Canada Treaty Amendments Affecting Private Equity Funds
September 24, 2008
On September 23, 2008, the United States Senate ratified the much anticipated fifth protocol (the “Protocol”) amending the income tax treaty between the United States and Canada. This newsflash highlights two features in the Protocol of particular importance to private investment funds:
LLC Members To Be Eligible for Treaty Benefits. With limited exception, the Protocol extends treaty benefits on a “look-through” basis to an otherwise qualified U.S. resident who derives income through a limited liability company (“LLC”) treated as a pass-thru entity for U.S. tax purposes. (By contrast, under the current treaty, neither the LLC nor any of its members is treated by Canadian tax authorities as a U.S. resident eligible for treaty benefits.) This welcome change resolves a potentially troublesome structuring issue for funds that invest in Canada, although some caution may still be appropriate with respect to structures involving other jurisdictions, which may continue to treat any LLC as a corporation.
No Withholding on Most Interest Payments. The Protocol eliminates withholding tax—currently 10%—on most cross-border interest payments between unrelated parties. The Protocol also provides for the gradual elimination, within two calendar years, of withholding on cross-border interest between related parties: a withholding rate of 7% will be imposed during the portion of the remaining portion of the first calendar year, 4% during the second year and 0% thereafter. The elimination of withholding on interest will provide additional flexibility to cross-border investment structuring.
The Protocol will enter into force following diplomatic exchanges; the benefits described above will generally become available as of the second calendar month beginning thereafter.
If you have any questions regarding this newsflash, please call your Davis Polk contact.