12 April 2010 External T.I. 2009-0317941E5 - Canada-US Tax Convention - Article XXIX A

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.

Principal Issues: (1) In applying the "base erosion" test in Article XXIX A(2)(e) or (4)(b), how will the CRA interpret the reference to payments made "indirectly" to persons other than qualifying persons? (2) In applying the "active trade or business" test in Article XXIX A(3), will the CRA treat the business activities of a U.S. LLC that is treated as a partnership for U.S. tax purposes as the business activities of its members?

Position: (1) The CRA will interpret the words "paid or payable...directly or indirectly" contained in Article XXIX A(2)(e) and (4)(b) of the Convention consistent with the approach we have taken in interpreting those words under subparagraph 95(2)(a)(ii) of the Income Tax Act; (2) No

Reasons: (1) Consistent with a textual, contextual, purposive approach to interpreting the meaning of the words; (2) The LLC is an entity separate from its shareholders.

Question 1

In applying the "base erosion" test in Article XXIX A(2)(e) or (4)(b) Canada-United States Tax Convention, how will the CRA interpret the reference to payments made "indirectly" to persons other than qualifying persons? Will the approach be similar to that taken in the context of paragraph 95(2)(a) of the Income Tax Act (the "Act"), where the CRA has previously expressed the view that there must be a relatively high threshold of connection between the two payments?

Response

Article XXIX A(2)(e) of the Canada-United States Tax Convention (the "Treaty") provides as follows:

2. For the purposes of this Article, a qualifying person is a resident of a Contracting State that is:
...
(e)

(i) a company, 50 percent or more of the aggregate vote and value of the shares of which and 50 percent or more of the vote and value of each disproportionate class of shares (in neither case including debt substitute shares) of which is not owned, directly or indirectly, by persons other than qualifying persons; or

(ii) a trust, 50 percent or more of the beneficial interest in which and 50 percent or more of each disproportionate interest in which, is not owned, directly or indirectly, by persons other than qualifying persons;

where the amount of the expenses deductible from gross income (as determined in the State of residence of the company or trust) that are paid or payable by the company or trust, as the case may be, for its preceding fiscal period (or, in the case of its first fiscal period, that period) directly or indirectly, to persons that are not qualifying persons is less than 50 percent of its gross income for that period;

Article XXIX A(4) of the Treaty provides as follows:

4. A company that is a resident of a Contracting State shall also be entitled to the benefits of Articles X (Dividends), XI (Interest) and XII (Royalties) if:

(a) its shares that represent more than 90 percent of the aggregate vote and value of all of its shares and at least 50 percent of the vote and value of any disproportionate class of shares (in neither case including debt substitute shares) are owned, directly or indirectly, by persons each of whom is a qualifying person or a person who:

(i) is a resident of a country with which the other Contracting State has a comprehensive income tax convention and is entitled to all of the benefits provided by that other State under that convention;

(ii) would qualify for benefits under paragraphs 2 or 3 if that person were a resident of the first-mentioned State (and, for the purposes of paragraph 3, if the business it carried on in the country of which it is a resident were carried on by it in the first-mentioned State); and

(iii) would be entitled to a rate of tax in the other Contracting State under the convention between that person's country of residence and that other State, in respect of the particular class of income for which benefits are being claimed under this Convention, that is at least as low as the rate applicable under this Convention; and

(b) the amount of the expenses deductible from gross income (as determined in the company's State of residence) that are paid or payable by the company for its preceding fiscal period (or, in the case of its first fiscal period, that period) directly or indirectly to persons that are not qualifying persons is less than 50 percent of the company's gross income for that period.

The CRA will interpret the words "paid or payable...directly or indirectly" contained in Articles XXIX A(2)(e) and (4)(b) of the Treaty consistent with the approach we have taken in interpreting those words under subparagraph 95(2)(a)(ii) of the Act. For example, for the purpose of applying Article XXIX A(2)(e) or (4)(b) of the Treaty, a payment by a company to a qualifying person will be considered to be made indirectly to a non-qualifying person if there is a sufficient link between the payment and a subsequent payment by the qualifying person to a non-qualifying person (e.g. back-to-back arrangement). To determine whether a sufficient link exists between two amounts, the CRA will consider all of the facts and circumstances including, for example, whether an amount paid or payable to a qualifying person was conditional on the amount being paid or payable to a non-qualifying person.

Question 2

In applying the "active trade or business" test in Article XXIX A(3), will the CRA treat the business activities of a U.S. LLC that is treated as a partnership for U.S. tax purposes as the business activities of its members?

Response

Article XXIX A(3) of the Treaty provides as follows:

Where a person is a resident of a Contracting State and is not a qualifying person, and that person, or a person related thereto, is engaged in the active conduct of a trade or business in that State (other than the business of making or managing investments, unless those activities are carried on with customers in the ordinary course of business by a bank, an insurance company, a registered securities dealer or a deposit-taking financial institution), the benefits of this Convention shall apply to that resident person with respect to income derived from the other Contracting State in connection with or incidental to that trade or business (including any such income derived directly or indirectly by that resident person through one or more other persons that are residents of that other State), but only if that trade or business is substantial in relation to the activity carried on in that other State giving rise to the income in respect of which benefits provided under this Convention by that other State are claimed.

[Emphasis Added]

Where a corporate entity is a person separate from its members/shareholders, the activities of the entity are not, in the absence of an agency relationship, the activities of its shareholders/members. Thus, we would not normally consider the members/shareholders of a U.S. corporation to be engaged in the business activities of the corporation whether or not the corporation is treated as a partnership for U.S. tax purposes. We note, however, that Article XXIX A(3) may apply to a resident of a Contacting State that is not a qualifying person if that person, or a person related thereto, is engaged in the active conduct of a trade or business in that State. Thus, if a member of a LLC is related to the LLC, within the meaning of subsection 251(2) of the Act, and the LLC is engaged in the active conduct of a trade or business in the U.S., that member may meet the requirements of Article XXIX A(3) as they pertain to an active trade or business being conducted in the U.S. by reference to the business activities of the LLC.