In a detailed and comprehensive review of the US-Canada Income Tax Convention, the recently issued Fifth Protocol, and the OECD Model Treaty and related Commentaries, as well as the domestic tax law treatment of single member limited liability companies, pass through entities and other organization, the Canadian Tax Court, in an opinion written by Patrick Boyle, on April 8, 2010, concluded that implicit in the clear intention of the OECD countries, including Canada and the US, that treaty benefits be enjoyed by TD LLC in the present circumstances, and given the context of the Canadian and US tax régimes and the text of the US Treaty : (i) TD LLC must be considered to be a resident of the US for purposes of the US Treaty otherwise the treaty could not apply; (ii) TD LLC must be considered to be liable to tax in the US by virtue of all of its income being fully and comprehensively taxed under the US Code albeit at the member level; and (iii) the income of TD LLC must be considered to be subject to full and comprehensive taxation under the US Code by reason of a criterion similar in nature to the enumerated grounds in Article IV, namely the place of incorporation of its member which is the very reason that TD LLC's income is subject to full taxation in the US. the Tax Court of Canada held that a single member US LLC was a US resident for the purposes of the Canada-US Tax Treaty. As "resident", the US LLC was entitled to branch tax relief on Article X (Dividends) under the U.S.-Canada Tax Treaty. The decision overrides the long-standing position adopted by the Canada-Revenue Agency that a US LLC is not"resident in the U.S." for treaty purposes on the rationale that income is not subject to the most comprehensive form of taxation in the U.S. at the entity level.

Facts of the Case.

Holdings II is a wholly owned direct subsidiary of Toronto Dominion Holdings (USA) Inc. ("TD USA") another Delaware corporation. In turn, TD USA is a wholly owned direct subsidiary of The Toronto-Dominion Bank, a Canadian Chartered Bank.

TD LLC is a registered US broker-dealer that provides financial services in capital markets such as foreign exchange trading and interest rate swaps. It has carried on its business for over 50 years and is based in New York City where most of its customers are located or headquartered. TD LLC has a branch operation in Canada for the purpose of serving its US customers. Given the regulation of the financial services sector in both countries, its US customers need or prefer to do business in Canada with a US company.

TD LLC's Canadian branch profits for 2005 and 2006 were reported by it in its Canadian tax returns. Non-residents of Canada that carry on business in Canada are subject to ordinary Canadian income tax under Part I of the Canadian Act on the income from their Canadian business activity. The US Treaty provides that a US resident that carries on business in Canada is only subject to Canadian income tax if the business is carried on through a permanent establishment ("PE") in Canada. It was undisputed that TD LLC’s Canadian branch is a PE for Canadian income tax purposes.

Part XIV of the Canadian Income Tax Act further provides that a non-resident carrying on business in Canada will be liable for an additional tax of 25% of its Canadian net after-tax income, i.e., Canadian "branch tax". For its U.S. counterpart see §884. . The "branch tax" mimics the impact of a 25% dividend withholding on dividends paid to a non-resident shareholder had it conducted its business operations in Canada through a Canadian subsidiary corporation instead of thru a branch. This branch tax results in yielding the same income tax consequences for non-residents of Canada whether their Canadian business is carried on thru a Canadian subsidiary or a Canadian branch.

Part XIV of the Canadian Act provides that, if a Canadian tax treaty with the country of residence of a non-resident carrying on business in Canada through a branch provides for a lesser withholding tax rate on dividends than 25%, the 25% rate under Part XIV is similarly reduced1 unless the treaty itself reduces the rate under Part XIV. The US Treaty expressly provides that the rate of Canadian Part XIV tax for Canadian branches of US residents is reduced to the same 5% rate applicable under the US Treaty to dividends paid by a wholly-owned Canadian subsidiary to its US parent. TD LLC claimed the reduced rate of Canadian branch tax of 5% under the US Treaty in respect of the 2005 and 2006 income of its Canadian branch. The Canada Agency Revenue ("CRA") assessed TD LLC to deny it the benefit of the 5% US Treaty rate of branch tax and assessed Part XIV branch tax at the statutory rate of 25% on the theory that TD LLC was not entitled to relief under the tax treaty reducing the branch profits tax in Canada to 5% on the argument that it was not a resident of the US for purposes of the treaty.

