Analyzing US-Canada Trade Relations

 The sale of shares in the Target Corporation held by the US Limited Partnership results in an income or capital gain is a factual decision. An ever-changing corpus of case law governs whether a gain or loss on the disposition of property is on the income or capital accounts. Given that capital gains were not taxed before 1972, no other area of tax law has resulted in as much tax litigation in Canada. In Canada, our courts consider a number of variables when deciding whether a profit is business income or capital gain. These include: (1) the taxpayer's intention, (2) the number and frequency of transactions, (3) the transaction's relationship to the taxpayer's regular business, (4) the nature of the transaction, including the nature of the disposed asset and the method of disposition, (5) the declared objects of a corporation in the case of corporate transactions, and (6) the type of assets being disposed of. Intention, whether main or secondary, is the most important factor to examine. If the US Limited Partnership purchases Target Corporation shares with the major or secondary goal or motivation of profiting from a speedy resale of the investment, such shares are likely to be deemed income account assets. In such cases, it is critical that the US Limited Partnership does not maintain a permanent establishment in Canada to avoid paying Canadian income tax on the sale of the Target Corporation's shares.

Canadian Partnership Structure. The structure examined here is a Canadian 

Limited Partnership formed under the rules of a Canadian province, with a Canadian person as the general partner. Other limited partners who live in Canada may also be part of this structure. It is envisaged that the Canadian Limited Partnership will hold shares in the capital of the Target Corporation as venture investments but will not conduct any business other than possibly providing management services to the Target Corporation. US investors would make restricted partnership investments in the Canadian partnership. Under this arrangement, the Canadian Limited Partnership will be treated as a conduit for Canadian tax purposes. However, because it contains at least one non-resident member, the Canadian Limited Partnership is classified as a non-resident for tax purposes in Canada. This normally requires the Target Corporation to withhold tax on dividends and interest in the same way that a US Limited Partnership would. The partners would then be required to seek proper refunds based on either treaty status (for US investors) or Canadian residency status (for Canadian investors). Furthermore, the clearance certificate requirements LAWSON LUNDELL 16 that apply to the sale of taxable Canadian property (such as Target Corporation shares) will apply. The application of withholding tax on interest and dividends received by the Canadian Limited Partnership, as well as the application of clearance certificate procedures on a potential sale of the Target Corporation(s) stock by the Canadian Limited Partnership, 

frequently prompt managers to form separate partnerships

one for Canadian investors and one for US investors. This allows the specific non-resident difficulties that arise in the context of US investors having interests in a Canadian partnership to be separated from the Canadian limited partners. One of the most critical considerations for US investors in a Canadian Limited Partnership is that any activities of the general partner in Canada are assumed to be those of the limited partners. As a result, if a limited partnership conducts business in Canada through a Canadian permanent establishment, all of the partners, including any non-resident limited partners, are considered to be doing the same business in Canada through a Canadian permanent establishment. This will have major repercussions if the partnership's activities include the realization of management fee income or active trading of securities on an income basis. In such cases, US investors would be obliged to submit income tax returns for the income allotted to them by the partnership. E. Nova Scotia Unlimited Liability Company If a US resident makes a significant venture investment in a Canadian Target Corporation, it may be appropriate to structure the Canadian Target Corporation as a Nova Scotia unlimited liability company (NSULC) to benefit from the NSULC's favorable US tax results. 

Nova Scotia is a Canadian province on the east coast

An NSULC is a corporation in Canada, but can be classified as a partnership in the United States under the "check the box" laws. The primary corporate distinction between an NSULC and a typical Canadian company is that the shareholders of an NSULC bear unlimited liability for the NSULC's debts and liabilities. As a partnership for US tax purposes, the NSULC's profits and losses are directly assigned to its US stockholders. Thus, losses suffered by the NSULC would be directly deductible by US shareholders on their US income tax returns. In contrast, revenue made by the NSULC would be included in the US return, and any Canadian income taxes paid on that income would be credited against US tax. Because the NSULC is a Canadian-incorporated corporation, it is considered a Canadian resident for tax purposes. As a Canadian resident, any money earned from Canadian operations is liable to Canadian tax. In the case of a venture investment, it may be reasonable to contemplate an NSULC structure that allows US investors to deduct start-up losses from the venture against their US income without actively operating the business. An NSULC may also be advantageous for international tax credit and financing reasons, as borrowing by the NSULC may allow the US participant to deduct interest in addition to the deduction provided to the borrowing NSULC.

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