Treaty Status of LLCs

In International Technical Assistance (ITA) 200019042, the IRS stated that a single-member limited liability company (SMLLC) that is a disregarded entity for U.S. tax purposes could not be certified as a U.S. resident. This issue is relevant when LLCs seek to reap the benefits of U.S. income tax treaties. The income tax treaties to which the U.S. is a party provide, inter alia, reduced withholding rates and other benefits to U.S. residents and residents of the other country that is a party to the treaty. The recent ITA highlights the often-uncertain treaty status of LLCs under U.S. bilateral income tax treaties. This item considers the Canadian and Mexican treaty treatment of U.S. LLCs.

Bilateral Treaty with Canada

In Income Tax Rulings and Interpretations Directorate, Internal Memo 971312 (May 20, 1997), the Canada Customs and Revenue Agency (CCRA) (formerly Revenue Canada) stated that it would not extend the benefits of the Canada-U.S. income tax treaty to U.S. LLCs or their members for Canadian-source income. In the absence of treaty benefits, Canadian-source income, including interest, dividends or management fees, would be subject to tax in Canada at the nontreaty rate of 25%. In contrast, for a corporation that is a U.S. resident for treaty purposes, Canadian-source interest income would be taxed at only 10% and Canadian-source dividend income at either 5% or 15% (depending on the degree and identity of ownership in the paying corporation). Under the treaty, management fees would generally be exempt from tax.

Given the fact that Canada does not treat a U.S. LLC as a U.S. resident for treaty purposes, such an entity may not be a suitable vehicle for U.S. residents to derive income from Canadian sources, unless all Canadian taxes will be recovered through foreign tax credits in the U.S.

However, Canada and the U.S. are in the process of negotiations for a Fifth Protocol to the U.S.-Canada income tax treaty, and there have been indications that the proper treatment of U.S. LLCs might be included in these negotiations.

Bilateral Treaty with Mexico

Unlike the Canadian position on the treatment of U.S. LLCs, under which treaty benefits are not available to LLCs or their members, Mexico treats U.S. LLCs as separate legal entities that would qualify for treaty benefits, provided there is proper certification. As such, if an LLC treated as a disregarded entity for U.S. purposes receives a payment from a Mexican resident, the Mexican tax authorities require the LLC to obtain a certification of U.S. residency from the IRS. Mexico, like Canada, does not treat a U.S. LLC as a flowthrough entity. The Mexican tax authorities consider the LLC's income as being derived by the LLC itself, not by its single owner. Accordingly, if the LLC is unable to obtain the certificate, it cannot use reduced withholding rates under the U.S.-Mexico income tax treaty.

In ITA 200019042, the IRS Office of the Associate Chief Counsel (International) stated that although the Service does not certify that an SMLLC is a U.S. resident, it would certify that the single owner of a disregarded SMLLC is. In the IRS's view, such certification is sufficient for the treaty countries to grant treaty benefits to the LLCs. Unfortunately, this certification, by itself, will not help SMLLCs deriving income from Mexican sources to obtain treaty benefits under the U.S.-Mexico income tax treaty.

In the absence of the required certification, the LLC can possibly secure a ruling from Mexican tax authorities granting it the treaty benefits set forth in the U.S.-Mexico income tax treaty. The ruling for an LLC can be obtained by:

• Providing a copy of U.S. tax law indicating that it is treated as a flowthrough entity and that the income derived by the LLC is subject to tax in the hands of its U.S. owner; and
• Demonstrating that the income derived is subject to tax in the hands of its U.S. owner.

Accordingly, it is recommended that the members of LLCs (single-member or multiple members) seek a ruling from the Mexican tax authorities prior to the receipt of any payment from Mexico granting LLCs benefits under the treaty on the basis of the U.S. residency of the LLC owner(s).

The Philadelphia Service Center processes U.S. certification requests. LLCs should send requests to:

Internal Revenue Service
U.S. Residency Certification
DP 8121
P.O. Box 16347
Philadelphia, PA 19114-0447

LLCs can obtain more information by calling the U.S. Residency Certification Unit at (215) 516-7135. The Service Center issues Form 6166, Certification of Filing a Tax Returm, stating that the person requesting the certification is a U.S. resident. Legal entities treated as flowthrough or disregarded entities are generally unable to obtain IRS certification, because they are not subject to income tax.

From Sadia Nazir, CPA, Oak Brook, IL