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2011 Spring MeetingSection of International Law, ABA
Delaware LLCs: Do They Have a Future in US Outbound Investment?
WASHINGTON, DC – April 5, 2011
Co-Chairs
Elinore J. Richardson Sonia Velasco Menal
Speakers
Sam Kaywood Juan Carlos Guerrero
Patrick Marley Andrea Bazzo
Overview
Elinore J. Richardson
3
Growth of US LLCs as US outbound investment vehicles
Issues from the perspective of foreign jurisdictions
Focus of recent initiatives by foreign jurisdictions both
domestically and in treaty negotiations on “hybrid” entities.
Should the US LLC as an outbound investment entity for use by US
(or foreign) investors be categorised as an endangered species?
Overview
U.S. LLC: U.S. Overview
Sam Kaywood
DELAWARE LLCsFormation
Simple to Form
File Certificate of Formation with Delaware Secretary of State
Contains basic information (e.g., name of entity, registered
address and any other information desired)
Certificate of Formation is publicly available
No requirement to file governing documents or financial
statements
Other types of entities (including a corporation, partnership or
trust) may convert into an LLC at any time
A Delaware LLC can convert to another type of entity
A Delaware LLC may transfer to or continue in a foreign
jurisdiction
The LLC may elect to keep its existence as an LLC in
Delaware
A foreign entity may become domesticated as a Delaware LLC
All of these can be done by filing relatively simple certificates
with the Delaware Secretary of State
DELAWARE LLCs Conversion, Transfer, etc.
DELAWARE LLCs Management
An LLC can be managed by its members or by one or more
managers
Voting rights of members usually covered in Operating Agreement
signed by members
An LLC can be managed by traditional officers, e.g., President,
Treasurer, etc., as set forth in Operating Agreement
An LLC can have a Board of Directors, again, as set forth in an
Operating Agreement
Operating Agreement is not made public
Other Matters Covered in Operating Agreement
Buy/Sell arrangements, rights of first refusal, etc.
Capital contributions and capital accounts
Distributions, allocation of income, loss, deduction, etc.
Liquidation, termination, etc.
Operating Agreements can be short and simple where there is one
member, but are more elaborate where there are two or more
members
US Tax Issues
Single member LLC disregarded for US tax purposes
An LLC with two or more members is treated as a partnership for
US tax purposes
Flow-through treatment: income, deductions, loss, etc., pass
through to the partners
An LLC may elect to be treated as a corporation for US tax
purposes
Can make retroactive election for up to 75 days – longer in
some cases
Tax Treatment of LLCs vs. Corporations
Income, loss, deductions and credits flow-through
No tax at LLC level LLC files a Partnership Return
(Form 1065) Members increase their tax basis for
their share of income and decrease for losses
Distributions are not taxable, but reduce basis
LLC
IndividualMembers
US Corp taxed at Federal rate of 35% (plus state)
Subsequent dividends also taxed currently at 15% (likely to increase)
Sale of shares taxable at capital gains rates (currently 15%)
No basis increase for income of US Corp
LLC
IndividualShareholders
US Corp
US Corp
Double TaxationSingle Taxation
US Individual
Flow-through of all income, deduction, loss, etc. of foreign business
Federal tax of up to 35%
Flow-through of foreign tax credits
No additional taxes upon distribution from LLC
US Corp
Same as above except:
Shareholders of US Corp are taxed again on dividends and capital gains
USLLC
USBusiness
USIndividual
USCorp
USCorp
Use of LLCs for Joint Ventures
Foreign Limited Liability Companies
Under the default rules, the foreign LLC
is treated as a corporation for US tax
purposes
Foreign LLC can elect to be treated as
a disregarded entity (or a partnership if
two or more members) for US tax
purposes
US CoUS Co
ForeignLLC
ForeignLLC
LLCs With A Foreign Business
US member taxed on its share of
income from foreign business
Foreign member not taxed in the US on
foreign income
No US trade or business
