United States

Canadian Revenue Agency issues statement on US partnership taxation

INSIGHT ARTICLE  | 

In a recent non-binding statement, representatives from the Canadian Revenue Agency (CRA) said that they will now prospectively employ an approach called ‘administrative grandfathering’ regarding the treatment of Florida and Delaware Limited Liability Partnerships (LLPs) and Limited Liability Limited Partnerships (LLLPs) for Canadian tax purposes.  While the statement limited its discussion to Florida and Delaware, the CRA policy is expected to have a broader impact on all U.S. LLPs and LLLPs.

Previously the CRA had announced it would consider all Florida and Delaware LLPs and LLLPs corporations for Canadian income tax purposes, a position that has not changed.  However, after analyzing the complexities associated with requiring such entities to transition from partnership to corporate filings, the CRA has decided against it.  Instead, the CRA officials have announced that they will apply rule prospectively through administrative grandfathering to certain Florida and Delaware LLPs and LLLPs. 

Under administrative grandfathering, a Florida or Delaware LLP or LLLP formed prior to April 26, 2017 will be accepted as a partnership for Canadian tax purposes for all prior and future years.  In order for a Florida or Delaware LLP or LLLP to qualify for administrative grandfathering the entity must meet the following conditions:

  • One or more members of the entity, or the entity itself, may not take an inconsistent position from one tax year to another, or within the same tax year, as to partnership or corporate status;
  • There must not be significant change in the membership or activities of the entity; and
  • The entity must not be used to facilitate abusive tax avoidance.

Florida and Delaware LLPs and LLLPs formed after April 26, 2017 will be treated as corporations by the CRA, and those that have consistently filed as corporations in prior years will be allowed to continue to file on that basis.

While this statement does not alter the CRA’s position that Florida and Delaware LLPs and LLLPs are corporations for Canadian tax purposes, it does provide some options for existing entities previously facing a transition from partnership to corporate filings.

Here are four situations where this news may be relevant:

Entities taking a pass-through position without currently reporting a permanent establishment (PE)

  • Entities taking a pass-through position without currently reporting a PE can now rely on the guidance that they are corporations for Canadian tax proposes in order to shield their partners from potential tax filing and liability risk
  • Entities choosing to pursue this position will need to revise all prior year partnership returns to corporate returns in order to maintain consistency

Entities that have a PE and would like corporate status

  • Entities with a PE that would like corporate status can now enjoy the benefit of streamlined reporting and compliance in Canada
  • Under this approach the entity, not the partners, will be responsible for filing and paying tax in Canada.  In addition, because these entities are still partnerships in the U.S., taxes paid will still flow through for U.S. foreign tax credit purposes
  • However, prior year returns will need to be amended to reflect corporate status

Entities filing as a partnership that would like to continue to do so

  • Under the administrative grandfathering approach described above, entities filing as a partnership will be able to continue to file as a partnership
  • Entities choosing to pursue this option will need to make sure they meet all applicable CRA requirements set forth above in order to qualify for administrative grandfathering
  • This may be the simplest approach provided no significant changes among the partners or in partnership activity occurs

New Florida and Delaware LLPs and LLLPs

  • Florida and Delaware LLPs and LLLPs formed after April 26, 2017 will be treated as corporations
  • These entities must file Canadian tax returns in order to claim any treaty PE benefits

It is worth noting that this statement by CRA representatives has no impact on the treatment of Florida and Delaware LLPs and LLLPs from a U.S. tax perspective, so these entities are still treated as partnerships in the United States. 

In addition to providing insight into the CRA’s approach to the taxation of Florida and Delaware LLPs and LLLPs, this statement also raises potential questions about how income earned by these hybrid entities will be treated moving forward under the U.S./Canada bilateral tax treaty.  It is not clear for example whether these entities will qualify for treaty benefits.

Taxpayers operating in Canada with entities organized as LLPs or LLLPs, especially those in Florida or Delaware, should pay particular attention to this statement by the CRA.  Although non-binding, it provides an important insight into the CRA’s current approach regarding these entities.  Taxpayers should decide how they wish to proceed going forward, in particular they should decide if they wish to change their existing filing positions or maintain them.

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