considered to have sold ULC shares for US tax purposes Character of income likely different if ULC were non-fte; quantum of income likely different as depends on US tax basis of shares vs. assets However proceeds received from arm s length purchaser, not from ULC Art. IV:7(b) does not apply Treaty benefits Note: Art. IV:7(b) could apply on share repurchase by ULC as proceeds would be received from ULC USco ULC 100% UNITED STATES Sale of ULC to 3P

27 Art. IV:7(b) Back-to-Back Dividends through ULC Ex. 11 Same facts as Ex. 7 except that ULC owns Canco (a non-fte); Canco pays dividend to ULC and ULC, in turn, pays dividend in same amount on same day to USco USco considered to receive dividend from Canco for US tax purposes; if ULC were not FTE, USco would be considered to receive dividend from ULC Part XIII tax applies to dividend paid by ULC to USco not to dividend paid by Canco to ULC; treatment of latter therefore not relevant to Art. IV:7(b) analysis Art. IV:7(b) applies no Treaty benefits USco ULC Dividend UNITED STATES Dividend Canco

28 Art. IV:7(b) ULC Pays Royalties to Third Party Ex. 12 Same facts as Ex. 7 except that arm s length third party has granted ULC right to use patented manufacturing process in return for royalties Royalties taxed under Part XIII, subject to Art. XII of Treaty IP Holder considered for US tax purposes to receive royalties from USco rather than ULC because ULC disregarded Nevertheless, quantum, character, timing and geographic source of royalties same regardless of whether ULC is FTE; only difference is ULC would be payor for US tax purposes if not FTE Art. IV:7(b) does not apply Treaty benefits USco 100% ULC IP Holder Royalty UNITED STATES

29 TD Securities case TD Securities (USA) LLC v. The Queen, 2010 DTC 3208 (TCC), reverses long-standing CRA position that US LLC not entitled to benefits under Treaty pre-5 th Protocol Facts: Appellant taxpayer was LLC that carried on business in Canada Sole member was C Corp and US resident for Treaty purposes Canadian branch profits for 2005 and 2006 reported in US consolidated tax return of indirect US parent that was US resident C Corp Taxpayer paid branch tax at 5% Treaty rate; CRA assessed branch tax at 25% on grounds not US resident

30 TD Securities case (cont d) The Toronto-Dominion Bank Canadian Branch of LLC Under reimbursement agreement, US tax on LLC s income charged back to LLC Converted from C Corp to LLC in 2004 for US state tax reasons Toronto Dominion Holdings USA Inc. ( TD USA ) TD Holdings II Inc. ( Holdings ) TD Securities (USA) LLC ( LLC ) LLC s income taxed in TD USA s consolidated US return LLC s income included in Holdings income for US tax purposes because LLC treated as branch for US tax purposes LLC carried on business in Canada through Canadian branch UNITED STATES

31 TD Securities case (cont d) Issue: Was taxpayer resident of US for Treaty purposes? To be resident of US for Treaty purposes, Art. IV requires that taxpayer be liable to tax in US by reason of its place of incorporation or any other criterion of similar nature CRA argued that because taxpayer was FTE for US tax purposes, was not itself liable to tax Tax Court of Canada ( TCC ) Judge concluded that CRA s strict application of Treaty led to unreasonable result that was: (1) inconsistent with object and spirit of Treaty; and (2) anomalous and irreconcilable with Canadian government s approach to foreign partnerships

32 TD Securities case (cont d) Conclusion: Taxpayer was US resident for purposes of Treaty because all of its income was fully and comprehensively taxed in US, albeit at member level Being liable to tax because of US incorporation of its member was criterion of similar nature for purposes of Art. IV Taxpayer therefore was eligible for 5% branch tax rate TCC Judge warned that not every LLC was necessarily US resident for Treaty purposes and did not find persuasive Minister concerns that reasoning could apply post-5 th Protocol said post-5 th Protocol years would be considered having regard to text and context of Treaty as amended

33 CRA Position on TD Securities case CRA sets out its views on TD Securities case in CRA Doc No C6 (Jun 16, 2010): LLC is not US resident for purposes of Treaty for post-5 th Protocol periods Art. IV:6 governs, not TD Securities rationale Will provide relief for pre-5 th Protocol periods based on TD Securities provided time has not expired to raise issue and LLC income fully taxed in US What (if any) are ramifications of case post-5 th Protocol? If US members of LLC are all comprehensively taxed in US, does TD Securities mean that LLC is US resident so not necessary to rely on Art. IV:6 of US Treaty? See example next slide