Distributions are tax-free to US
members – they have already been
taxed
USLLC
ForeignBusiness
ForeignUS
LLCs With All Foreign Members
Foreign members not taxed in the US
on foreign income
No US trade or business
US LLC still a US partnership and files
an information return (Form 1065)
Used to avail of favorable Delaware
laws, governance, etc without US tax
USLLC
ForeignBusiness
ForeignForeign
Delaware LLC: U.S. Outbound Investment in Brazil
Andrea Bazzo Lauletta
INTRODUCTION
Brazilian Scenario for Non-Resident Investments Brazil has a specific set of rules for non-resident investments in the
country in the Brazilian capital and financial markets as well as private equity and direct investments
Foreign exchange mechanismsRegulatory requirements for registration of the investmentsTax specific rules
Tax Rules As a rule, Brazil imposes taxes on investments made by non-
residents in respect to: (i) income assessed locally and/or paid by Brazilian source and (ii) capital gains assessed on disposal of assets located in Brazil
Beneficial tax treatment (exemptions or lower rates) may be granted in some circumstances, which does not apply to investors located in favorable tax jurisdictions (“FTJ”), but may apply to privileged tax regimes (“PTR”)
DELAWARE LLC
Delaware LLC as Vehicle of Investment
Historically, Delaware LLC is commonly used as the vehicle for
investments in Brazil, specially for investments in the Brazilian
financial and capital markets (which includes transactions in stock,
future and commodities exchanges, over-the-counter, investments
funds, public bonds, derivatives, among others)
As a rule, Delaware LLC is well accepted and known type of vehicle
DELAWARE LLC
General Rules in Brazil for Delaware LLC
Brazil does not provide specific rules dealing with entities located
abroad and their corporate status
There is no rule expressly treating differently a vehicle because of
its type, corporate status or legal nature or imposing a transparent
regime or a “disregarded” status for foreign entities
DELAWARE LLC
General Rules in Brazil for Delaware LLC
However, it is common sense and preferential to use vehicles for
investments in Brazil that have legal personality and are treated as
corporations/companies instead of vehicles incorporated only based
on contractual arrangements. The fact that such vehicles have a
transparency regime for tax purposes should not impact or change
the view of having an investment made by a foreign company
This approach minimizes tax and regulatory potential
questionings by authorities
Delaware LLC fits this approach as it is treated in the U.S. as a
separate entity with legal personality, despite of the tax regime
it adopts in the U.S.
DELAWARE LLC
Tax Rules in Brazil for Delaware LLC
Brazil has not signed a tax treaty with the U.S. As a consequence,
there is no specific rule or agreement between the countries in
respect to LLC
Tax authorities have not listed Delaware LLC as FTJ
Tax authorities have listed Delaware LLC as PTR
Corporate entities incorporated as a State LLC held by non-
residents and not subject to federal income tax in the United
States of America
DELAWARE LLC
Tax Rules in Brazil for Delaware LLC Legal concept of FTJ: countries or dependencies which do not tax or imposes
income tax at a maximum rate lower than 20% Delaware LLC is incorporated in a country highly taxed Specific tax regimes are special rules for the tax imposed in the country
Legal concept of PTR: (i) no income tax income or income tax at a maximum rate lower than 20%; (ii) tax benefits to non-resident: a) without substantial economic activity carried out locally; b) contingent upon no substantial economic activity being carried out locally; (iii) no income tax or income tax at a maximum rate lower than 20% for income assessed outside its territory; (iv) not providing access to information related to shareholding composition, ownership of goods or rights or the economic transactions carried out
In fact, there might have some discussions on some characteristics of PTR in respect to Delaware LLC
DELAWARE LLC
What Are the Problems to be PTR?
