3 January 2001 Internal T.I. 2000-0024247 - Section 6.2 of Income Tax Convention

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues: Would section 6.3 of the Income Tax Convention Interpretation Act apply to deem the gain on the disposition of the shares of a Canadian private corporation by a resident of New Zealand to arise in Canada

Position: Yes

Reasons: Interpretation of the law including section 6.3 of the Income Tax Convention Interpretation Act and Article 20 of the Canada-New Zealand Income Tax Convention

		January 3, 2001

	Vancouver Tax Services Office	International Section
	Robert Thomson	S. Leung
	International Tax Service Pacific Region	957-2115

		2000-002424

T2062 XXXXXXXXXX
Section 6.3 of the Income Tax Convention Interpretation Act
and Article 20 of the Canada-New Zealand Income Tax Convention

We are writing in reply to your memorandum of May 2, 2000 in which you requested our opinion on the application of Article 20 of the Canada-New Zealand Income Tax Convention (the "Convention") and Section 6.3 of the Income Tax Convention Interpretation Act (the "ITCIA") to the gain resulting from the disposition of the shares of a Canadian private corporation held by a resident of New Zealand where the sale took place outside Canada. In this regard you provided us with a copy of the memorandum of April 25, 2000 by Gord McDougall of Southern Interior BC TSO and several schedules attached thereto, including the letter of October 17, 1999 from XXXXXXXXXX, the representative of XXXXXXXXXX.

The facts of the case are quite simple. XXXXXXXXXX (the taxpayer), who is a resident of New Zealand and who has never been a resident of Canada, disposed of taxable Canadian property on XXXXXXXXXX consisting of shares of a Canadian-controlled private corporation, XXXXXXXXXX ("Canco"). The sale was transacted in New Zealand. The purchaser was a company resident in XXXXXXXXXX which dealt at arm's length with the taxpayer. Canco did not own any real property or resource property in Canada. The amount of the capital gain on such disposition was Canadian $XXXXXXXXXX. The taxpayer filed his XXXXXXXXXX Canadian income tax return and reported the taxable portion of the capital gain and at the same time claimed a deduction of that amount in computing his taxable income earned in Canada.

Our Comments

Since the shares of Canco were taxable Canadian property, the taxable portion of the capital gain on the disposition of such shares by the taxpayer would be required to be included in computing the taxable income earned in Canada by him under paragraph 2(3)(c) and subparagraph 115(1)(a)(iii) of the Act. If the taxpayer can find a relief in the Convention from taxation by Canada, a deduction under paragraph 115(1)(d) of the Act with reference to paragraph 110(1)(f) of the Act would be available. Neither paragraph 1 nor paragraph 2 of Article 13 of the Convention applies because Canco did not own any real property or resource property in Canada and as the income is not dealt with in the other articles of the Convention, Article 20 of the Convention applies to the gain from the disposition of such shares of Canco.

Paragraphs 1 and 2 of Article 20 of the Convention state:

"1. Subject to the provision of paragraph 2, items of income of a resident of a Contracting State which are not dealt with in the foregoing Articles of this Convention shall be taxable only in that State.

2. However, if such income is derived by a resident of a Contracting State from sources in the other Contracting State, such income may also be taxed in that other State and subject to paragraph 3, according to the law of that State."

Under these paragraphs, it is clear that in this case if the gain from the disposition of the shares of Canco by the taxpayer can be said to be derived from a source or sources in Canada, such gain may be taxed in Canada. Otherwise, the gain shall be taxable only in New Zealand. The source of the income is determined independent of Article 20 of the Convention and that determination must be made before the provisions of Article 20 can be applied.

In this regard unless there is a provision in one of Canada's income tax conventions which explicitly prohibits Canada from taxing the capital gain realized on the disposition of taxable Canadian property by a resident of the other Contracting State, it is our understanding that it was the intention of the Department of Finance that Canada retains its first right to tax such gain.

XXXXXXXXXX

Where an exemption from Canadian tax was not explicitly provided in respect of the capital gain resulting from the disposition of taxable Canadian property, in order that the provisions of the Convention and other Canadian income tax conventions could be applied in the manner consistent with what was intended, the Department of Finance added section 6.3 to the ITICA for dispositions of taxable Canadian property that take place after February 23, 1998.

It should be noted that, as was mentioned in Gord McDougall's memorandum of April 25, 2000, the Department of Finance used the words "for greater certainty", "confirms" and "more explicit" in the Notice of Ways and Means Motion of February 24, 1998 and in the Explanatory Notes of October 1998 and March 1999 to indicate that it has always been the intention of the Canadian negotiators of Canadian income tax conventions that the source of income on the disposition of taxable Canadian property is from Canada. From this perspective, section 6.3 of the ITCIA does not result in an override to any tax conventions but rather reflects the original intention of the Department of Finance when negotiating the conventions.

The only reason for the phase "except where a convention expressly otherwise provides" to be in section 6.3 of the ITCIA is to clarify that section 6.3 of the ITCIA is not intended to override nor does it override the sourcing rule in the Elimination of Double Taxation Article of any convention that Canada has with the other countries (in this case, Article 21 (Elimination of Double Taxation) of the Convention or Article 22 (Source of Income) of the Australian Convention). This sourcing rule is for the purpose of determining the income in respect of which Contracting States have to grant foreign tax credits and has nothing to do with Article 20 (Other Income) of the Convention as was suggested by the representative of the taxpayer. For example, for the purposes of granting foreign tax credits, if a capital gain realized by a resident of the other Contracting State on the disposition of taxable Canadian property is explicitly exempt from tax in Canada under another provision of a convention, such gain will be deemed to arise in the other Contracting State. It should be noted that except for this sourcing rule, there is no other sourcing rule for capital gains in Canada's income tax conventions.

Section 6.3 of the ITCIA states:

"Except where a convention expressly otherwise provides, any amount of income, gain or loss in respect of the disposition of a property that is taxable Canadian property within the meaning assigned by the Income Tax Act is deemed to arise in Canada."

The result of the enactment of section 6.3 of the ITCIA is that the capital gain in the case at hand for the purpose of the Convention is sourced to Canada and, by virtue of paragraph 2 of Article 20 of the Convention, Canada can tax that gain.

In addition, as Canada can tax the gain, such gain is also considered to be Canadian source income for the purposes of Article 21 of the Convention.

Conclusion

Section 6.3 of the ITCIA operates to deem the income, gain or loss realized from the disposition of taxable Canadian property to arise in Canada for the purpose of Article 20 of the Convention. Paragraph 2 of that Article operates together with section 6.3 of the ITCIA to allow Canada to tax the gain with respect to the disposition of the shares of Canco. We would like to point out that this position is supported by Mr. Brian Arnold's article "Canada Amends Income Tax Convention Interpretation Act" published in Tax Notes International, vol. 18, Number 6, February 8, 1999.

As a matter of interest, it appears that New Zealand did not tax the capital gain realized by the taxpayer in this case as it is our understanding that New Zealand only taxes capital gain in certain limited circumstances which do not include the situation dealt with in this case. Therefore, there should not be any possibility of double tax issue in this case. In any case, in accordance with Article 21 of the Convention, if New Zealand taxes the gain, New Zealand would be required to grant a foreign tax credit for Canadian taxes paid on the gain.

for Director
Reorganizations and International Division
Income Tax Rulings Directorate
Policy and Legislation Branch

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