Limited Liability Company under the Protocol
Assume a U.S. limited liability company (“LLC”) is 100% owned by Mr. X, a U.S. resident individual. The LLC has not elected to be treated as a corporation under the U.S. “check-the-box” regulations and, consequently, is treated as a disregarded entity for U.S. tax purposes. Mr. X would be the beneficial owner of the dividend if he owned the shares of the Canadian corporation directly.
Question
If the LLC owns all of the shares of a Canadian corporation and the Canadian corporation pays a dividend to the LLC, what rate of Canadian withholding tax will apply to the dividend payment under the proposed 5th Protocol to the Canada-U.S. Income Tax Convention (the “Convention”)?
Response
The CRA has examined several state limited liability company statutes, but not all. We assume that the LLC in this example would constitute a corporation for Canadian income tax purposes.
Subparagraph 2(b) of Article X (Dividends) of the Convention provides that dividends paid by a resident of one Contracting State may be taxed by the State of source at 15% if paid to a resident (other than a company described in subparagraph (a)) of the other Contracting State who is the beneficial owner of such dividends.
Proposed paragraph 6 of Article IV (Residence) of the Convention provides:
“An amount of income, profit or gain shall be considered to be derived by a person who is a resident of a Contracting State where:
- The person is considered under the taxation law of that State to have derived the amount through an entity (other than an entity that is a resident of the other Contracting State); and
- By reason of the entity being treated as fiscally transparent under the laws of the first-mentioned State, the treatment of the amount under the taxation law of that State is the same as its treatment would be if that amount had been derived directly by that person.
Assuming U.S. tax law would in fact apply to consider Mr. X to have derived the dividend through the LLC, and that Mr. X is treated for U.S. tax purposes as if he had received the dividend directly from the Canadian corporation, we are of the view that the dividend paid to the LLC would be subject to the reduced rate of 15% by virtue of Article X and proposed paragraph 6 of Article IV of the Convention.
Proposed paragraph 6 of Article IV of the Convention will have effect, in respect of withholding taxes, for amounts paid or credited on or after the first day of the second month that begins after the date on which the Protocol enters into force.