As a rule, there is no major tax impact for the most investments
carried out in Brazil by a Delaware LLC
Delaware LLC as a PTR have the down side of certain disadvantaged
tax rules in respect to:
Transfer pricing
Thin capitalization
Restricted rules for deduction of payments made abroad
DELAWARE LLC
Example of Tax Benefit in Use of Delaware LLC
Exemption of income tax on capital gains on disposal of shares in the stock
exchange, provided that the acquisition of the shares were made as a
portfolio investment (Resolution No. 2,689)
Delaware LLC
Public traded corporation
Delaware LLC FTJ Investor
Dividends: no income tax
Dividends: no
income tax
Capital gain on sale on exchange: 0%
Capital gain on sale on exchange: 15%
Capital gain on sale as private sale or IPO: 15%
Capital gain on sale as private sale or IPO: 25%
DELAWARE LLC
Example of Tax Benefit in Use of Delaware LLC
Exemption of income tax for investments in private equity funds (“FIP”),
provided that the investor does not hold more that 40% of the FIP or receives
more than 40% of the income from the FIP
Delaware LLC (<40%) FTJ Investor
Distribution form the FIP: 0%
Distribution form the FIP: 15%
Capital gain on sale of FIP on exchange: 0%
Capital gain on sale of FIP on exchange: 15%
Capital gain on sale of FIP on private sale or
liquidation: 0%
Capital gain on sale of FIP on private sale or
liquidation: 15%
FIP
Target BrazilianCompany
Delaware LLC 1
Delaware LLC 2
Delaware LLC 3
DELAWARE LLC
Conclusions Currently, Delaware LLC is still an attractive tax alternative vehicle
for investments in the Brazilian capital and financial markets as well as private equity and direct investments
The main current tax benefits applicable to investments held in Brazil are still valid for an investor through Delaware LLC
Although listed as PTR, the use of Delaware LLC for investment purposes does not generate major tax disadvantages
Legislation may change to limit the application of certain beneficial tax rules
Brazil and U.S. Tax Treaty under discussion may have specific considerations for LLC
Potential future discussions on substance over form on use of LLC Some investors are considering the use or using other jurisdictions
as alternatives: Luxembourg, Netherlands, UK
Patrick Marley
US LLCs: Canada’s Perspective
US LLCs: Canada’s Perspective
Treatment of LLCs in Canada Common Uses for LLCs in Canada Access to tax treaties Comparisons to other entities
US LLCs: Canada’s Perspective
Canada Revenue Agency generally treats US LLCs as corporations for Canadian tax purposes.
Limited case law Legal test is to characterize LLC based on a preponderance of
its characteristics – is it more like a Canadian corporation or partnership? See UK Swift case
US LLCs: Canada’s Perspective
Common Uses for LLCs in Canada Hybrid entity (treated as corporation in Canada,
disregarded or partnership in US) Foreign tax credit planning for Canadian investments Loans to US corporations (led to IRC 894(c))
More flexible rules for distributions (such as return of capital v. dividend) for US inbound investment
US LLCs: Canada’s Perspective
Availability of tax treaty benefits CRA’s historic position was no treaty benefits for LLCs,
regardless of whether income of LLC was taxed in the US. Contrary to CRA’s position on partnerships (generally look
through to members to determine treaty benefits) or S-corporations (generally eligible for treaty benefits)
US LLCs: Canada’s Perspective
Availability of tax treaty benefits Article IV(6) of Canada-US Treaty
Intended to reverse prior CRA position, look-through LLC to determine whether member eligible for tax treaty benefits.
CRA’s historic position successfully challenged in TD Securities LLC treated as US resident, eligible itself for tax treaty
benefits.
TD Securities (USA)
TD Bank Canadian
TreatyResident
TD USA U.S. Treaty
Resident
BranchProfits
Tax Rate5% or 25%
Canada
Securities LLC U.S. Treaty Resident?
Consolidated Group ForU.S. Federal Income Tax Purposes
United States
Holding s II U.S. Treaty
Resident
US LLCs: Canada’s Perspective
TD Securities Interpreted Canada-US treaty (prior to Article IV(6)) Held liable to tax based in part on OECD Commentary,
1999 OECD Partnership Report, having regard to text, context and purpose of treaty provisions.
Court sought consistency with treatment of other entities (such as partnerships, S-corps)
US LLCs: Canada’s Perspective
Interaction of TD Securities and Article IV(6) CRA did not appeal TD Securities, but disagrees with the
result. CRA considers LLCs to not be resident for tax treaty
purposes (Article IV(6) looks through LLC to determine whether member gets benefits).
Continued inconsistent treatment between LLCs,
partnerships and S-corps.
US LLCs: Canada’s Perspective
Article IV(7) of Canada-US Treaty Denies treaty benefits to certain hybrid entities Canadian ULCs and most US LLCs are treated as
corporations in Canada – eligible for “check the box” in the US.
Most payments by hybrid Canadian ULC to US are denied treaty benefits.
