Selling a US Subsidiary or LLC From Canada: Tax and Withholding

Am I selling shares, a partnership interest or LLC assets?

Your US tax classification, not the LLC's legal name, decides what you are selling. A single-member LLC with no corporate election is "disregarded": the US treats it as part of its owner.

The defaults come from the IRS LLC classification rules. An entity classification election on Form 8832, signed by each member or an authorized officer, manager or member, changes them; it generally cannot take effect more than 75 days before filing or 12 months after (late election relief). If a buyer purchases only part of a single-member LLC, the LLC becomes a partnership: you are treated as selling that share of each asset to the buyer, and you and the buyer then contribute the assets to a new partnership (Revenue Ruling 99-5).

Canada generally treats a US LLC as a corporation regardless of its US treatment (CRA guidance, paragraph 88). Selling your LLC interest can therefore be a Canadian share sale and a US asset or partnership-interest sale. Annual filings for an LLC you already own are in Canadian owner of a US LLC; a partner's reporting is in Canadian partner in a US LLC. If the buyer wants a US subsidiary's assets instead of its shares, the subsidiary generally pays US tax on the gain and the share-sale results below do not apply.

Does the US tax a Canadian seller, and when does the treaty help?

A qualifying Canadian treaty resident's gain on ordinary US corporate shares is generally taxable only in Canada. US real property interests and the business property of a US permanent establishment, including one the seller had in the previous 12 months, are exceptions under Article XIII. The US may also tax an individual who was a US resident for at least 120 months in a 20-year period, including some time in the previous 10 years, on property owned when that residence ended, unless the individual was treated as having sold it on leaving (Article XIII(5)).

Shares can themselves be US real property interests when the company is a US real property holding corporation. That test looks back over the shorter of the seller's holding period or five years, so today's balance sheet alone may not settle it (IRS FIRPTA rules).

A single-member LLC the US ignores. The US treats you as selling the LLC's assets. If they were used in a US trade or business, the gain is generally effectively connected income, taxed at the 21% corporate rate on Form 1120-F (an individual files Form 1040-NR). The treaty can remove US tax on gain other than US real property where there was no US permanent establishment, but a corporation that ran a US business through the LLC still files Form 1120-F (Form 1120-F instructions).

For a partnership-taxed LLC, section 864(c)(8) looks through the interest to a hypothetical sale of partnership assets. Gain can be effectively connected with a US business, meaning the US taxes it as business income; with no US trade or business, the look-through finds none. The regulation's treaty rule preserves tax on gains attributable to US permanent-establishment assets or US real property and excludes qualifying treaty-exempt amounts.

An LLC treaty claim needs review. The regulation's worked treaty example assumes the partnership is fiscally transparent under the treaty country's law. Canada instead treats a US LLC as a corporation, and Article IV(7)(a) can deny treaty treatment to amounts the US sees as derived through an entity Canada does not treat as transparent. Whether a Canadian seller can treat the gain as treaty-exempt is fact-dependent and open to challenge, so the position needs documenting before certifying treaty exemption. A Canadian corporation must also meet the treaty's limitation-on-benefits rules, which test who really owns it.

The treaty covers US federal tax only, so a federal exemption does not settle state tax (Article II).

Will the buyer withhold under FIRPTA or section 1446(f)?

On ordinary shares, usually not. On shares that are US real property interests, FIRPTA generally requires 15% of the amount realized (everything the seller receives or is relieved of); on a partnership-taxed LLC interest, section 1446(f) generally requires 10% of it. Withholding is a payment toward US tax, not the final tax on the gain.

Sources: Publication 515, FIRPTA withholding and partnership withholding. Contingent payments for transferred intellectual property or goodwill have separate withholding treatment, so the ordinary-share result does not carry over to an asset-sale earnout.

The amount realized includes cash payable later, buyer shares, assumed debt and, for a partnership interest, the reduction in the seller's share of partnership liabilities (section 1.1446(f)-2(c)). If the buyer cannot confirm that share of debt, or 10% of the amount realized would exceed the cash and other consideration, the buyer must withhold all of that cash and other consideration. A real-estate-heavy partnership can also fall under FIRPTA; the Form 8288 instructions give coordination rules, so the two rates are not simply added.

What should I give the buyer before closing?

Exemption and reduction documents generally have to reach the buyer before it must withhold. A routine W-8 form documenting foreign status does not, by itself, remove FIRPTA or partnership-transfer withholding.

Maximum-liability certifications go to the buyer, not to the IRS for approval; FIRPTA withholding certificates require IRS action (Form 8288 instructions).