34 TD Securities case Application Post-5 th Protocol? US Resident Individual USco Under Art. IV:6 and Art. X of Treaty, dividend withholding tax rate = 15% (25%) + 5% (75%) Under TD Securities case, withholding tax rate = 5%? BUT: 5 th Protocol TE to Art. IV:6 states that Since USLLC is not itself taxable in the United States, it is not considered to be a U.S. resident under the Convention; but for new paragraph 6 Canada would not apply the Convention in taxing the income. 25% 75% LLC Dividend UNITED STATES Canco

35 S Corps S Corp is considered FTE in US but Canada treats as corporation entitled to Treaty benefits See e.g. CRA Doc No C6, CRA Doc No E5, CRA Doc No E5, CRA Doc No E5, CRA Doc No E5, CRA Doc No E5 and 5 th Protocol TE Following slide illustrates second last CRA document: Did dividend qualify for 5% withholding rate?

36 S Corp Receiving Dividend thru LLC For US tax purposes Mr. X receives dividend, whereas for Canadian tax purposes US LLC receives dividend Mr. X CRA confirmed in CRA Doc No E5 (Jun 28, 2010) that 5% withholding rate applies to dividend since S Corp considered under Art. IV:6 to derive dividend paid by Canco and S Corp satisfies 10% voting stock ownership test under look-through rule in Art. X:2(a) 100% S Corp 100% US LLC This assumes that S Corp qualifies under LOB; CRA commented that S Corp satisfies ownership test in Art. XXIXA:2(e)(i) of LOB but must also satisfy base erosion test in Art. XXIXA:2(e) to be qualifying person for LOB purposes Dividend 100% Canco UNITED STATES

37 LLC Carrying on Business in Canada If LLC is carrying on business in Canada, look at presence and activities in Canada of US LLC itself and not of members to determine if PE exists (5 th Protocol TE page 6) Only portion of LLC profits attributable to US residents that qualify under LOB are eligible for Treaty benefits CRA Doc No E5 (Apr 12, 2010): In applying active trade or business test in Art. XXIXA:3 do not attribute business activities of LLC to member However, Art. XXIXA:3 may apply to member in respect of LLC activities if LLC and member are related Next slide illustrates Treaty benefits in this context

38 LLC Carrying on Business in Canada (cont d) Bermuda Corporation USco US Tax Exempt 25% 25% 25% 25% US Resident Individual FOREIGN US LLC Canadian Branch CRA stated at 2009 Roundtable that Art. IV:6 reduces branch tax payable by US LLC to 5% in respect of USco and nil in respect of US Tax Exempt, but that Art. IV:6 is N/A to Bermuda Corporation and US Resident Individual [Branch tax rate is therefore 50% (25%) + 25% (5%) + 25% (nil) = 13.75%]

39 LLC with Non-US Members Receiving Dividend Form NR303 Example US Parent USco LLC* 25% 50% Partners: Ireland Resident Corporation and US Resident Individual Foreign Partnership Widely Held John Smith 10% 30% Global Co APAN LLC* 35% UNITED STATES Dividend OTHER FOREIGN Canco * APAN and USco are fiscally transparent US LLCs

40 LLC with Non-US Members Receiving Dividend (cont d) APAN members: (1) John Smith US resident individual; (2) USco LLC wholly owned by US resident C Corp; (3) Foreign Partnership partnership for US tax purposes, with US resident individual and Ireland resident corporation as its 50% partners; (4) Global Co widely held corporation resident in Australia not a hybrid Withholding tax rate is 17.5% weighted average of rates 10% (15%) + 25% (5%) + 30% (20%) + 35% (25%): John Smith: 15% Art. IV:6, X:2(b) USco: 5% Art. IV:6, X:2(a) Foreign Partnership: 20% 15% for US individual and 25% for Irish corporation (no treaty that considers Irish corporation to derive dividend) Global Co: 25% no treaty that considers Global Co to derive dividend

41 Solutions to ULC Anomalies Generally recognized that Art. IV:7(b) applies to many situations that are not offensive in policy terms and are outside the double dip structures the provision was intended to eliminate CRA has acknowledged this and approved, in general terms and subject to the general anti-avoidance rule ( GAAR ), the following to avoid Art. IV:7(b): (1) interposition of Luxco, (2) moving debt up a level to indirect shareholder, and (3) capitalizing surplus and returning capital instead of paying a dividend These structures have been addressed in a number of rulings see e.g. CRA Doc Nos R3, R3, R3, R3, R3, R3 and R3