It should be interjected that this case arose prior to the adopting and entering into force the Fifth Protocol entered into between Canada and the United States amended the US Treaty to add specific rules that apply to LLCs and other fiscally transparent entities including partnerships (the "Fifth Protocol Amendments"). However the Fifth Protocol Amendments were adopted and came into force well after the periods in question. Department of the Treasury Technical Explanation of the Protocol Done at Chelsea on 9/21/07 Amending the Convention Between the United States of America and Canada With Respect to Taxes on Income and on Capital, Done at Washington on 9/26/80 as Amended by the Protocols Done on 6/14/83, 3/28/84, 3/17/95 and 7/29/97.

TD LLC did not file an election under the "check-the-box" regulations and so it was a "disregarded" entity for U.S. tax purposes and all of its income is taxable to Holdings II. The 2005 and 2006 income of TD LLC's Canadian branch was therefore included in the income of Holdings II which in turn was included in the consolidated taxable income of its US parent, TD USA. TD USA did not claim a full foreign tax credit on the branch tax payable on the income of TD LLC based on the foreign source income (rate) limitation.

The question that was before the Court was whether a single member, Delaware LLC should be treated as a "resident of a Contracting State". This question also involved whether a reciprocal approach would be taken in the U.S., i.e., would a court in the U.S. similarly permit a disregarded entity owned wholly by a Canadian corporation not doing business in the U.S. do be treated as a "resident" of the U.S. The Court stated that it was unable to conclude as a matter of fact whether or not the IRS would have regarded a Canadian flow-through entity in those years as a resident of Canada for purposes of the US Treaty entitled to treaty benefits in respect of any of its US-sourced income. It further noted the record before it was silent on whether TD LLC and/or Holdings II requested the assistance of the US competent authority as provided for in the US Treaty to resolve their treaty dispute nor, if so, what the positions of the US and Canadian competent authorities were, nor what the outcome was. See Article XXVI of the Treaty.

The Canadian Department of Revenue argued that TD LLC was not a "resident" of the U.S. since it was not itself liable for tax in the U.S. or, alternatively, the Canadian branch tax is not imposed by reason of criterion of a similar nature" as required by Article IV of the US Treaty. It was further argued that were TD LLC to prevail, other LLCs, similarly would be able to claim treaty relief on the same basis in lieu of the basis set forth under the Fifth Protocol Amendments, which latter authority has specific conditions which must be met.

The taxpayer-appellant made two arguments in support of its position: (i) the phrase "liable to tax in" the US is not defined in the US Treaty and therefore, by default, must be defined by the Canadian Court by reference to Canadian law. On this issue, the taxpayer argued the Canadian Court had the power to determine that TD LLC was liable to tax in the US and therefore was a resident of the US for purposes of Article IV; or (ii) consistent with commentary with the OECD Model Treaty, a liberal interpretation and application of the US Treaty designed to achieve its purpose must interpret "resident of a Contracting State" to include a US LLC such as TD LLC.

Decision of the Canadian Tax Court in TD Securities (USA) LLC v. Her Majesty the Queen

After reviewing the U.S.-Canada Tax Treaty and its history, the Court found that for purposes of applying Article III, TD LLC is a company, i.e., any body corporate or any entity which is treated as a body corporate for Canadian income tax purposes, since Canada treats such an LLC as a body corporate under the Canadian Tax Act. As noted, where a term is not defined in the Treaty, the Canadian Court is permitted to interpret such term in the US Treaty based on the meaning that term has in Canadian law for purposes of the Canadian Act unless the context otherwise requires. See also Article IV (definition of "resident" of a Contracting State).

The Fifth Protocol Amendments were agreed to between Canada and the US in 2007 and specifically address the treatment of fiscally transparent entities, such as partnerships and LLCs. See Article IV of the Treaty, ¶¶6, 7. The Fifth Protocol Amendments are not retroactive and, as mentioned, were not applicable to TD LLC's 2005 and 2006 Canadian branch profits. Still, the US had not agreed with Canada’s position that, absent the Fifth Protocol Amendments, the US Treaty did not extend to US LLCs. While the Court found there was still some ambiguity as to the scope and interpretation of the Fifth Protocol Amendments, they were, in its view, clearly intended to ensure the US LLC's income enjoys the benefits of the US Treaty but observed that the same Fifth Protocol Amendments do not provide that the LLC will be treated as a "resident" of the U.S. The Fifth Protocol Amendment, ¶6, does not address how, or why, the LLC would be able to claim the treaty reduction on its Canadian income tax return. The Canadian taxpayer will still be the LLC, not the member. The Fifth Protocol Amendments contemplate relief at the member level, Holdings II, and not at the entity level; yet they do not by these terms deliver the contemplated relief if applied strictly and literally. But the member of TD LLC is not "resident" in Canada as though the LLC did not exist.

