Before 2010, Canadian direct selling companies were often organized as Unlimited Liability Companies ("ULCs"), for good reason.
The ULC structure could operate under the US "check-the-box" rules as a flow-through entity, which was often desirable from the perspective of the US corporate owner, which was usually structured as an S Corp or LLC.
Changes to the US-Canada Tax Treaty (the "Treaty") made effective in 2010 threw a wrench into these historically common structures – exposing some to a 25% unrecoverable tax under Part XIII of the Canadian Income Tax Act on any payments of dividends, interest, and royalties.
More specifically, the changes operated to deny treaty benefits under newly enacted anti-hybrid rules in Article IV(7)(b) of the Treaty, which meant that Treaty reduced withholding rates on dividends (often only 5%) and interest and royalties (often only 10%) lost that protection, and rose to the general 25% rate. Significantly, these were unrecoverable taxes imposed under Part XIII of the Canadian Income Tax Act, and they began to apply to payments made on or after January 1, 2010 by Canadian ULCs.
The Canada Revenue Agency ("CRA") gave their approval to some work-arounds prior to the implementation date (i.e., to mitigate the effects of these changes on ULCs), and continued to tweak their feedback on those work-arounds in the years that followed.
Despite the work-arounds to date, there are a number of remaining issues, not the least of which is ensuring that the corporation's tax advisers remember to implement those work-arounds!
To keep this discussion at a high-level, the work-arounds can be criticized on the following bases:
- Most were directed toward dividend payments, with less attention to equally common occurrences of interest payments, and payments in the nature of licensing or royalty fees.
- Most were directed at ULCs owned by either US C Corps or S Corps, and work-arounds were not developed at all for LLCs owning ULCs.
This last point, in fact, may be the most frightening, as what that means is that a historically common structure (i.e., an LLC owning a ULC) does not actually work under the current Treaty, and the result of that structure will be an unrecoverable tax of 25% on all profits earned overall – that is in additional to the expected Canadian Part I taxes, and US income taxes on the flow-through. So for those US owners with that particular structure, you had better be picking up the phone right now, to try and figure out what to do about it!
For the better informed, many US owners of Canadian direct sellers have avoided these issues by adopting Canadian structures that do not rely on the ULC.
In our experience, however, an equal number or more of them may be totally oblivious to the issues that they currently face, including the tax liability which continues to mount from 2010.
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