US S Corporations

Article XXIX (Miscellaneous Rules) Paragraph 5 of the Canada-US Treaty discusses the special situation of S Corporations.  

Canadian resident shareholders of US S Corporations do not have the option of the new flow-through rules the same as US resident shareholders of those same corporations.  However, they do have the option of applying to the Competent Authority of Canada to have their income to be taxed similar to the US rules to eliminate the timing rules.  Basically what the rules will do is as follows.

- the S Corporation will be a considered controlled foreign affiliate

- all income will be foreign accrual property income (FAPI)

- the separate deduction from income for foreign property taxes paid will not be permitted (they will calculated under the FAPI rules instead of separately)

- dividends will be excluded from income and adjusted to the cost base of the shares

In many cases, it is a good idea to take this option.  But, you need to look at this option carefully before jumping in with both feet.  

There can be some unintended consequences such as the designation that "all income" will be FAPI.  Normally in Canada you pay taxes on ½ of the capital gain but if you select this option, 100% of the gain will be taxed.  (I'll write more about FAPI in another post).

Taking advantage of the special treaty rules for an S Corporation can be beneficial but be sure to look at the whole situation before making a final decision.  You may want to think about long term decisions and apply for the special designation only for those years where you are fairly sure of your type of income.