What is produced from the Fifth Protocol is: (i) Canada will not require the member(s) of US LLC to file Canadian tax returns in respect of income that benefits from new ¶6; (ii) instead, the US LLC, as a company, will file a Canadian tax return in which it will claim the benefit of the paragraph and supply any documentation required to support the claim; (iii) where the income in question is business profits, it will be necessary to determine whether the income was earned through a permanent establishment in Canada based on the presence and activities in Canada of the US LLC.

The Court thus had to decide whether TD LLC was a "resident" of the US for purposes of the Treaty and entitled to the benefits of the rate reduction under Canada’s branch profits tax. The Court relied on the analysis emanating from the Supreme court of Canada in The Queen v. Crown Forest Industries Limited, et al, 95 DTC 5389" which had to interpret the phrase "resident of a Contracting State" in Article IV of the U.S. Treaty and, in particular, what it meant to be "liable to tax" in the US by reason of the enumerated criteria. That case stated that a literal or legalistic interpretation of a tax treaty or convention must be avoided where the basic object of the treated would, based on such literal or formalistic interpretation, defeat or frustrate the intent of the parties to the treaty citing Coblentz v. The Queen, 96 DTC 6531 (FCA). Thus, in Crown Forest, the Canadian Supreme Court opined that a court may refer to extrinsic materials which form part of the legal context, including model conventions and official commentaries, without the need to first find an ambiguity before turning to such materials. Here, the Preamble to the US Treaty has as its purposes the reduction in or elimination of double taxation of income earned by a resident on one country from sources of the other country and of preventing tax avoidance or evasion. In Crown Forest, supra, the Supreme Court of Canada held that the purposes of the US Treaty also included the promotion of international trade between the two countries and the mitigation of administrative complexities arising from having to comply with two uncoordinated taxation systems. As to the Canadian Income Tax Act, citing Canada Trustee Mortgage Co. v. Canada v. Canada, 2005 SCC 54, 2005 DTC 5523, the Court confirmed that the objectives of the Canadian Income Tax Act of "consistency, predictability and fairness" should be compromised in any way by the proper interpretation and application of international tax conventions forming part of applicable Canadian income tax law.

Turning to the issue at hand as to the proper meaning of a "resident of a contracting state liable to tax", etc., the Supreme Court of Canada in Crown Forest held that such term describes a person subject to comprehensive tax liability imposed by a state, which in the US as in Canada is taxation on worldwide income. Still the factual context in Crown Forest was different than the case here. Still, the Court found it as corroborative that the intended purpose and scope of Articles I and IV of the US Treaty were that the treaty apply to those bearing full tax liability in either of the contracting states based upon the nature and extent of their connections with that country.

OECD Model Treaty Reviewed: Article 1 and IV

The language used in Article I of the US Treaty and Article 1 of the OECD Model Treaty differ in that the US Treaty provides that the treaty is "generally applicable" to residents of a contracting state whereas the OECD Model Treaty uses the word "applicable". The use of the phrase "generally applicable" in the US Treaty suggests that the US Treaty may also be applicable to others in particular circumstances. Indeed, this is confirmed in the original Technical Explanation to the US Treaty. The OECD Commentary on Article 1 on partnerships is instructive in interpreting the phrase "liable to tax" in a contracting state because neither the OECD Model Treaty nor, in the years in question, the US Treaty expressly provided how they applied to partnerships and partners. Of specific interest are paragraphs 4, 5 and 6.3 of the OECD Commentary on Article 1 which read as follows:

4. A first difficulty is the extent to which a partnership is entitled as such to the benefits of the provisions of the Convention. Under Article 1, only persons who are residents of the Contracting States are entitled to the benefits of the tax Convention entered into by these States. While paragraph 2 of the Commentary on Article 3 explains why a partnership constitutes a person, a partnership does not necessarily qualify as a resident of a Contracting State under Article 4.

