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May 19, 2024

Tax Tips

U.S. Companies Investing in Canada
Subject: US Inbound Investing
Number: 05-25
Date: 9/30/2005
Be aware of using U.S. LLC's to hold shares in Canadian companies

U.S. companies frequently consider carrying on a business in Canada. Sometimes, the U.S. business considers buying shares in a Canadian company, and sometimes the U.S. business plans to expand its own business into Canada. One of the most popular vehicles used to carry on business in the U.S. is a limited liability corporation ("LLC"). For U.S. tax purposes, this entity is treated as a flow-through entity, meaning that the income or loss of the LLC is allocated to its shareholders and the amounts are taxed in their hands.

This is beneficial to U.S. taxpayers because it overcomes the problem that there is no integration between U.S. corporate and personal taxes. To achieve integration, it is better to pay tax only at the personal level. There are, however, some issues arising from the attitude of the Canadian tax authorities to a U.S. LLC.

The CRA does not accept that a U.S. LLC is a flow-through entity, but treats it as a corporation. Since a U.S. LLC does not pay tax, it cannot benefit from the Canada-U.S. Tax Treaty (the "Treaty") because, in the view of the CRA, it does not qualify as a U.S. taxpayer under the Treaty. This has a significant effect on the decision to use a U.S. LLC to acquire normal shares of a Canadian company, or to become a shareholder of a Canadian company. The normal withholding tax rate on dividends paid by a Canadian company is 25%. However, under the Treaty, there is a reduction in the withholding tax rate to 15% for U.S. taxpayers and to 5% when a U.S. company owns at least 10% of the voting shares of a Canadian company.

Many U.S. taxpayers and advisors assume that a U.S. LLC can be a shareholder of a Canadian company and the LLC does not pay tax on dividends and suffers only 5% withholding tax on Canadian dividends. Unfortunately, because the U.S. LLC is excluded from the Treaty, the withholding tax rate is 25%.

A simple solution is to use a U.S. "S Corporation" to own shares of a Canadian company. An S Corporation is also treated as a flow-through entity for U.S. tax purposes; so there is U.S. tax integration. The benefit of an S Corporation is that it is acknowledged to be a corporation for purposes of the Treaty. Therefore, if an S Corporation were to own at least 10% of the voting shares of a Canadian corporation, withholding tax on dividends from the Canadian company would be 5%.

TAX TIP OF THE WEEK is provided as a free service to clients and friends of the Tax Specialist Group member firms. The Tax Specialist Group is a national affiliation of firms who specialize in providing tax consulting services to other professionals, businesses and high net worth individuals on Canadian and international tax matters and tax disputes.

The material provided in Tax Tip of the Week is believed to be accurate and reliable as of the date it is written. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing any tax planning arrangements. Neither the Tax Specialist Group nor any member firm can accept any liability for the tax consequences that may result from acting based on the contents hereof.