Question
Before the fifth protocol was signed in the fall of 2007, it was widely expected that it would apply to provide treaty benefits to US-owned limited liability companies (LLCs). With this expectation in mind, some US parties structured their investments in Canada through an LLC owning a ULC. As expected, Article IV(6) was included in the protocol to provide treaty benefits to the owners of fiscally transparent entities, including LLCs.
However, in a recent technical interpretation,[Footnote 15] the CRA was asked whether treaty benefits would be available before 2010 (when Article IV(7)(b) comes into effect) on payments by a ULC (Canco) to an S corporation. The CRA stated the following:
“In the case of the payment of a dividend to an S‑corporation, which is considered a fiscally transparent entity for United States income tax purposes, Article IV(6) may apply to treat an amount of the dividend income allocated to a shareholder of the S-corporation to be dividend income derived by the shareholder. However, in light of Canco’s fiscal transparency and the resulting United States income tax treatment of the payment of dividends by Canco to USco, it is our view that Article IV(6) will not apply to treat a dividend paid by Canco to USco to be derived by the shareholder of USco because, for United States income tax purposes, the shareholder will not be considered to have derived a dividend (i.e., an amount of income) through USco.”[Footnote 16]
The concern is that on the same logic, Article IV(6) would not apply to a dividend from a ULC to an LLC paid after Article IV(6) came into effect and before 2010 (or after 2010 in circumstances where Article IV(7)(b) would not apply). There is also a concern in respect of other circumstances where income of a fiscally transparent entity such as an LLC exists for Canadian tax purposes (for example, a deemed dividend under section 84 or 212.1 of the Act) but does not exist for US tax purposes.
In the CRA’s opinion, would treaty benefits be available with respect to payments such as dividends or interest made by ULC to LLC after January 31, 2009 and before January 1, 2010? Does Article IV(6) not apply where an amount of income profit or gain does not exist for US tax purposes?
Response
Article IV(6) of the treaty is effective, in respect of taxes withheld at source, for amounts paid or credited on or after February 1, 2009. Conversely, Article IV(7) has effect from January 1, 2010. Accordingly, an amount paid or credited to a US LLC by a Canadian ULC before January 1, 2010 and after January 31, 2009 would be eligible for treaty-reduced rates to the extent that the amount is considered, by Article IV(6), to be derived by a resident of the United States who is a “qualifying person” as that term is defined in Article XXIX A(2) of the treaty.