5. Where a partnership is treated as a company or taxed in the same way, it is a resident of the Contracting State that taxes the partnership on the grounds mentioned in paragraph 1 of Article 4 and, therefore, it is entitled to the benefits of the Convention. Where, however, a partnership is treated as fiscally transparent in a State, the partnership is not "liable to tax" in that State within the meaning of paragraph 1 of Article 4, and so cannot be a resident thereof for purposes of the Convention. In such a case, the application of the Convention to the partnership as such would be refused, unless a special rule covering partnerships were provided for in the Convention. Where the application of the Convention is so refused, the partners should be entitled, with respect to their share of the income of the partnership, to the benefits provided by the Conventions entered into by the States of which they are residents to the extent that the partnership's income is allocated to them for the purposes of taxation in their State of residence (cf. paragraph 8.7 of the Commentary on Article 4). (emphasis added).

6.3 The results described in the preceding paragraph should obtain even if, as a matter of the domestic law of the State of source, the partnership would not be regarded as transparent for tax purposes but as a separate taxable entity to which the income would be attributed, provided that the partnership is not actually considered as a resident of the State of source. This conclusion is founded upon the principle that the State of source should take into account, as part of the factual context in which the Convention is to be applied, the way in which an item of income, arising in its jurisdiction, is treated in the jurisdiction of the person claiming the benefits of the Convention as a resident. For States which could not agree with this interpretation of the Article, it would be possible to provide for this result in a special provision which would avoid the resulting potential double taxation where the income of the partnership is differently allocated by the two States.

The OECD commentaries to Article 1 with respect to partnerships are expressly stated to be the conclusions of the OECD Partnership Report. Two OECD countries expressly reserved on paragraphs 5 and 6 of the commentary on the basis that express language in a treaty would be required. A third country made a similar reservation in respect of all of the commentary to Article 1. Neither Canada nor the US reserved nor made an observation on this point.

The OECD Partnership Report provides examples in determining "resident" for treaty purposes. Example 4 highlights where the country in which the income is sourced treats a partnership as a taxable entity and the other treats it as a fiscally transparent entity. While this is not the case for Canada as source country with respect to partnerships, it is the case for Canada as the source country with respect to US LLCs, and is to that extent instructive. Paragraphs 60 to 62 of the report provide: 60. Under [source] State S domestic law, the taxpayer will be partnership P. State S could then argue that since partnership P is not entitled to the benefits of the treaty, it can tax the income derived by P regardless of the provisions of the S-P Convention. This, however, would mean that the income on which A and B are liable to tax in State P would be subjected to tax in State S regardless of the Convention, a result that seems in direct conflict with the object and purpose of the Convention.

61. The Committee compared that approach, under which State S applies the provisions of the Convention by reference to the treatment of the partnership under its domestic law, with another approach, under which State S considers the entitlement to treaty benefits of A and B, both residents of State P, under the principles put forward above. Under the latter approach, State S would determine that the provisions of the Convention should be applied to prevent it from taxing the royalties since, under these principles, the income must be considered to be paid to A and B, two residents of State F, who should also be considered to be the beneficial owners of such income as these are the persons liable to tax on such income in State P. The Committee concluded that this approach was the correct one as it is more likely to ensure that the benefits of the Convention accrue to the persons who are liable to tax on the income.

Article 4 of the OECD Model Treaty does not differ in any material respect from Article IV of the US Treaty with respect to the meaning of the term "resident of a Contracting State". The OECD Commentary to Article 4 makes it clear in paragraphs 8 and 8.5 that the concept of persons liable to tax by reason of the enumerated criteria is trying to capture those who are subject to comprehensive taxation, being a full liability to tax on all income wherever earned. This is consistent with the comments of the Supreme Court of Canada in Crown Forest. Paragraph 8.7 of the OECD Commentary to Article 4 provides: 8.7 Where a State disregards a partnership for tax purposes and treats it as fiscally transparent, taxing the partners on their share of the partnership income, the partnership itself is not liable to tax and may not, therefore, be considered to be a resident of that State. In such a case, since the income of the partnership "flows through" to the partners under the domestic law of that State, the partners are the persons who are liable to tax on that income and are thus the appropriate persons to claim the benefits of the conventions concluded by the States of which they are residents. This latter result will be achieved even if, under the domestic law of the State of source, the income is attributed to a partnership which is treated as a separate taxable entity. For States which could not agree with this interpretation of the Article, it would be possible to provide for this result in a special provision which would avoid the resulting potential double taxation where the income of the partnership is differently allocated by the two States. Some countries did reserve on paragraph 8.7 but neither Canada nor the US reserved or made a relevant observation.

