ULCs: From Disregarded To Denied

Canada’s Phase 2 hybrid mismatch rules — Here is what to do before July 1, 2026.

Starting July 1, 2026, the Phase 2 amendments to Canada’s hybrid mismatch arrangement rules in s. 18.4 of the Income Tax Act (the “HMA Rules”) will deny deductions on a far broader set of payments than Phase 1 reached. If your structure includes a Canadian unlimited liability company (“ULC”) or a partnership that is treated as a corporation for US tax purposes, deductions in the structure may be denied. In the case of denied interest deductions, the interest will also be subject to Canadian withholding tax at 25% (subject to potential treaty relief).

Phase 2 targets entity-level hybridity, most commonly a corporation for Canadian tax purposes that is fiscally transparent for foreign tax purposes (a hybrid), such as a Canadian ULC with U.S. tax residents in the ownership chain, or a partnership that is fiscally transparent for Canadian tax purposes and a corporation for foreign tax purposes (a reverse