July 1, 2016

Canada Revenue Agency Announces US LLPs and LLLPs to be Taxed as Corporations for Canadian Tax Purposes

Residents of Canada, including US citizens living there, should avoid investing in US Limited Liability Partnerships, (LLPs) and Limited Liability Limited Partnerships (LLLPs), absent advice to do so from an experienced cross-border tax advisor. The reason stems from a very recent comment by the Canada Revenue Agency (CRA).

CRA has stated that LLPs and LLLPs that are formed in Delaware and Florida will be taxed as US corporations for Canadian income tax purposes. It is likely this treatment will also be applied to LLPs and LLLPs formed in other US States.

Thus, Canadian resident owners of LLPs and LLLPs could have double tax on their profits. This could occur because the Canadian owner will pay US tax immediately in the year the profit is earned. However the Canadian owner will not pay Canadian tax until the profit is paid out from the LLP/LLLP to the owner. If this payout occurs in a subsequent year, the US tax paid might not be creditable (deductible) against the Canadian tax. Therefore, double tax can arise.¹ Even if the earnings and payout occur in the same year, the amount of the US tax that can be used as a direct deduction from taxes in Canada may be limited to 15% or less of the US income, even if the actual US tax is higher. (A deduction against income – not tax – may be available for any excess).

What can you do if you have a US LLP or LLLP? You can examine converting it to a US Limited Partnership (LP). Under present rules, CRA treats a US LP as a partnership for Canadian tax purposes also, and therefore double tax can potentially be avoided with this structure. The owner is taxed simultaneously in the US and Canada so the full US tax can potentially reduce or eliminate the Canadian tax. CRA has stated you may be able to make this conversion retroactively if you act relatively soon. The retroactive conversion only succeeds if:

1. The LLP or LLLP was formed before July, 2016, and carried on business before July, 2016, and
2. The owner intended that the LLP or LLLP be taxed as a partnership in Canada and the LLP or LLLP and each of its owners treated it as a partnership for Canadian tax purposes, and
3. The conversion occurs “no later than 2018”.

In many cases there may be no negative tax consequences in Canada or the US due to the conversion.

Unfortunately, if the LLP or LLLP is controlled by US resident individuals, they may not agree to the conversion, and you may need to seek some other form of tax relief. Please consult your cross-border tax adviser before proceeding with any option.

CRA will be issuing a formal ruling with more details shortly. We will keep you informed of these details via our free “International Tax Alert”.

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