US LLCs: Canada’s Perspective
Article IV(7) Work Around for ULC Dividends Step 1 – ULC increases its capital causing deemed dividend
in Canada. Step 2 – ULC makes a distribution as a return of the capital
increased in Step 1. Article IV(7) not applicable since Step 1 ignored in US. CRA’s view is that this solution does not apply where ULC
held by US LLC.
US LLCs: Canada’s Perspective
CRA’s current approach to Article IV(6) and LLCs likely to be litigated. Does not take into account context and purpose of treaty
provisions. Could lead to anomalous results:
5% withholding on ULC distribution to S-corp. 15% withholding on ULC distribution to partnership held
by US individuals. 25% withholding on ULC distribution to LLC held by US
individuals.
Disregarded payment to LLC: CRA View #2009-0345351C6
• CRA: “better view” is that Art. IV(6)(a) is not satisfied (payment by ULC is disregarded in US, so not derived by US resident through LLC for US tax purposes)LLC
US Resident
ULC
Distribution
100%
US
Canada
US LLCs: Canada’s Perspective
Branch Profits Issue – US LLC wanting to commence business in Canada. CRA’s view is that 25% withholding tax on branch profits if
LLC held by US individuals. Contrast to 5% withholding on branch profits of US S-corp. May not be suitable alternative (potential issues with LLC
forming a US corporation or Canadian corporation, likely not practical to reorganize LLC into a partnership).
US LLCs: Canada’s Perspective
LLCs investing in Canada: Should get treaty benefits if all members of LLC are US
treaty residents. Treaty benefits denied under Article IV(6) to the extent
members of LLC are resident in other countries. May be preference to use partnership or S-Corp for
Canadian investments to avoid anomalous CRA positions.
U.S. LLC: Outbound Investment in Mexico
Juan Carlos Guerrero
US LLCs: Mexico’s Perspective
Vehicles created abroad are afforded different tax regimes based on their legal nature: Foreign “Entities” are defined as corporations and other
vehicles that have separate legal personality from its shareholders or members.
Foreign “Legal Figures” are defined as partnerships, trusts, investment funds and any other similar figures that lack legal personality.
US LLCs: Mexico’s Perspective
Mexican Income Tax Law does not grant a “disregarded” status to any type of corporations (domestic or foreign)
This is true even in the case of CFC rules applicable to Mexican residents
Net profit must be determined based on tax regime applicable to Mexican corporations
Resulting net income taxed in the hands of the shareholders.
US LLCs: Mexico’s Perspective
US LLCs were difficult to decipher because they have separate legal personality, but their income is commonly taxed in the US in the hands of its members
It was not clear under the US–Mexico Treaty whether or not treaty benefits are applicable to US LLCs. Protocol 2(b) addressed the case of US Partnerships, Trusts and
Estates, but does not specifically address LLCs. US Partnerships, Estates and Trusts are considered US residents
for Treaty purposes to the extent that income is subject to tax in the US as income of a US resident person, either in the hands of the vehicle or in the hands of its members.
US LLCs: Mexico’s Perspective
Mexico and US signed a Mutual Agreement on August 2005.
The conclusions were not clear, so it was replaced by a new MA signed on December 2005.
US LLCs: Mexico’s Perspective
Second MA makes it clear that: Mexico will consider a US LLC as a US tax resident
for Treaty purposes in proportion to the amount of its income that is taxed in the US as income of a US resident.
Same regime applicable to non-US LLCs that have US resident members, provided that such jurisdiction has a TIEA with Mexico.
However, Mexico will continue to regard the LLC as a separate legal person (e.g: capital gains exemption on interest < 25% determined at LLC level).
US LLCs: Mexico’s Perspective
This means that any income obtained by a US LLC that is not taxed in the US as income of a resident will never have access to treaty benefits, even if members are resident of a treaty jurisdiction.
Even worse, income of a US LLC that is allocated to non-US members could be subject to a punitive 40% withholding tax rate if the Mexican payor is a related party of the US LLC.
US LLCs: Mexico’s Perspective
Conclusions: US LLC is a good option to invest in Mexico if
members are US residents. Not a good idea when members include non-US
residents that could otherwise have access to treaty benefits.
Terrible idea when the members include Mexican resident individuals (may lead to double taxation on dividends).
