For many years the Nova Scotia Unlimited Liability Company (“NSULC”) was a little used holdover from UK Company law that remained on the books for Nova Scotia. Unlike a traditional company with limited liability for shareholders, these entities exposed shareholders to liabilities for a company’s obligations, but only upon liquidation of the company. These entities were seldom used until the 1990s.
In the 1990s, legal and tax advisors assisting US companies carrying on business in Canada came to recognize the utility of the NSULC for cross border investment and tax planning. Depending on the number of shareholders of the NSULC, it is considered either a partnership (more than one shareholder) or a branch (only one shareholder) of a U.S. domestic corporation (in each case a disregarded entity for US tax purposes), but maintains its corporate status for Canadian tax purposes. This means that a NSULC will pay Canadian income tax on its income, but a US parent can claim a US foreign tax credit for these taxes. Further, as a disregarded entity, income and losses can be flowed through a NSULC to its US parent.
The Utility of the NSULC
Some of the tax advantages available utilizing a NSULC are as follows:
1. Utilization of Losses - Losses of the NSULC flow through to the U.S. shareholders. In order to protect the U.S. investor, the shares in the NSULC are usually held by an “S” corporation. To protect the benefits of the flow through treatment provided by the NSULC structure, the “S” corporation’s income and losses flow through to its shareholders.
2. Decreased Withholding Tax - Dividends paid by the NSULC to an U.S. company holding more than 10% of the NSULC’s voting shares are subject to Canadian withholding tax of 5% as opposed to 15% in the absence of the NSULC structure. In addition, Canadian income tax paid by the NSULC can be claimed as a credit against U.S. income tax incurred by the U.S. investor on its share of the NSULC’s income.
3. Liability Protection - Unlike the unlimited liability associated with a proprietorship or partnership, shareholders of a NSULC are protected from liability for the debts and activities of the company. However, shareholders are liable upon the winding up of the company or if the company becomes bankrupt. Current and past shareholders (within the previous year) are then required to contribute to the payment of the NSULC’s liabilities to the extent that they exceed the assets upon liquidation.
Since holding shares directly in a NSULC exposes the shareholder to potential liability for the company’s obligations, it is beneficial to insert an “S” corporation between the NSULC and the investor. While the “S” corporation serves as a liability shield, it will not restrict the flow–through of tax nor will it create any unanticipated Canadian withholding tax issues.
4. Foreign Tax Credit - Individual U.S. investors can claim a foreign tax credit on their individual U.S. tax return for Canadian corporate taxes paid by the NSULC, thereby avoiding double taxation. This credit flows through the “S” corporation, for example, and is not available to an individual taxpayer if a limited liability corporation is used in Canada.
5. Utilization of Excess Foreign Tax - A number of methods may be available to utilize excess foreign taxes created by a NSULC, and thereby increase the after-tax yield on Canadian income. For example, U.S. law allows excess foreign taxes to be carried back two years, and forward five years. So long as the income is in the same category, excess taxes paid in high-tax countries such as Canada may create a credit against a foreign-source income from low tax countries because the U.S. foreign tax credit is not subject to a per-country limitation.
6. Transfer Pricing – By making the Canadian subsidiary a NSULC, payments to the parent U.S. corporation are disregarded for U.S. taxation purposes. This eliminates double taxation resulting from application of the Canadian transfer pricing rules. In addition, U.S. transfer pricing rules do not apply.
7. Financing Benefits – if the Canadian subsidiary is a NSULC, it can borrow monies directly for U.S. tax purposes and the U.S. parent can deduct the interest paid. In addition, since the NSULC is not borrowing from the U.S. parent, Canadian thin-capitalization rules with respect to the deductibility of interest do not apply.
8. Resident Directors – As with other Nova Scotia companies, there is no requirement that a NSULC have directors resident in Canada or Nova Scotia. A U.S. citizen and resident may be the sole director of the NSULC.
9. Acquisition of a Canadian Corporation by a U.S. Corporation – Introducing an NSULC to this type of transaction can enable the U.S. Corporation to acquire the assets of a Canadian Target while not constituting a change in control. This is beneficial in situations for example, where a Landlord Consent Clause exists and a change in control is deemed to be an assignment of lease.
Creation of the NSULC
The creation of a new NSULC involves the filing of a memorandum of association and articles of association. Alternatively, existing Canadian operations can be continued as NSULCs. A limited liability company in another Canadian jurisdiction can be continued in Nova Scotia and then either amalgamated with a shell NSULC created for the purpose, or converted through the statutory “plan of arrangement” process. In either event, an application must be made to the Courts of Nova Scotia for approval. The Court will assess the existence or degree of prejudice to existing creditors and shareholders, but this is generally relatively routine. The choice of mechanisms is primarily dependent on the particular needs of the client.
Once created, the NSULC affords tremendous operational ease. There are no requirements that the promoters maintain any ties with the province other than the designation of a registered office and agent. The incorporating solicitor typically performs these roles for a fee. As noted, there is no residency requirement for the directors of the company, and no stipulation that the company maintains any active operations in Nova Scotia.
How We Can Help
At BOYNECLARKE we have the experience and knowledge to deal with transactions involving NSULCs. We can assist in their formation, structuring cross border transactions that involve NSULCs, and rendering opinions in transactions involving NSULCs. If you have a client that is looking to structure their affairs in such a way that makes the use of a NSULC potentially viable, then we would be happy to assist.
This information has been provided for general reference only. For advice on an actual matter, you should consult a lawyer. To contact a member of our team call us at 902-469-9500 or 1-866-339-3400 or contact us online to make an appointment.