The IRS generally acts on a complete FIRPTA application within 90 days, including all parties' taxpayer identification numbers (withholding certificate guidance), so timing is usually a point to settle while the agreement is being negotiated. An application submitted by the transfer date, with the seller's written notice to the buyer on the day of or the day before, can postpone remittance while the IRS decides, but the buyer must still withhold at closing; remittance is generally due within 20 days after the decision is mailed.

Will I receive Form 1042-S, and which US return claims a refund?

Usually not for a private sale. A sale subject to FIRPTA or section 1446(f) produces Form 8288-A, which the IRS stamps and sends to the seller. Form 1042-S (income code 57 reports the amount realized) is the broker's form for publicly traded partnership interests (Form 1042-S instructions; see US partnership units and withholding for Canadians).

Withholding does not replace the seller's return. A foreign corporation files Form 1120-F if it was engaged in a US trade or business, even when a treaty exempts the income, or had US-source income that withholding did not fully tax; it is due by the 15th day of the sixth month after year-end with no US office and the 15th day of the fourth month after year-end with one. A nonresident individual with no wages subject to US withholding files Form 1040-NR by June 15 for a calendar year. The IRS issues the stamped Form 8288-A only once it has the seller's US tax number, so the name and number on the withholding documents need to match.

A Form 1120-F filed more than 18 months after its due date generally forfeits deductions and credits against effectively connected income (Form 1120-F instructions), so a corporation relying on a treaty position may file a protective Form 1120-F (see Canadian corporation US tax return). Effectively connected gain can bring US branch profits tax, which the treaty can reduce (see Canadian business expanding into the US).

The LLC's operating-income withholding under Forms 8804 and 8805 is separate: see foreign partners and partnership withholding.

How does Canada tax my company's sale of US subsidiary shares?

A Canadian corporation selling US subsidiary shares held as capital property generally computes a capital gain from proceeds less adjusted cost base (your cost for tax purposes) and selling costs. The general taxable inclusion is 50% of the capital gain, before applicable adjustments (sections 40 and 38).

If the subsidiary is a foreign affiliate (a non-resident corporation in which you hold at least 1% and, with related persons, at least 10%), a section 93 election can treat a designated amount, limited to the otherwise determined gain, as a dividend immediately before the sale. That amount is removed from sale proceeds. Canada treats a US LLC as a corporation, so the same election can apply to an LLC interest. It does not make every sale exempt. A capital loss on the shares can be reduced by exempt dividends received on them before the sale (subsection 93(2.01)).

The deemed dividend's treatment depends on the affiliate's surplus accounts. Section 113 allows a deduction for the portion prescribed to come from exempt surplus, which is why the election can matter; other surplus categories have different rules. Qualifying active-business earnings in a treaty country can contribute to exempt surplus, but bank cash, accounting retained earnings and sale value do not establish the balance (Regulation 5907). For a direct sale, the Canadian corporation makes the election by filing the prescribed form by its return filing deadline for the sale year (Regulation 5902(5)). A late election is accepted within 3 years after that day if the corporation pays an estimate of the penalty (subsection 93(5)). The surplus records need reconstructing before choosing the elected amount.

The ordinary foreign tax credit does not apply to a foreign-affiliate dividend: corporate relief for that income runs through provisions such as section 113. For a corporation, section 126(1)(a) also excludes foreign tax paid in respect of income from shares of a foreign affiliate, and the CRA folio paragraphs cited here do not say whether that reaches US tax on a gain from selling the shares, so a credit for that tax is not assured (CRA folio, paragraphs 1.28 and 1.50). See claiming US tax on your corporate return.

A foreign affiliate held at any time in the sale year also goes on that year's Form T1134, due 10 months after the year-end (section 233.4; foreign property and affiliate reporting).

How does Canada tax an individual selling US shares or an LLC interest?

A Canadian-resident individual generally reports a capital gain when US shares or an LLC interest held as capital property are sold; the section 93 election is available only to a corporation resident in Canada. Proceeds and cost are each converted to Canadian dollars at their own transaction-date rates (CRA capital gains guide; more in foreign income on a Canadian return). The general taxable inclusion is 50% (section 38).

If you became a Canadian resident after buying, your Canadian cost is generally the market value on the day you became resident, not what you paid (section 128.1(1)). The US calculation still starts from your original cost, so the two gains can differ widely.

The lifetime capital gains exemption is usually unavailable because US corporation or LLC interests generally are not qualified small business corporation shares, which need Canadian-controlled private corporation status (section 110.6). For founder shares and the US section 1202 question, see Canadian founder selling US startup shares.

Can deferred payments put the US and Canadian tax in different years?

Yes. Each country applies its own timing rules, and a foreign tax credit does not automatically bridge the difference.

