Understanding U.S. LLC Tax Treatment in Canada
Are you an American small-business owner considering expansion into Canada? Are you a Canadian small-business owner considering expansion into the United States? Do you run your business as a Limited Liability Company(LLC)? Are you considering bringing on Canadian investors? If you answered yes to any of these questions, then there are a few things that you need to know about Canada’s tax system to save yourself from double taxation.
LLC Taxation in America
First of all, let’s talk about LLCs and how they are treated in the United States. The United States recognizes two types of LLCs—single member (disregarded entity) and multiple member (partnership). A single member LLC is required to report their earnings as a part of their personal income, while a multiple member LLC files a partnership return. If you are an American citizen conducting business outside of the United States, you are required to report these earnings both here in the Unites States and in the country where you are doing business—this is double taxation. Fortunately, because of the United States’ extensive business dealings across the globe, income tax treaties have been established to provide relief and benefits for business owners.
Canada and the Fifth Protocol
You must understand that the tax benefits extended to business owners changes from country to country. The tax laws in Canada vastly differ from those here in America. Until 2008, if you conducted business in Canada under a U.S. LLC the Canadian government viewed your LLC as a corporation, not as a pass through entity—as happens in the U.S. This meant that you had to file your Canadian tax return as a corporation, and were subject to a 25 percent withholding on any cross-border profits, plus a 25 percent branch tax. Additionally, because the LLC itself was not liable to taxation in the U.S. and therefore not technically subject to double taxation you were denied treaty benefits that would reduce this rate to 5 percent.
This all changed on September 21, 2007, when amendments to the Fifth Protocol to the Canada-U.S. Income Tax Convention were proposed and subsequently ratified to become effective January 1, 2008. Under the protocol amendments, U.S. LLCs now qualify for the same treaty benefits as any other U.S. citizen or entity. Some LLCs are even entitled to enter refund claims on the taxes paid prior to the enactment of this new protocol, as a result of the recent Canadian court ruling in TD Securities (USA) LLC v. The Queen.
It is tax treaties such as the Fifth Protocol that make it is crucial to having experienced tax professionals like INTAXACT assist you with filing. We can wade through the sea of confusing codes, credits, exclusions, and treaties—lessening the chance of double taxation and helping you avoid unnecessary audits and penalties. Speak with an INTAXACT CPA and get started today!