Many Canadian investors often consider whether incorporating a US legal structure into their overall investment plan will provide an increase in benefits and returns. Many may have received unsolicited advice regarding the tax and other benefits of using a US limited liability company. While smart investors will seek personalized advice from the relevant US legal and tax authorities, this article will explain generally the US LLC vehicle and the noteworthy takeaways for Canadians.
Double taxation occurs when income taxes are paid twice on the same source of income. For example, a corporation is taxed on annual earnings, and shareholders are taxed when they receive a dividend from the corporation. Partnerships, on the other hand, are not considered separate legal structures for tax purposes and therefore profits are taxed in the hands of the partners. This eliminates the first layer of tax, therefore allowing the investor to retain a higher portion of his or her earnings. The LLC is also very flexible in that members can make an election to be treated as a corporation for US tax purposes if they deem that to be the better choice.
The downside of partnerships, however, is the lack of protection in the form of limited liability. It’s clear why many people see the hybrid LLC as a viable option. However, it’s important to understand how the LLC is treated from a Canadian perspective. The LLC is not considered a corporation under US law. Conversely, the CRA views the LLC as a non-resident corporation for Canadian tax purposes. Since Canadian residents must declare US income back to the CRA, a double taxation results.
When a Canadian investor uses a LLC, he or she can elect to be treated as a disregarded entity for tax purposes and therefore will pay personal tax on the amount received. However, Canadian investors would not be able to claim a foreign tax credit against other Canadian income for the payment of US tax. This is because the CRA will treat the income received from the LLC as a foreign dividend (since they view the LLC as a corporation) and therefore taxable for Canadian purposes. This creates a mismatched tax consequence. The CRA will tax the Canadian investor on the full amount of income without allowing foreign tax credits for tax paid to the IRS. Therefore, double taxation occurs.
It is also important to consider whether the US LLC holds passive assets. If so, then Canada’s Foreign Accrual Property Income (“FAPI”) rules may be invoked. This would impute income received by Canadian investors, even if that income was not actually received by the investor. The CRA disallows Canada-US Income Tax Convention benefits to LLCs that have not elected to be treated as a corporation for tax purposes. Generally, the Tax Convention reduces Canada’s jurisdiction to tax.
As a result of the foregoing, Canadians should be cautious about owning US property through an LLC. For example, the CRA may view US vacation property as a taxable benefit under the shareholder benefit rule, resulting in onerous tax consequences. In addition, if the Canadian investor holds his membership in a LLC through a corporation, then a Canadian taxable benefit could result. As well, any transfer of property to an LLC will occur at fair market value since it is not eligible for tax deferred treatment.
It is encouraged to seek advice from tax and US legal professionals. If you are a Canadian investor incorporating a US Legal Corporation or if you’d like to talk about how to set up a business in the US, feel free to contact J.P. McAvoy of ConductLaw at our Ottawa office.
ConductLaw is an Ottawa based business law firm with locations in Ottawa, Barrhaven and Kanata. Our professionals are experienced business lawyers who can help implement with commercial real estate, liens, or corporate structures that manage tax obligations, whether as a corporation, partnership, family trust, testamentary trust, or any other type of legal entity.
ConductLaw is an Ottawa based business law firm with three locations in the Ottawa area to serve clients. Feel free to call or write one of our professionals at email@example.com or 613.440.4888 for all of your business, commercial, real estate and estate planning needs