From these OECD materials, the TD LLC Court viewed that the OECD Model wants to be able to maintain that a partnership that is treated as a flow-through in its country of establishment will not be considered liable to tax therein for purposes of the OECD Model Treaty. However, the OECD makes it equally clear that, the OECD Model Treaty is intended to, and should be interpreted and applied in a manner that nonetheless extends the benefits of the Convention to the income of such a partnership notwithstanding that it is not, strictly speaking, a resident of its home country. In the case of partnerships this is to be done at the partner level notwithstanding that the partnership is not liable to tax in its home country and its partners are not considered to have earned the income in the source country.

Taxpayer, TD Securities (USA)LLC ("TD LLC") is a limited liability company formed and organized in Delaware. It’s sole member is TD Holding II, Inc. ("Holdings II"), a Delaware corporation that is not "resident" in Canada under the Canadian Income Tax Act and is resident in the U.S. under the US-Canada Income Tax Convention. TD LLC was the successor of a Delaware corporation which was converted into an LLC (and renamed) in 2004 as part of a non-taxable consolidation of certain subsidiaries of Holdings II for U.S. state income tax purposes. The parties agreed that a US LLC is treated under Canadian law, as it is in Delaware and in the U.S., as a distinct legal entity apart from its members and that TD LLC is properly treated as a corporation under Canadian law.

While these two conclusions -- that a partnership is not liable to tax in its home country if it is treated as fiscally transparent and that its income from a source country that does not regard it as fiscally transparent should nonetheless get the benefit of the tax convention -- are developed in the context of fiscally transparent entities that are partnerships, the TD LLC Court saw no reason that the conclusions should be any different in the case of a fiscally transparent US LLC. Since the OECD Model Treaty was the template for the US Tax Treaty with Canada, and given the absence of reservations or observations thereon by Canada and the US, the Court accepts that these reflect the intentions of Canada and the US with respect to the US Treaty specifically and how its objects and purposes are to be achieved.

Canadian Interpretation and Administration

In Crown Forest the Supreme Court of Canada quoted with approval from the decision of the U.S. Supreme Court in Sumitomo Shoji America, Inc. v. Avagliano et al‚ 457 U.S. 176 (1982), that "[a]lthough not conclusive, the meaning attributed to treaty provisions by the Government agencies charged with their negotiation and enforcement is entitled to great weight." In CRA Income Tax -- Technical News No. 35 dated February 26, 2007, the CRA outlines its "long-standing position" on liability to tax for treaty purposes. In it the CRA wrote: it remains CRA's position that, to be considered "liable to tax" for the purposes of the residence article of Canada's tax treaties, a person must generally be subject to the most comprehensive form of taxation as exists in the relevant country. This, however, does not necessarily mean that a person must pay tax to a particular jurisdiction. There may be situations where a person's worldwide income is subject to a contracting state's full taxing jurisdiction but that state's domestic law does not levy tax on a person's taxable income or taxes it at low rates. In these cases, the CRA will generally accept that the person is a resident of the other Contracting State unless the arrangement is abusive. . .

It is not disputed that the CRA has a long-standing practice of characterizing the income earned by a foreign partnership made up of foreign partners consistent with the OECD Partnership Report. That is, even though the partnership is a fiscally transparent entity, the partners of the partnership will be entitled to treaty benefits. With respect to the US Treaty, the CRA has acknowledged this is based upon its understanding of the intent of Canada and the US. The CRA has also confirmed that it will treat a so-called "S Corporation" as a resident of the US for purposes of the US Treaty. A US corporation that elects under subchapter S of the US Code is treated as a flow-through entity whose income is taxed under the US Code in the hands of its shareholders. This was again confirmed by the CRA in a 2008 Technical Interpretation13 without mention of new paragraphs 6 and 7 of the Article IV added by the Fifth Protocol Amendments.

But, in the case of LLCs, the CRA appears to have departed from the above consistency. In a 1993 Technical Interpretation the CRA had to deterrnine whether a particular US state's LLCs should be considered corporations or partnerships. It concluded that, if an LLC is treated as a partnership for purposes of the US Code such that the partners rather than the company are liable to tax on the company's income, the LLC will not be considered a resident of the US for purposes of the US Treaty. It does not expressly deal with whether or why members of the LLC will or will not enjoy treaty benefits on the same basis as partners of a partnership. In its later May 20, 1997 interpretation the CRA identifies its concern as being that, if a US LLC enjoys US Treaty benefits, a Canadian resident could carry on its Canadian business in Canada through a US LLC and avoid both Canadian and US taxes on the income of its Canadian business.

