Spring 2010 issue of Horizons

Raise Your Expectations CERTIFIED PUBLIC ACCOUNTANTS AND BUSINESS CONSULTANTS

entities. A hybrid entity is an entity that is fiscally transparent in one country but not the other.

In the U.S., dividends are characterized as first paid from retained earnings and next from additional paid-in capital when retained earnings are exhausted. In contrast, Canada allows a distribution to be designated as paid from PUC, even when positive retained earnings exist. In order to get the favorable lower 5 percent dividend rate, the ULC first increases its PUC. This increase creates a deemed dividend for tax purposes. The ULC then distributes the PUC as a non-taxable transaction in Canada. The deemed dividend is likely eligible for the beneficial 5 percent dividend withholding rate under the treaty. Recent changes to the Nova Scotia Companies Act may permit these transactions for a Nova Scotia ULC with positive retained earnings. These new elements in the treaty can be quite complex to understand and even more challenging for planning purposes. What would we recommend now? If your business has a Canadian presence, or if you are considering expansion across the northern border, RubinBrown can help you create an efficient tax strategy. RubinBrown can partner with our Baker Tilly affiliates in Canada for unique, clear solutions.

For example, one common structure is for a U.S. company to form a Canadian ULC. The provinces of Nova Scotia and Alberta are common for the formation of these entities. The ULC is treated as a division of its owner and does not file a separate U.S. tax return. For Canadian purposes, the ULC is taxed as a corporation. Thus, the entity is taxed differently in each country. Under these new unfavorable provisions, a U.S. shareholder of the ULC will not be able to receive the benefits of the treaty with respect to interest on the debt, dividends or other inter-company payments. Prior to this amendment, a ULC would withhold 5 percent on dividends and 10 percent on interest payments made to its U.S. owner. Effective January 1, a ULC is required to withhold 25 percent on dividends, interest, royalties and management fees paid to its U.S. owner. One mitigating factor may be that the Canadian withholding taxes paid are eligible for a foreign tax credit in the U.S. If your U.S. company owns a ULC, RubinBrown — in partnership with our fellow Baker Tilly International independent member firms in Canada — may be able to assist you in minimizing the impact of these higher tax withholding rates. We understand that Revenue Canada did not necessarily intend these provisions to negatively impact active businesses organized as flow-through entities in the U.S., such as an S corporation that owns a ULC. Revenue Canada already has provided one helpful ruling regarding dividends paid by a ULC. In this recent ruling, Revenue Canada discussed the payment of distributions to the U.S. of Paid-Up Capital or PUC, which is similar to additional paid-in capital. ADDITIONAL ISSUES RELATED TO ULC

Questions? Contact:

Linda Paradis, CPA Partner Manufacturing & Distribution Services Group 314.290.3382 linda.paradis@rubinbrown.com

40 u spring 2010 issue