On the 26th of May 2016, the Canada Revenue Agency (CRA) confirmed that it will treat U.S. limited liability limited partnerships (LLLPs) and U.S. limited liability partnerships (LLPs) as corporations for Canadian tax purposes as these structures resemble Canadian corporations.
This decision of the CRA is likely going to cost Canadians owning U.S. real estate through U.S. LLPs & LLLPs significantly in the form of tax bills and tax planning making LLPs and LLLPs a less preferred structure for owning U.S. real estate.
The following is a brief overview of U.S. LLPs & LLLPs, and its updated tax treatment method in Canada.
What are limited liability limited partnerships (LLLPs) & limited liability partnerships (LLPs)?
Currently there are four available types of partnerships in the U.S.:
1) A general partnership in which all owners share control as well as unlimited liability.
2) A limited partnership which is required to have at least one general partner. The general partner has unlimited liability and is the only active manager of the company. The limited partners are primarily investors.
These two entities will continue to be treated as partnerships. The remaining two entities are subject to the new rules.
3) A limited liability partnership (LLP) does not have limited partners. It is a general partnership with limited liability protection. Each partner can be involved in the decision making without accepting liability for another partner’s misconduct much like shareholders of a corporation.
4) A limited liability limited partnerships (LLLP), is the same as a limited partnership in that they both have general partners and limited partners. The difference is that a LLLP protects the general partners by providing them with a liability protection similar to that of a limited liability partnership. Therefore, the general partners are only liable for the debts and obligations of the partnership and are not liable for the negligence or misconduct of the other general partners.
Taxation of U.S. LLPs & LLLPs in Canada.. Until Now
Until recently, U.S. LLPs and LLLPs with Canadians interests were treated as ‘partnerships’ in Canada as well as in the U.S.. As partnerships, they are treated as ‘flow-through’ entities. That is, the income earned in the partnership is reported on each of the partners’ personal income tax returns, and the taxes are paid accordingly with no separate taxes paid by the partnership.
Therefore, in order to comply with U.S. taxes, the LLP/LLLP would need to file IRS Form 1065, Return of Partnership Income, while the Canadian investor would need to file Form 1040NR – Individual Non-resident Alien Income Tax Return to report his/her share of the income from the partnership in the United States.
Similarly, to comply with Canadian tax laws, the individual would need to report the income from the U.S. LLP or LLLP on their Canadian personal income tax return, and claim foreign tax credits (FTCs) for taxes paid in the U.S. on that income.
General partnerships and limited partnerships will continue to be taxed in this manner.
Taxation of U.S. LLP & LLLP in Canada under the New Rule
With the CRA treating a U.S. LLP or LLLP as a corporation for Canadian tax purposes, a Canadian taxpayer holding an interest in a LLP or LLLP will be considered to hold an interest in a U.S. corporation. As a result, the entity will be taxed as a foreign corporation in Canada, and distributions from the U.S. LLP/LLLP will be treated as ‘dividend distribution’.
While in the U.S., the reporting will remain as mentioned above, i.e. filing of Form 1065 and reporting the income on the individual income tax returns of each partner.
This difference in tax status could lead to confusion regarding the residency status of the entity, eligibility for foreign tax credits, and application of Canada-U.S. Treaty tax rulings, since the entity is taxed as a partnership in the U.S. and as a corporation in Canada. Altogether, this would result in double taxation. Overall U.S. and Canadian combined tax rates could exceed 65% for individuals and 100% for corporations on income earned in the LLP/LLLP.
Conclusion
As the CRA is aware of the hardship this announcement has created, the CRA, also announced short-term grandfathering provisions which will allow taxpayers to treat U.S. LLP/LLLP’s as ‘partnerships’ for Canadian tax purposes, provided the LLP/LLLP fulfills the following conditions:
- Was formed before July 2016 and carried on business before this date;
- The taxpayers had intentions of classifying the LLP/LLLP as a partnership for Canadian tax purposes;
- The LLP/LLLP and all of its owners have treated the entity as a partnership for Canadian tax purposes; and
- The existing U.S. LLP/LLLP (formed before July 2016) is converted to an entity that the CRA treats as a ‘partnership’ for tax purposes before tax year 2018.
That being said, Canadians holding U.S. real estate though U.S. LLP/LLLPs should immediately consult their tax practitioners for re-structuring or other tax saving measures to avoid double taxation, and/or other tax issues that could arise due to this difference in tax treatment of U.S. LLP/LLLPs in Canada and U.S..
It is important to note that many Canadian taxpayers obtain advice from U.S. accountants and lawyers without considering the Canadian consequences. As these vehicles are very popular in the U.S. a U.S. based advisor may likely recommend that a Canadian use a LLP or LLLP. Canadians should always consult with a Canadian or cross border tax advisor to determine if there are no adverse Canadian tax consequences when investing in the U.S.
AG TAX LLP CAN HELP
If you have any tax-related queries, need assistance with tax planning or filing your tax returns please contact us. Our team comprises of highly experienced tax professionals with extensive knowledge of US and Canadian tax laws as well as cross-border compliance.
Furthermore, as a full service accounting firm, AG Tax assures complete assistance with even your most complex tax needs.
We can assist with:
- Canadian Personal and corporate tax returns
- Cross Border Taxation and Business Planning
- US Personal and Corporate Taxation
- Disclosure of Foreign Assets and other information filings
- Retirement planning
- Estate Planning, Inheritance tax advice
To obtain a quote or to arrange for a consultation to discuss your tax related queries, please contact us at:
- 416-238-5920 (Greater Toronto Area, ON)
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