In Income Tax -- Technical News No. 16 dated March 8, 1999 the CRA confirmed its positions that S Corporations will be treated as treaty residents and that LLCs will not. It noted the inconsistency and regretted, but did not reverse, its S Corporation position. It did not acknowledge, address or attempt to reconcile its treatment of LLCs with its treatment of partnerships nor did it address specifically the members of an LLC.

In summary, the Court observed that Canadian tax authorities have, with the sole exception of their approach to LLCs, been consistent in their interpretation and application of the US Treaty provisions applicable to a determination of treaty residence. They extended treaty benefits to US not-for-profit organizations and pension funds notwithstanding that these entities did not generally pay tax under the US Code. They similarly extended treaty benefits to government entities notwithstanding that they were not liable to tax under the US Code. They extended treaty benefits to S Corporations notwithstanding that their income is flowed through to their shareholders under the US Code. They extended treaty benefits to the income of foreign partnerships notwithstanding that their income is flowed through to partners, such treaty benefits to be determined and enjoyed at the partner level. Accordingly, the "sole anomaly" is the CRA's position with respect to US LLCs which, even after the lengthy trial herein, remains largely unexplained and entirely irreconcilable with the Canadian government's approach to foreign partnerships.

Now the Court was ready to tip its position and therefore the holding in the case. It stated that "The treatment of partnerships and of LLCs should be analagous for purposes of the interpretation and application of the US Treaty. A non-Canadian partnership is deemed to be a person with respect to payments made to it for Part XIII non-resident withholding tax purposes: see paragraph 212(b) of the Canadian Act. A US LLC such as TD LLC is treated as a corporation and thus a separate person for purposes of the Canadian Act. In each case the partnership and the LLC are the taxpayers for purposes of the Canadian Act. In neither case are the partners or members the taxpayers

Conclusion

"This Court concludes, from the overwhelming consistency of the Canadian government's approach to fiscally transparent entities and to other entities that are not liable to tax under a treaty partner's domestic legislation, that it was not intended that an entity whose income was fully and comprehensively taxed in the other contracting state would be denied the benefit of a treaty simply because its income was taxed by the other country at the level of its shareholders, members or partners.

Further, implicit in the CRA's position with respect to partnerships and S Corporations is that the basis of taxation of an owner (partner or shareholder) is a similar criterion to the enumerated criteria for purposes of Article IV of the US Treaty. Similarly, paragraph 6.2 of the Income Tax Conventions Interpretation Act also makes it clear that, in considering whether a partnership is a resident of another state for purposes of a tax treaty, the residence of the partners is relevant. This is also implicit in the CRA's administrative positions described above as well as in the OECD Commentary and Partnership Report. "

Court’s Taking Judicial Notice of the US Interpretation and Administration

All of the US material before the Court confirms that the approach of the US authorities to the interpretation and application of tax treaties to fiscally transparent entities is consistent with the OECD look-through approach. As support, the Court noted that Chief Counsel of the US Treasury issued a Technical Assistance dated March 15, 2000 on the subject of Certification of Limited Liability Companies. It addressed the issues of whether and how the IRS should respond when requested to certify to a treaty partner country's tax authorities that a single-owner LLC is a resident of the US that is entitled to treaty benefits under the US tax convention.

The Chief Counsel's conclusion is: Because a single-owner LLC that is disregarded as an entity separate from its owner is not a "person", nor is it "liable to tax", the [IRS] may not certify that the LLC is a resident of the United States. However, the [IRS] may certify that the single-owner of the LLC is a resident of the United States, which should suffice to establish that income derived by the LLC in the treaty country is being derived by a resident of the United States and is entitled to treaty benefits.

The US competent authority has also determined under the mutual agreement procedures with several of its other treaty partners that the income of LLCs will be extended treaty benefits at the member level on a look-through basis. The United Kingdom revenue authority had also confirmed this approach to US LLCs in its Double Taxation Relief Manual prior to being "formalised" by amendments to the US-UK Treaty.