The US rules are in Publication 537. Each country's ordinary installment and reserve rules are in selling your business in the US and selling your business in Canada. The CRA's archived earnout guidance describes a conditional cost-recovery approach for share sales; confirm its application to the agreement before relying on it.

Canada's foreign tax credit uses the final qualifying US tax for the year to which the US liability relates, even if paid later; refundable withholding is excluded. Article XXIV treats gains the treaty lets the US tax (other than former-resident gains) as arising in the US, which supports a credit. Where it qualifies, tax on a Canadian capital gain is generally non-business-income tax, and unused non-business credits cannot carry to another year, so US tax paid in a year with no matching Canadian gain can go unused (CRA folio, paragraphs 1.24, 1.32–1.34 and 1.89).

A later US payment may support an adjustment to the corresponding Canadian return; it does not automatically create a credit in the payment year.

Is cash plus rollover equity tax-deferred?

Receiving buyer shares does not establish a rollover in either country. The issuer, the shares exchanged, the cash and the legal steps decide it, whatever the letter of intent calls the equity.

Canada's section 85.1(5) foreign-share exchange rule covers only a non-resident corporation issuing its own shares for the seller's shares of another non-resident corporation, and it applies unless the seller includes some of the gain or loss in its return for that year. Under subsection (6) it does not apply at all if the seller also receives anything other than those shares, such as cash, for the exchanged shares, or if the parties are not at arm's length or the seller, with related persons, ends up controlling the buyer or holding more than half its value. Cash paid for a separate block of shares can be analyzed on its own.

US nonrecognition requires an applicable US provision too, and partial nonrecognition may require a withholding reduction rather than a full exception (Form 8288 instructions). The treaty also permits competent-authority deferral for some reorganizations, but only by agreement (Article XIII(8)).

What if the buyer withheld the wrong amount or nothing?

The seller still must determine and report taxable US gain. Missing buyer withholding does not remove that liability; excessive withholding is reconciled against final tax through the seller's US return.

The buyer can be liable for required withholding, interest and penalties, and responsible persons, such as a corporate buyer's officers, can be penalized personally under section 6672 for the amount that should have been withheld (Form 8288 instructions). For a private partnership-interest transfer, the LLC can also be required to withhold from later distributions to the buyer to collect the shortfall plus interest (Form 8288 instructions). The closing statement, remittance evidence and withholding forms show what was actually paid; money held in escrow is not proof that the IRS received it. Inconsistent seller details or amounts are corrected with the buyer, and any refund is reconciled with the Canadian foreign tax credit.

What should I gather before signing or closing?

Missing elections, debt balances or surplus records can change the closing cash and the available relief.

• Ownership chart, LLC agreement, entity elections, recent US returns, balance sheet, tax bases, real property list, liability allocation, and for an asset sale the price allocation.
• Canadian share-cost records, exchange rates, foreign affiliate filings and surplus schedules.
• Letter of intent and purchase agreement: cash, debt relief, buyer equity, earnouts, payment dates and withholding clauses.
• Seller and buyer US tax numbers (an EIN for a company, an ITIN for an individual who needs one) and any certificates.

Example

Illustrative only. All amounts are US dollars; no final income tax is calculated.

A Canadian corporation sells its interest in a partnership-taxed US LLC for US$1,000,000 cash and is relieved of US$200,000 of partnership liabilities. Assume the sale triggers section 1446(f), no exception or reduction applies, and FIRPTA does not apply.

The amount realized is US$1,200,000. The buyer withholds 10%, or US$120,000, leaving US$880,000 of closing cash before other costs. The withholding is not calculated on the seller's profit.

The corporation computes its US taxable gain separately and reconciles the US$120,000 on Form 1120-F. Canada treats the LLC interest as a corporate interest and requires its own Canadian-dollar calculation; any foreign affiliate election and foreign tax relief need separate analysis.

Different for you?

• Corporate seller, LLC mismatch, uncertain treaty claim, closing soon, cash plus buyer shares, deferred proceeds or incorrect withholding: bring the records above, the agreement and remittance records to a cross-border tax review.
• Individual founder selling US corporate shares: see Canadian founder selling US startup shares.
• Selling a Canadian corporation's shares or assets: see selling your business in Canada.
• Keeping, paying out or winding up a company when you move: see moving across the border with a company.
• Selling personally owned US real estate: see Canadians selling US real estate.
• Canadian corporation owns US real estate directly: see Canadian corporation owning US real estate.
• US citizen or green card holder living in Canada: see Americans living in Canada.
• A Canadian corporation that never filed Form 1120-F or Form T1134 for earlier years: see missed US returns for a Canadian corporation and missed T1134 for a US company.