Terrible idea when members include non-US residents and the LLC is a related party to Mexican payor (40% withholding tax may apply).
US LLCs: Mexico’s Perspective
Conclusions: When pass-through status/treaty benefits desired for
all participants, a “legal figure” should be used instead.
Administrative rule grants automatic pass-through status to “legal figures” established in TIEA jurisdictions.
Also, “legal figures” established in non-TIEA jurisdictions can obtain pass through status by applying for a private ruling.
US LLCs: Mexico’s Perspective
Conclusions: US LLCs are still attractive for some Mexican
residents doing business in the US. Not attractive for wealth planning structures
Complexity of reporting requirements (FBARs) Exposure to US Estate Tax
US LLC: Spanish perspective and other UE countries
Sonia Velasco
5252
Characterization of U.S. LLCs by Spain - Competent Authority Mutual Agreement - Spain–U.S. Treaty
The Competent Authority Mutual Agreement entered into force January 1st, 1998 but signed in 2006
Clarifies treatment of LLCs, S corps, and other entities, organized within or without the US, treated as partnerships or disregarded entities for U.S. tax purposes
Income will be treated as derived by a resident of the US to the extent that income received by the LLC or other entity is subject to U.S. tax as the income of a U.S. resident
5353
Characterization of U.S. LLCs by Spain - Domestic Characterization
Inconsistent opinion of the Spanish tax authorities Entities incorporated abroad the legal nature of which is
identical or analogous to a Spanish transparent entity will be treated as look-through entities
Ruling V0997-05 (June 2, 2009) does not analyze the legal/tax nature of the LLC but qualifies it as a transparent entity
Ruling V2097-09 (September 21, 2009) treats the LLC as not tax transparent
US LP is clearly fiscally transparent (need to analyze the tax residency of partners)
54
Characterization of U.S. LLCs by Germany - Article 1(7) Germany–U.S. Treaty
An item of income, profit or gain derived by or through a person that is fiscally transparent under the laws of either Contracting State, will be considered to be derived by a resident of a State to the extent that the item is treated for the purposes of the taxation laws of that State as the income, profit or gain of a resident
55
Characterization of U.S. LLCs by Germany - Federal Finance Ministry CircularIssued March 19, 2004
Affirmed by German Supreme Tax Court, decision dated August 20, 2008 docket # I R 34/08)
Criteria that qualify an LLC as a corporation Centralised management (as opposed to management and representation
by partners) Limitation of liability Transfer of LLC interest without consent requirements Profit distribution requires a resolution before owners have a claim Contribution of capital required Unlimited lifetime of the company (irrespective of whether a partner
dies/retires) Profit distribution is proportional to the nominal share capital Registration of LLC as a formal requirement for formation
There is no “beat all” criterion (all facts and circumstances have to be considered)
An LLC is deemed to be a corporation if a majority of the first five criteria are met
56
Use of an Intermediary Jurisdiction between the US LLC and the Jurisdiction of Investment- Equity
SPAIN BRAZIL CANADA MEXICO
DIVIDEND
DIVIDEND
DIVIDEND
USinvestor
Foreigninvestor
DELAWARELLC
DELAWARELLC
LUXLLC
LUXLLC
57
Use of an Intermediary Jurisdiction between the US LLC and the Jurisdiction of Investment- Debt Financing
US CO.US CO.
USLLC
USLLC
FOREIGN ENTITY
FOREIGNOP CO
LOAN
LOAN
LOAN
Foreign entity could be a corporation or a pass through.
58
Thank You!
Elinore J. Richardson Toronto, Ontario, Canada +1 416 859 8631 [email protected]
Sonia Velasco Menal Cuatrecasas, Goncalves Pereira Spain +34 93 2905590
Juan Carlos Guerrero Chavez, Ruiz, Zamarripa Mexico +1 212. 223. [email protected]
Patrick Marley Osler Canada +1 416.862.6580 [email protected]
Andrea Bazzo Mattos Filho Veiga Filho Marrey Jr. e Quiroga Advogados Brazil +55 (11) 3147 7600 / 7799 [email protected]
Sam Kaywood Alston & Bird LLP US +1 404 881 7000 [email protected]
#4299075.v5