The Associate International Tax Counsel of the US Department of the Treasury addressed the 1994 Annual Conference of the Canadian Tax Foundation as part of a panel on Canada-US Cross-Border Issues. According to the published summary, in discussing the Third Protocol Amendments to Article IV of the US Treaty dealing with government entities, not-for-profit organizations and pension funds, the US attached no significance to the failure of the Protocol to deal specifically with the treatment of partnerships and confirmed that the existence of a partnership will not preclude the availability of treaty benefits. "The US authorities generally apply a look-through approach to analysing partnerships in the treaty context: treaty benefits are granted to the extent that the partners themselves qualify for such benefits.". It is noted that the Canadian Assistant Deputy Minister of Finance responsible for the Tax Policy Branch -- the very group responsible for the negotiation of Canada's tax treaties including the US Treaty and the Protocols thereto -- was on the same panel and did not express a different view. Indeed, the rapporteurs note by way of footnote that the CRA has expressed the same view in the technical interpretations going back to 1983.

Treasury Regulations under section 894 of the US Code provide that the US will only extend treaty benefits to passive income derived by a treaty resident of another country through a fiscally transparent entity if the income is taxed by the other country on the same basis as to timing, character and source as had the treaty resident earned the income directly. Treasury Decision 8722 which announced the Temporary Regulations makes it clear that it is well established that, in interpreting and applying US tax treaties, fiscally transparent entities are ignored and a look-through approach is intended, with the result that the entity's owners are treated as the persons who derive the income. Treasury Decision 8889 of 2000 which announced the Final Regulations confirms that the US regards the principles behind Treasury Regulations 894 as fully consistent with its treaties. These comments in these last two documents are not limited to passive income.

The United States Model Income Tax Convention of 2006 (the "US Model Treaty") provides expressly in Article 1 that income derived through an entity that is fiscally transparent under the laws of either contracting states shall be considered to be derived by a resident of a state to the extent that the item is treated for purposes of the taxation law of such contracting state as the income of a resident. The Technical Explanation to the US Model Treaty confirms expressly that this would apply in the case of an LLC. While the US Model Treaty is simply that, a model treaty, the Technical Explanation to it provides that the intention of the rule is to "eliminate" certain "technical problems" that "arguably" would have prevented persons investing through a fiscally transparent entity from claiming treaty benefits. The predecessor US Model Treaty of 1996 was to a similar effect.

It is clear from the above that the US has throughout intended that the entitlement to treaty benefits of income earned by a fiscally transparent entity such as a partnership or LLC be determined at the member level using a look-through approach and that the US has consistently interpreted Article IV of the US Treaty to permit or require that approach.

Conclusion

Based on the manner in which TD LLC subjects its member and members of an affiliated group of corporations to full income taxation, it "seems clear that the income of TD LLC should enjoy the benefits of the US Treaty. .. evidence is overwhelming that the object and purpose of the US Treaty read in the context of all of the evidence and authorities would not be achieved and would be frustrated if the Canadian-sourced income of TD LLC that is fully taxed in the US under the US Code does not enjoy the benefits of the US Treaty including Article X(6). The appeal must therefore be allowed and the assessments be sent back to the Minister for reconsideration and reassessment on the basis that the Canadian branch profits of TD LLC enjoy the favourable reduced Part XIV branch tax rate reduction provided for in Article X(6) of the US Treaty. "

The Court further observed that, just like the US, Canada gets to choose who to tax under the Canadian Income Tax Act, a US LLC or its members, a partnership or its partners. However, when deciding how to apply its international convention with its treaty partner, Canada must consider as part of the context that the US also gets to choose at which level to impose its domestic tax under the US Code on that income, partnership or partner, LLC or member. This was clearly intended by the treaty countries in order to give effect to the US Treaty's object and purpose. It makes little sense to think that treaty entitlement should be affected by a US LLC's exercise of its right under the US Code to elect to have its income taxed in its hands or flowed through and taxed in the hands of its US resident members.

The proper method of interpreting the US Treaty to determine if it applies to income earned by to US partnerships that are fiscally transparent and by US LLCs including TD LLC prior to the Fifth Protocol Amendments, is to follow the interpretive approach taken by the OECD countries, the OECD Model Treaty and the related commentaries and report. That is, to read the text of the opening sentence of Article IV in the context of the treaty as a whole, in the context of the object and purpose of the treaty, and in the context of how our treaty partner chooses to fully and comprehensively impose tax under its domestic tax legislation, the US Code, on the income of TD LLC and other fiscally transparent entities. This is consistent with the approach taken by Canada and the US with respect to the interpretation of the US Treaty in its application to government entities and not-for-profit organizations prior to the addition of specific amendments confirming the treaty's application to such entities. It is also consistent with both countries' approach to determine the treaty entitlements of non-corporate entities such as partnerships and S Corporations prior to the Fifth Protocol Amendments. The result also harmonizes with section 219.2 which does not require that a treaty's reduced withholding tax rate apply to the particular taxpayer.

