Global Tax Adviser
February 2010

More CRA Guidance on Canada-US Treaty's Hybrid Entity and LOB Rules

Heather O'Hagan
International Tax, Toronto

The CRA's latest issue of Income Tax Technical News (ITTN No. 41) contains further details on topics discussed at the Canadian Tax Foundation's (CTF) 2008 Annual Conference (now included in the CTF's 2008 Conference Report. The CRA also answers additional questions on the Canada-US treaty's hybrid entity and limitation on benefits (LOB) provisions that were not discussed at the conference.

We highlight the questions (Q) posed and the CRA's responses (A) below.

Canada-US treaty – LOB
Among other things, where 50% or more of the votes and value of a private company's shares (including disproportionate classes of shares owned by qualifying persons) is owned by qualifying persons, the company meets the treaty's definition of a qualifying person for LOB purposes, and is thus eligible for treaty benefits.

Q: Does the CRA agree that indirect ownership is not tested through a publicly traded company that is a qualifying person?
A: In applying the indirect ownership test, the CRA will not look through to the ownership of the shares in a publicly traded company. This position is based on the comments to the LOB article in the technical explanation:

It is understood by the Contracting States that in determining whether a company satisfies the ownership test described in subparagraph 2(e)(i), a company, 50% or more of the aggregate vote and value of the shares of which and 50% or more of the vote and value of each disproportionate class of shares (in neither case including debt substitute shares) of which is owned, directly or indirectly, by a company described in subparagraph 2(c) will satisfy the ownership test of subparagraph 2(e)(i). In such case, no further analysis of the ownership of the company described in subparagraph 2(c) is required. [emphasis added]

Q: Where 50% of a company's relevant shares is owned directly by a qualifying person and the other 50% is owned directly by an individual who is not a U.S. resident, would that tested company be regarded as a qualifying person?
A: A tested company is a qualifying person if 50% of its relevant shares is owned directly by a qualifying person. This position is consistent with the comments to the LOB article in the technical explanation to the fifth protocol.

Q: Will the CRA consider both the direct and indirect relevant shareholdings in a tested company to determine whether 50% or more of the relevant shares of the tested company is not owned, directly or indirectly, by persons other than qualifying persons?
A: Yes.

Canada-US treaty – Hybrid entities
Q: Assume that a U.S. limited liability corporation (LLC) is owned 30% by a U.S. resident individual, 30% by a U.S. resident tax-exempt entity (US Trust), and 40% by a U.S. resident corporation (USCo) (i.e., 100% owned by U.S. qualifying persons). The U.S. LLC is treated as a partnership for U.S. tax purposes. The LLC owns all of the shares of a Canadian resident corporation (Canco). US Trust deals at arms length with Canco and is exempt from tax on dividends derived from Canada. What is the Canadian withholding tax that applies to dividends paid by Canco to the LLC on or after February 1, 2009?
A: We assume that each of the shareholders of the LLC is considered under U.S. law to have derived the dividends through the LLC. Because the LLC is treated as fiscally transparent under U.S. law, the treatment of the dividends is the same as it would be if the dividends had been derived directly by each of the shareholders.

In this situation, dividends paid to the LLC by Canco are considered to be derived by the shareholders of the LLC. Under the treaty, the following withholding would be required:

• 40% of the gross amount of the dividends paid by Canco to the LLC (the amount considered to be derived by USco) is subject to a 5% withholding tax
• 30% of the gross amount of the dividends paid by Canco to the LLC (the amount considered to be derived by the individual) is subject to a 15% Canadian withholding tax
• 30% of the gross amount of the dividends paid by Canco to the LLC (the amount considered to be derived by US Trust) is exempt from Canadian withholding tax.

For more information on the CRA's guidance on the Canada-US treaty's hybrid entity and LOB provision, see TaxNewsFlash-Canada 2009-39, "CRA Offers Insight into the Canada-U.S. Treaty Hybrid Rules" and TaxNewsFlash-Canada 2009-24, "Canada-US Tax Treaty’s New LOB Rule Takes Aim at Treaty Shopping".

For more information, contact your KPMG Tax adviser.

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