Florida and Delaware LLPs and LLLPs to be taxed as corporations, Canadian tax officials say

by Kabir Jamal, Goodmans LLP

The Canada Revenue Agency (the CRA) on May 26 announced that it will treat Florida and Delaware LLPs and LLLPs as corporations for Canadian income tax purposes. The CRA also announced limited administrative relief for taxpayers that have adopted a contrary position in previous tax filings. The announcement, made at the 2016 IFA Conference in Montreal, Quebec, follows extensive analysis and calls for submissions from the Canadian tax community on the issue.

The classification of foreign entities under Canada’s income tax regime generally follows a two-step approach. First, the characteristics of a foreign entity are determined by reference to the applicable foreign commercial law and the terms of any relevant agreements relating to the entity. Second, the characteristics of the foreign entity are compared to the characteristics of recognized entities under Canadian law. Essentially, the Canadian tax treatment of a foreign entity is based on the Canadian entity that the foreign entity most fundamentally resembles.

In the CRA’s view, the separate legal personality and the extensive limited liability of Florida and Delaware LLPs and LLLPs were of “overwhelming significance” in determining that such entities should be treated as corporations for Canadian income tax purposes. It is unclear from the announcement whether the CRA’s position extends to LLPs and LLLPs that are governed by the laws of other US states.

The CRA also stated that, absent abusive tax avoidance, it is prepared to treat Florida and Delaware LLPs and LLLPs as partnerships retroactively from the time of formation, provided the following four conditions are met:

• Neither the particular LLP or LLLP nor any of its members has ever taken a position that the entity was anything other than a partnership for Canadian income tax purposes.

• It is clear from the surrounding facts and circumstances that the members of the particular LLP or LLLP are carrying on business in common with a view to profit, and intended to create an entity that would be treated as a partnership for Canadian income tax purposes.

• The particular LLP or LLLP was formed and began to carry on business before July 2016.

• The particular LLP or LLLP must convert to an entity that the CRA recognizes as a partnership (e.g., a general partnership or a limited partnership) before 2018.

This administrative relief is not available where the particular LLP or LLLP was originally formed as an entity that is treated as a corporation for Canadian tax purposes (e.g., an LLC or a C corp.) but later converted to an LLP or LLLP, and where there was no significant substantive change to the legal context.

The announcement raises a number of thorny issues in the cross-border context, similar to those encountered by taxpayers with respect to US LLCs. These include whether and in what circumstances such foreign entities will be entitled to benefits under the Canada-US Income Tax Convention (1980), whether a Canadian foreign tax credit will be available for foreign taxes paid by members of such foreign entities, and issues relating to the determination of their tax treaty residency for Canadian tax purposes. It remains to be seen how the CRA will respond to these issues.

A published administrative statement outlining the CRA’s formal position on the classification of LLPs and LLLPs is expected in the coming months.

— Kabir Jamal is an attorney with Goodmans LLP, Toronto, where he specializes in domestic and international corporate taxation, including cross-border mergers, corporate reorganizations, domestic and international corporate finance, debt restructurings, and private equity investments. He can be reached at [email protected].