Principal Issues: Should a US LLC, which has a US Corporation as its sole member and which has not checked the box to be treated as a corporation for US tax purposes, compute its earnings in accordance with subparagraph (a)(i) of the definition of "earnings" in subsection 5907(1) of the Regulations (i.e. pursuant to the income tax laws of the U.S.) or in accordance with subparagraph (a)(iii) of the definition of "earnings" in subsection 5907(1) of the Regulations (i.e. pursuant to the income tax laws of Canada)?
Position: Subparagraph (a)(i) of the definition of "earnings" in subsection 5907(1)of the Regulations applies, so that the US LLC must compute its earnings pursuant to the income tax laws of the US.
Reasons: A single member US LLC which has not checked the box to be treated as a corporation for US tax purposes is disregarded for US tax purposes. As a consequence, the income of the US LLC will be included in the computation of the income of its member (i.e. the US Corporation) for US tax purposes. This obligation to compute the income of the US LLC is sufficient to bring the US LLC within the provisions of subparagraph (a)(i) of the definition of "earnings" in subsection 5907(1) of the Regulations.
May 20, 2011 IFA Conference
Question 9
A US limited liability company ("US LLC") is a foreign affiliate of corporation resident in Canada ("Canco"). All the shares of the US LLC are owned by another foreign affiliate ("Holdco") of Canco. Holdco is resident in the United States and taxed under the Internal Revenue Code (the "Code") as a corporation. US LLC has not checked the box to be treated as a corporation under the Code and is instead treated for US tax purposes as a disregarded entity. In these circumstances must the "earnings" of USLLC be computed in accordance with subparagraph (a)(i) of the definition of "earnings" in subsection 5907(1) of the Regulations (i.e. pursuant to the income tax laws of the U.S.) or in accordance with subparagraph (a)(iii) of the definition of "earnings" in subsection 5907(1) of the Regulations pursuant to the Income Tax Act (Canada) (the "Act") such that deductions that are discretionary (e.g. capital cost allowance) may be ignored?
CRA Response
Subparagraph (a)(i) of the definition of "earnings" in subsection 5907(1) of the Regulations applies, so that the "earnings" of the US LLC must be computed pursuant to the income tax laws of the U.S. Although such computation may be made for the purposes of the Code only to determine the U.S tax liability of Holdco, this is in our view sufficient to bring the scenario under provisions of subparagraph (a)(i).
A U.S. limited liability company which is disregarded for US income tax purposes may not have all the hallmark characteristics of a corporation (e.g. issuance of capital stock) or be subjected to taxation in the United States. However, the CRA has adopted a series of positions that have allowed the Canadian foreign affiliate regime in the Act to produce, for Canadian corporations that have invested in such U.S. limited liability companies, results that are roughly in line with what would have happened if the U.S. limited liability company were a conventional non-resident corporation. These positions are a package and a Canadian taxpayer cannot pick and choose between the positions that comprise that package. If the CRA encounters a Canadian corporation that has attempted to inflate the surplus balances of a foreign affiliate that is a US limited liability company by computing its "earnings" in accordance with the Act and ignoring discretionary deductions, the CRA may challenge the taxpayer's filing position as if none of these positions existed. The result may be that U.S. limited liability company does not qualify as a "foreign affiliate" as defined in subsection 95(1) of the Act.