15 May 2019 IFA Roundtable Q. 8, 2019-0798841C6 - Active Trade or Business Test under the LOB Clause

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: In the scenario provided, does paragraph 3 of Article XXIX-A of the Canada-U.S. Tax Treaty apply where a Canadian corporation (“Canco”) pays a dividend to its U.S. resident parent corporation (“USco”), if such income is indirectly derived through the business of Canco’s foreign affiliate that is a resident in a third country?

Position: No.

Reasons: The dividend income paid to USco is not derived from Canada in connection with or incidental to the trade or business of USco.

2019 International Fiscal Association Conference
CRA Roundtable

Question 8 – Active Trade or Business Test under the LOB Clause

Paragraph 3 of Article XXIX-A (this Article hereinafter referred to as the “LOB Clause”) of the Canada-U.S. Tax Convention (the “Treaty”) generally provides that a U.S. resident, that is not a qualifying person under paragraph 2 of the LOB Clause and that is engaged in the active conduct of a trade or business in the U.S., can claim Treaty benefits with respect to items of income that are derived from Canada in connection with or incidental to that trade or business, provided a number of other conditions are met.

In a situation where a corporation resident in Canada (“Canco”) pays a dividend to its U.S. resident parent corporation (“USco”), would paragraph 3 of the LOB Clause apply in connection with the dividend paid to USco if such income is indirectly derived through the business of Canco’s foreign affiliate (“FA”) that is a resident in a third country?

More specifically, would the requirements of paragraph 3 of the LOB Clause be met in the following hypothetical scenario:

• Canco pays a dividend to USco;
• USco is owned by non-resident individuals that are residents in a non-treaty country;
• USco is a corporation formed in the U.S. and is engaged in the active conduct of a trade or business in the U.S.;
• Canco does not have any active business operations in Canada; it is used solely as a holding company for FA, which has an active business that is carried on in a third country;
• FA is in the same business as USco’s business and FA’s activities are all connected to USco’s business.

CRA Response

Paragraph 3 of the LOB Clause generally applies when the following conditions are met:

• The U.S. resident person, that is not a qualifying person, is engaged in the active conduct of a trade or business in the U.S. (the “Active Conduct Test”);
• The item of income is derived from Canada in connection with or incidental to that trade or business (including any such income derived directly or indirectly by the U.S. resident person through one or more other persons that are residents of Canada) (the “Connected Test”); and
• The trade or business carried on in the U.S. is substantial in relation to the activity carried on in Canada giving rise to the income in respect of which the Treaty benefits are claimed (the “Substantiality Test”).

In the scenario provided, we are of the view that paragraph 3 of the LOB Clause would not apply as the Connected Test is not met. Whether the other requirements of paragraph 3 of the LOB Clause are met would require a review of all relevant facts of a situation.

To the extent that a taxpayer considers that the denial of benefits under the LOB Clause is not appropriate in the taxpayer’s particular circumstances, the taxpayer can request discretionary relief by the CRA Competent Authority under the procedure provided under paragraph 6 of the LOB Clause.

Yves Grondin/Marie-Claude Routhier
2019-079884
May 15, 2019