The result does not jeopardize the Canadian approach to partnerships under all Canadian tax treaties but for the US and France treaties where we now have express language. Such an approach is also entirely consistent with the approach Canada and the US have taken in respect of the application of the US Treaty in later years under the Fifth Protocol Amendments, the terms of which textually do not provide that partnerships, LLCs and other fiscally transparent entities are deemed to be residents for purposes of Article IV; the treaty partners instead chose to rely upon the Technical Explanation to impose the obligation on the tax administrators of each country to ensure that treaty benefits would nonetheless be enjoyed on the income earned in or from the other country by a partnership, LLC or other fiscally transparent entity. Therefore, the rate reduction to the branch tax under Article X(6) applies to Canadian branch profits of TD LLC.

While the court observed that there were further conclusions that must be drawn. It noted that the OECD Commentaries may have been purposely vague and not have reached, by design, hard and fast rules applicable to the treatment of fiscally transparent entities under bilateral tax conventions. Perhaps this was attributable to, as the Court suggested, the vastly different legal and tax régimes represented by the member countries OECD.

Still the Court stated that it was not difficult to analyze the intent on how Canada and the US can be presumed to have the US Treaty apply given that they subsequently addressed the issue in the Fifth Protocol Amendments and the Technical Explanation thereto. While Canada and the US try to walk both lines -- in the treaty text not treating the entity as a resident because it is not liable to tax yet acknowledging their intention of applying the text as if the LLC was a resident --, having forced this matter to court, Canada can perhaps no longer leave it ambiguous.

This Court has to decide whether TD LLC is a resident of the United States and liable to tax therein by reason of one of the enumerated or similar grounds, it concludes that it is

Canadian Department of Revenue’s Criticism of the Impact the Holding in TD LCC Will Have and In Particular Its Adverse Impact on the Fifth Protocol to the Treaty

Although Judge Boyle and the Court were not persuaded by this concern, the CRA argued that the holding in this case, which accepts that US LLCs and partnerships that are fiscally transparent, US persons will be able to choose in the future between having the US Treaty apply in accordance with the reasons herein or, alternatively, in reliance upon new paragraph 6 of Article IV. Potential abuse and frustration of the purpose of the Fifth Protocol Amendments would result since the application of the reasons in this case would not incorporate the requirements of paragraph 7 of Article IV added by the Fifth Protocol Amendments.

Judge Boyle noted that irony that the decision here, although issued after the Fifth Protocol was entered in force, was effectively overridden. Accordingly, the Court cautioned that "this decision cannot be said to stand for the simple proposition that every US LLC is a resident of the US for the purposes of the US Treaty".

"On the facts of this case, as put before this Court, and the applicable law and authorities advanced and argued by the parties, the requirements of new paragraphs 6 and 7 of Article IV would be satisfied by TD LLC and Holdings II if the Fifth Protocol Amendments were applicable to the years in question. For that reason the decision in this case does not constitute a materially different gate to access the US Treaty by US LLCs, much less a potential flood gate. " Here it was agreed that there was business purpose and not abusive state tax planning for TD LLC to operate a US brokerage as a Canadian branch.

The Court concludes that implicit in the clear intention of the OECD countries, including Canada and the US, that treaty benefits be enjoyed by TD LLC in the present circumstances, and given the context of the Canadian and US tax régimes and the text of the US Treaty : (i) TD LLC must be considered to be a resident of the US for purposes of the US Treaty otherwise the treaty could not apply; (ii) TD LLC must be considered to be liable to tax in the US by virtue of all of its income being fully and comprehensively taxed under the US Code albeit at the member level; and (iii) the income of TD LLC must be considered to be subject to full and comprehensive taxation under the US Code by reason of a criterion similar in nature to the enumerated grounds in Article IV, namely the place of incorporation of its member which is the very reason that TD LLC's income is subject to full taxation in the US.

(emphasis added). In the years in question the US Treaty did not have an express rule for partnerships or for LLCs or other fiscally transparent entities. The CRA applies a look-through approach in applying Canadian tax treaties to partnerships, even though the taxpayer for Part XIII Canadian non-resident withholding tax purposes is the partnership, not the partners."