In the context of cross-border business transactions, the term hybrid entity is often mentioned. Generally, a hybrid entity is considered, for tax purposes, as one type of entity (e.g., a corporation) in one jurisdiction while being considered another type of entity (e.g., a partnership) in another jurisdiction.
One example of a hybrid entity is an unlimited liability corporation (ULC). These are Canadian corporations that are offered in Alberta, British Columbia and Nova Scotia. Shareholders of ULCs are liable for the debts and liabilities of the company. For Canadian income tax purposes, ULCs are considered corporations and are subject to Canadian income taxation. However, for US tax purposes ULCs may be considered “flow-through entities” (i.e., the ULC is disregarded and the earnings of the ULC are flowed through to the ultimate owners of the ULC). This tax treatment may be useful since the income of the ULC may be consolidated with that of its US parent for US tax purposes. This may be more tax efficient.
Another example of a hybrid entity is a limited liability company (LLC). An LLC is a type of entity that is offered in the US, and for US tax purposes, is a flow through entity. Again, the earnings of the LLC are flowed through to the ultimate owners of the LLC for US tax purposes. On the other hand, for Canadian income tax purposes, an LLC is considered a corporation and is subject to Canadian income taxation if it carries on business in Canada. This is definitely a factor that American businesses need to consider if they want to do business in Canada through an LLC.
Hybrid entities certainly have a place in devising tax-efficient business structures, especially when Americans are considering doing business in Canada. However, there should be careful consideration of the tax consequences if these vehicles are used as tax treaties may provide for restricted benefits for these types of entities.
The author would like to thank Joe Bricker, articling student, for his assistance in preparing this legal update.
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