42 Luxco Inserted between USco and ULC At 2009 Roundtable CRA was asked re inserting société à responsabilité limitée formed under laws of Luxembourg ( Luxco ) between USco and ULC Luxco would be resident of Luxembourg but disregarded for US tax purposes USco Purpose was to avoid 25% withholding tax on dividends paid by ULC to USco due to Art. IV:7(b) CRA commented: 5% withholding tax would normally apply to dividend paid to Luxco provided that Luxco is beneficial owner of dividend (see Prévost Car case and CRA Doc No C6 (May 21, 2009)); NOTE: April 29, 2011 OECD Discussion Draft re Meaning of Beneficial Owner application of GAAR would depend on facts and circumstances; CRA would not normally apply GAAR provided that ULC carrying on active business in Canada and Luxco inserted to qualify for 5% withholding rate on dividends Luxco ULC UNITED STATES Dividend LUXEMBOURG

43 Moving Debt to Grandparent so Interest Not Paid to US Parent At 2009 Roundtable CRA was asked whether debt could be move up to US Grandparent from US Parent to avoid Art. IV:7(b) CRA commented that, after transfer, US Grandparent regarded for US tax purposes as receiving interest from Canadian branch of US Parent; for Canadian tax purposes, ULC is paying interest to US Grandparent CRA confirmed that provided US tax treatment of amount in US Grandparent s hands same as would be if ULC not FTE, Art. IV:7(b) N/A (fact that different payor for US purposes in FTE/non-FTE scenario does not matter) CRA noted that not possible to make categorical statements re GAAR and that GAAR may apply if ULC structure results in duplicated interest deductions or interest deductions in one jurisdiction without corresponding income inclusion in other jurisdiction US Grandparent US Parent Interest Payment Before Transfer ULC Interest Payment After Transfer UNITED STATES

44 Capitalizing Surplus and Returning Capital CRA Doc No R3 (Dec 15, 2009): Dividend Alternative: ULC wants to pay dividend to USco but due to Art. IV:7(b) would be subject to withholding tax at 25% So, instead, ULC capitalizes its surplus to create paid-up capital ( PUC ), which triggers deemed dividend under section 84 Art. IV:7(b) N/A because no US tax consequences on capitalization regardless of whether ULC is FTE; Treaty applies to deemed dividend US Holdco USco US Subco US CONSOLIDATED REPORTING ULC then returns PUC to USco Dividend Interest Interest: ULC paying interest to US subsidiary of USco; eliminated in US consolidated return Art. IV:7(b) N/A to interest included in US Subco income regardless of whether ULC is FTE GAAR N/A ULC UNITED STATES

45 Capitalizing Surplus and Returning Capital (cont d) Rulings/Reasons Deemed dividend under section 84 will be dividend for Treaty purposes because of broad dividend definition in Art. X:3 Art. IV:7(b) N/A to dividend because deemed dividend subject to same US treatment (non-event) regardless of whether ULC is FTE Art. IV:7(b) N/A to interest because same US treatment (included in US Subco income) regardless of whether ULC is FTE GAAR N/A

46 Problems with LLC Owning ULC CRA asked to consider whether LLC members entitled to Treaty benefits where LLC owns ULC CRA indicated in CRA Doc No C6 (Feb 11, 2010) that since dividend or interest paid by ULC to LLC was disregarded for US tax purposes, not possible to apply Art. IV:6 to provide relief to LLC members, i.e. need amount for US tax purposes for Art. IV:6 to operate Illustrated on next slide

47 Problems with LLC Owning ULC (cont d) CRA considered in CRA Doc No C6 (Feb 11, 2010) whether LLC entitled to claim Treaty benefits where Canadian source dividends or interest paid by ULC to LLC CRA: better view is that Art. IV:6 does not apply to treat particular amount of Canadian source income, profit or gain as being derived by US resident members of LLC if that amount is disregarded under US tax laws, i.e. there is no amount for US tax purposes Appears therefore that surplus capitalization transaction will not work in this context since Art. IV:6 can t operate Art. IV:7(b) of Treaty applies so no Treaty benefits US Members US LLC Dividend Interest ULC UNITED STATES

48 Withholding Tax Compliance CRA issued updates to IC and final versions of forms NR301, NR302 and NR303 on April 19, 2011: NR301: benefits under tax treaty for non-resident NR302: benefits under tax treaty for partnership with nonresident partners NR303: benefits under tax treaty for hybrid entity CRA identifies situations where beneficial ownership should be questioned CRA specifies circumstances where payor may choose not to obtain relevant form or equivalent information

49 Presenters Kathleen S.M. Hanly Fasken Martineau DuMoulin LLP 333 Bay Street, Suite 2400 Toronto, Ontario M5H 2T6 Tel: Fax: Kevin H. Yip Fasken Martineau DuMoulin LLP 333 Bay Street, Suite 2400 Toronto, Ontario M5H 2T6 Tel: Fax:

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