delaware presentation

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


Treatment of LLCs in Canada Common Uses for LLCs in Canada Access to tax treaties Comparisons to other entities


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


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


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)


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


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)


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.


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.


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.


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


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).


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.


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 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.


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.


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).


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.


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).


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.


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

[email protected]

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

delaware presentation

Documents

llc level llc

basis llc corp us corp

aba delaware llcs

us tax purposes flow

tax basis

foreign entity

rights of members

cases tax treatment