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US LLC’s may have rights to refunds

Canada – US Tax Team

For more information contact Jonathan Levy at jlevy@uhyvictor.com .

Many Americans structure their business activities through limited liability corporations (LLC’s), thereby benefiting from an election to flow income directly to the US investors.

In past years, the Canadian Revenue Agency (CRA) did not extend treaty benefits to US LLC’s and, as a result, US LLC’s operating in Canada were obligated to pay branch tax at the rate of 25%.  Changes to the US Canada Tax Treaty in 2009 corrected this anomaly and, accordingly, the branch tax rate was reduced to 5%.

However, recently TD Securities (USA) LLC challenged the CRA's 25% withholding rate in tax court, and won [see TD Securities (USA) LLC 2010 TCC 186].  The judgement concluded that a US LLC does indeed have access to treaty benefits, including the preferential 5% branch tax rate.

The Tax Court of Canada judgment states:

‘The decision in this case stands for no more than the proposition that, properly interpreted and applied in context in a manner to achieve its intended object and purpose, the US Treaty’s favourable tax rate reductions apply for years prior to the Fifth Protocol Amendments to the Canadian-sourced income of a US LLC if all of that income is fully and comprehensively taxed by the US to the members of the LLC resident in the US on the same basis as had the income been earned directly by those members.

 

Accordingly, on the basis of this case, US LLC’s which previously remitted the branch tax at the rate of 25% can now apply for a refund of 80% of the amounts remitted.

The CRA has indicated that they will process refund requests under very restricted circumstances.  However, given the tone of the CRA's initial response, US LLC's applying for refunds may find more success using the tax treaty's remedies by addressing the matter with Competent Authority. Article XXVI of the US Canada Tax Treaty deals with General Procedures and sets the time limit for an application to six-years (currently January 1, 2004).

The implications of this ruling reach further than just branch profits tax. The ruling declares that US LLC’s have access to treaty benefits, and therefore these entities can apply for refunds for excess withholding taxes for:

  • Interest (10% rather than 25%)
  • Dividends (5% or 15% rather than 25%)
  • Royalty payments ( nil or 10% rather than 25%)
  • Capital gains (possibly no withholdings required) 

In order for a US LLC to apply for these refunds, it should submit an application to US Competent Authority with a copy to Canadian Competent Authority (for notification purposes).

Note that this is somewhat uncharted territory, and experience demonstrates that the ultimate outcome of an application is highly dependent on the applicant's particular set of circumstances.  Accordingly, applicants should be aware that a completely positive outcome is not guaranteed.

However, given the clarity of the of the judgement, and the context of the subsequent changes to the US Canada Tax Treaty that accorded US LLC’s treaty protection, US LLC’s that remitted 25% withholdings are strongly recommended to apply for refunds. This ruling indicated that the CRA was wrong in its interpretation of the law, and there is no reason why taxpayers should pay excess taxes as a result.

Please contact us if you require assistance with your withholding tax requirements and recovery.

 



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