The Canadian dollar might not be as strong as it once was, but that still hasn’t stopped many Canadians from investing in the US real estate market. Each day we meet with new clients who are looking to the US to develop a portfolio of residential rental properties in order to generate a secondary, or in some cases, primary source of income. These clients are also purchasing commercial properties such as strip malls and office buildings and each and every time they ask the same question, “how should I hold title?” The answer to this question is not generically the same across the board.
The Standard – Limited Partnership
The minimization of taxes is one of the main concerns when dealing with cross border issues. No Canadian investing in the US wants to deal with the dreaded double taxation that would apply if you lose the ability to claim a foreign tax credit in Canada for the taxes you have paid in the US. This is one reason why we like using Limited Partnerships (“LP”), when structured properly, the foreign tax credit can be claimed back in Canada.
LP’s have some wonderful advantages, as the tax treatment of LP’s are the same on both sides of the border and are considered disregarded entities for tax purposes if properly structured. They act as a flow through and pass the tax liability up to the partners. This basically means no double taxation and more favourable tax rates on the US side. LP’s will also provide creditor protection to its limited partners, which is necessary when investing in the US.
The New Kid on the Block – Limited Liability Limited Partnership
A relatively recent structure we have seen being recommended to Canadian investors is a US limited liability limited partnership (“LLLP”). The LLLP is not something many Canadians are familiar with, as they do not exist here in Canada. Yet some Canadian and US professionals have been recommending them to Canadian clients. The question we want to address is weather LLLP’s are a tax effective cross border structure for Canadian investors.
The LLLP is essentially a variation of a LP discussed above, which we recommend to clients when the circumstances are appropriate. The main difference between these two entities is the liability of the general partner. In an LP the general partner, who would normally hold a nominal interest, has unlimited liability to the obligations and debts of the partnership. Where the limited partners, who hold a much larger interest, can only lose what they have contributed to the partnership. Their liability is limited to the amount of their investment. An LLLP on the other hand is somewhat different.
Under State law applicable in the US, the LLLP can make an election that the general partners are also given limited liability protection for the time the election is in place, thereby protecting the general partners from losing more than they have contributed. The form of the election will vary depending on the State so it is important to ensure that the State requirements are being met, should you chose to make such an election. In fact only certain States have enacted statutes that allow LLLP’s to exist while others have remained silent. Time will tell whether the protections afforded to LLLP’s will exist in states that have not enacted similar statutes.
The Canadian Revenue Agency vs. Limited Liability Limited Partnerships
As we have discussed, an LP is treated as a disregarded entity on both sides of the border. This is what allows the limited partner to pay tax to both the Internal Revenue Service (“IRS”) and the Canadian Revenue Agency (“CRA”) at their own personal rates. Although the LLLP is a partnership in the eyes of the IRS, how is it viewed by the CRA?
This is where the complication arises. Does the CRA view the LLLP as a foreign partnership as it does with an LP, or does the fact that the general partner(s) are now afforded limited liability change the nature of the structure? There is certainly an argument to be made that the increased liability protection can alter the way the CRA views the LLLP and as a result classify it for tax purposes as a foreign corporation instead of a partnership.
Foreign corporations are not treated as disregarded entities for tax purposes on the Canadian side. Should the CRA take the position that an LLLP is a foreign corporation, Canadians can find themselves in the dreaded double taxation position. One of the essential objectives in cross border tax planning is to ensure that you have the same tax treatment on both sides of the border and qualify for a foreign tax credit to avoid double taxation.
In fairness, there are arguments to be made that the LLLP should retain its partnership nature in the eyes of the CRA, however the question remains to be answered. Until the CRA takes a clear stance on how it views an LLLP, it is very difficult to recommend this structure to a Canadian investor.
Should you wish further cross border tax information on limited partnerships please contact our firm to book a consultation.