www.taxprofessionals.com - TaxProfessionals.com
Posted by The Accounting and Tax

Explanation and Interpretation of Article IV under U.S. Law

Explanation and Interpretation of Article IV under U.S. Law

4.3.1  (a) Residence of Individuals

Under U.S domestic tax law, all individuals are subject to U.S tax, unless specifically exempted.

U.S citizens are subject to U.S. tax on a worldwide basis.

An alien individual will be considered a resident of the U.S. with respect to any calendar year if one of the following three requirements is met:

  • Such individual is a lawful permanent resident of the U.S. at any time during such calendar year.
  • Such individual meets the “substantial presence test”, or
  • Such individual elects to be treated as a resident under certain special rules.

With regard to the first test, a lawful permanent resident is an individual who has been granted permanent residency status. Such an individual is commonly referred to as a “green card holder”.

Under the substantial presence test, an individual will be considered to be a U.S. resident if:

1 – Such individual was present in the U.S. on at least 31 days during the calendar year; and

2 – The aggregate number of days such individual was present in the U.S. during the current and preceding two years, applying certain multipliers to the actual days present during such years, equals or exceeds 183 days.

As a rule of thumb, spending more than 121 days a year in the U.S. may make an alien a U.S. resident under the substantial presence test.

Residence  of Companies:

Under U.S. domestic tax law, all corporations are subject to U.S. tax, unless specifically exempt.

Foreign corporations are limited to gross income derived from U.S.

A foreign company is defined as a corporation that is not domestic.

Most of the income earned by an S – Corporation is taxed at the shareholder level.

4.3.1(b)  Fiscally Transparent Entities:

S-Corporations, LLCs and grantor trusts are generally separate legal entities, but are not subject to tax at the entity level.

S –  Corporations

The income of an S-Corporation is generally taxed in the hands of its shareholders on the basis of each shareholder’s pro-rata share of the income.

Shareholders of an S-Corporation must generally be such individuals who cannot be non-resident aliens.

An S-Corporation must be a domestic corporation.

Canada recognizes an S-Corporation as resident in the U.S. for the purposes of the treaty.

LLCs

If an LLC has not made an entity classification to treat it as an association taxable as a corporation, and it has two or more members, will be treated as a partnership.

A single member LLC will be disregarded for U.S federal tax purposes and the income or loss, the assets and liabilities, and the activities of the LLC will be considered the income or loss, the assets and liabilities, and the activities of the member directly.

Grantor  Trust

A grantor of a grantor trust generally is treated as the owner of the trust to the extent of his transfer, and must report on his her return for U.S. income tax purposes, income earned with respect to that portion of the trust. In such a case, the grantor will directly include in his income those items of income, deductions, and credits that are attributable to that portion of the trust of which the grantor is treated as the owner.

4.3.1  (c) Partnerships

As a general rule, partnerships are not taxable entities under U.S. domestic tax law.

Income of a partnership is included in the income of the various partners of such partnership, and such income is taxed at the partner level.

A business entity that is not classified as a corporation under the regulations can elect its classification for federal tax purposes. An eligible entity with at least two members can elect to be classified as either an association or a partnership. Under the default classification rules, a domestic eligible entity is a partnership if it has two or more members.

The correct characterization of whether an entity or a business arrangement results in a partnership for U.S. tax purposes is important for both domestic and Treaty purposes.

Whether an entity or business arrangement is a partnership may impact whether or not a Canadian taxpayer may be deemed to have a permanent establishment in the U.S., based on the activities and facts of its U.S. “partner”, because a partnership’s permanent establishment is attributed to its partners.

4.3.1  (d) Trusts and Estates

A trust, is, for U.S. income tax purposes, classified as either “grantor trust” or a “non-grantor” trust.” A non-grantor trust or an estate is generally treated as a conduit for U.S. income tax purposes.

If a non-grantor trust or an estate receives income and retains the income, the trust or estate is taxed at graduated rates on that income, subject to certain deductions.

If the income is distributed to a beneficiary, the trust or estate includes the income in its gross income, but gets a deduction for the amount distributed, while the beneficiary is obligated to report as part of his or her gross income for U.S. income tax purposes, the amount received from the trust or the estate.

4.3.1 (  e ) Dual Resident Taxpayers

Under U.S. domestic rules, a “dual resident taxpayer” is an individual who is considered a resident of the United States pursuant to the internal laws of the U.S. and also a resident of a treaty country pursuant to the treaty partner’s internal laws.

If the alien individual claims a Treaty benefit as a non-resident of the U.S. so as to reduce the individual’s U.S. income tax liability with respect to any item of income covered by the Treaty during a taxable year in which the individual was considered a dual resident taxpayer, then that individual shall be treated as a non-resident alien of the U.S. for purposes of computing that individual’s U.S. income tax liability under the provisions of the Code for that portion of the taxable year the individual was considered a dual resident taxpayer.

It possible for a corporation that is incorporated under the laws of a country other than the U.S., to “domesticate” into the U.S. under certain domestication statues present in certain states. In such a case, the “domesticated” entity will be treated, under domestic U.S. tax laws, as a domestic corporation. The concept of domestication is similar of corporate continuance in Canada.

References:

Advisor’s Guide to Canada – U.S. Tax Treaty

By:  Vitaly Timokhov, Raymond Montero, David Kerzner

Published by: Thomson Carswell

The Accounting and Tax
Contact Member