the CRA views these entities to be corporations for Canadian income tax purposes.
Residents of Canada who currently invest in Delaware or Florida Limited Liability Partnerships (“LLPs”) and Limited Liability Limited Partnerships (“LLLPs”) should be aware of recent announcements made by the Canada Revenue Agency (“CRA”). If action is not taken by the end of 2017, these vehicles may yield unintended, but significantly adverse tax consequences to Canadian partners.
Recently, the CRA has stated that an advance tax ruling will be released concluding that, rather than being partnerships, Delaware and Florida LLPs and LLLPs the CRA views these entities to be corporations for Canadian income tax purposes.
From a cross-border tax perspective, partnerships allow the US and Canadian tax systems to integrate well as the income tax implications under both systems are the same. The CRA’s ruling that these Florida Delaware LLLPs and LLPs entities are corporations for Canadian tax purposes (not partnerships) eliminates this integration and could result in significant double taxation for Canadian investors who hold these US investments.
Normally, US partnerships are flow-through entities for Canadian tax purposes. This means the partnership income is taxed in the hands of the partners both in the US and in Canada. Thus, any taxes paid in the US by a partner may be used as a credit to deduct against the Canadian tax payable on the US source partnership income.
This treatment will end as a result of the CRA’s pending ruling. Canada will levy tax on the LLP or LLLP’s income as if it were a foreign corporation. This basis of taxation is very different than the partnership basis used for US tax purposes and can result in significantly higher combined tax rates than under the status quo.
The classification of these entities as corporations for Canadian purposes also means that they may be subject to Canada’s foreign affiliate taxation regime and that partners may have to file a Form T1134, annually.
The CRA has stated that it will treat existing LLPs or LLLPs as a partnership for all years prior to 2018, provided the following conditions are met:
- The LLP or LLLP was formed and carried on business before July 2016;
- The taxpayers intended that the LLP or LLLP be classified as a partnership for Canadian tax purposes and have reported the income in this manner in prior years;
- No member, or the entity itself, has ever taken the position that the entity is anything other than a partnership for Canadian tax purposes; and
- The LLP or LLLP is converted to a legal form that is generally recognized as a partnership for Canadian tax purposes, no later than 2018.
If these conditions are met the CRA will also allow the conversion of a LLP or LLLP to a limited or regular partnership on a tax free basis.
It can take time to manage the conversion from an LLP or LLLP to a different form of US partnership so don’t delay. There may also be logistical issues. For example, US investors may be reluctant to convert the legal form of the partnership due to the loss of additional liability protection. Also, supplier agreements, contracts, finance documents and licenses may have to be revised. There are solutions to these problems but they take time and must be implemented before January 1, 2018.
At Cadesky Tax we are well prepared to assist you with managing this change to the treatment of LLLPs and LLPs for Canadian tax purposes.
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.