The Canada-US Income Tax Convention (Canada-US Treaty) was recently amended to include a so-called hybrid denial rule. This rule will adversely affect Canada-US cross-border structures involving Canadian unlimited liability companies (ULC). Over the last several years ULCs were used in many cross-border structures, including those employed by technology enterprises.
The hybrid denial rule is subject to a delayed coming into force rule, so that it will generally apply after January 1, 2010.
The amended Canada-US Treaty will deny treaty benefits where a US resident receives income, profit or gain from an entity that is treated as being fiscally transparent under US laws but not under Canadian law (e.g., a Nova Scotia ULC). This rule is broadly worded and applies to many situations where there is no apparent tax policy abuse. Tax treaty benefits will be denied where a US resident receives dividends or interest from a ULC even where there is no double-dip in respect of a deductible payment, such as interest, and the denial of tax treaty benefits will extend to structures used for legitimate business reasons. Generally, the effect of this rule will be to subject affected payments to 25 per cent Canadian withholding tax.
Administrative comments from both the Canadian taxing authorities and the US Treasury do not suggest the rule will be narrowly applied.
Taxpayers having such Canadian ULC structures should review their structures prior to 2010 and consider whether a restructuring is appropriate.