Stanley Coblentz v. Her Majesty the Queen, [1994] 1 CTC 2661, 94 DTC 1364

Teskey, J.T.C.C.:—The appellant appeals his 1989 assessment, wherein the Minister of National Revenue (the "Minister"), assessed income tax on a lump sum payment received by the appellant from his United States employer ("U.S." employer).

Issue

The issue is whether the lump sum is exempt from taxation in Canada.

Facts

The parties, at the opening of the trial, filed with the Court an agreed statement of facts and law, which I reproduce:

1. The parties hereto, through their respective solicitors, hereby agree to the following facts and law:

(a) the appellant is a United States citizen who resides in Windsor, Ontario;

(b) during the 1989 taxation year, the appellant was a resident of Canada and was not a resident of the United States.

(c) prior to December 1988, the appellant was employed for a fifteen year period in

the United States with the firm of Toplis and Harding Inc. (the U.S. employer);

(d) during his employment he belonged to the pension plan of his U.S. employer;

(e) during the 1989 taxation year, the appellant received an amount of $111,560.68 [$90,395 (U.S.)] as a lump sum payment on the winding up of the pension plan of his U.S. employer;

(f) for U.S. income tax purposes, the appellant included the total amount of the lump sum payment in computing his gross income in accordance with the provisions of the Internal Revenue Code (the "Code") for the 1989 taxation year;

(g) also for U.S. income tax purposes, the appellant elected to treat the total amount of the lump sum payment as a lump sum distribution under section 402 of the Code;

(h) the total taxable amount of the lump sum distribution (being the amount referred to in paragraph (g) above) was allowed as a deduction from the appellant’s gross income pursuant to paragraph 402(e)(3) of the Code;

(i) the purpose of the election referred to in paragraph (g) above was to have the total amount of the lump sum payment subject to income tax in the United States using the ten-year averaging rules;

(j) the amount of U.S. income tax on the lump sum payment using the ten-year averaging rules was calculated as U.S. $12,770 and added to the appellant’s total U.S. income tax liability on his 1989 U.S. income tax return;

(k) the Code provisions providing for the ten-year averaging and related 402(e)(3) allowance of deduction were first enacted in 1974 pursuant to the provisions of the Employment Retirement Income Security Act

(l) because of the election referred to in paragraph (g) above, the appellant’s lump sum payment for the 1989 taxation year was excluded from his U.S. "taxable income” (as that term is defined in subsection 63(a) of the Code). This situation would have been the same even if the appellant would have been a resident of the United States for the 1989 taxation year;

(m) in accordance with paragraph 56(1)(a) of the Income Tax Act, the appellant must include in his income the lump sum payment for the 1989 taxation year and, in accordance with section 126 of the Income Tax Act, is allowed to deduct from his tax payable under Part I of the Income Tax Act an amount equal to the tax paid by him for the 1989 taxation year to the United States;

(n) with respect to the reassessment in issue, the appellant was allowed to deduct an amount of $12,770 U.S. as an “income or profits tax" paid by him to the U.S. in accordance with paragraph 126(7)(c) of the Income Tax Act with the result that the amount of $12,770 was allowed as a reduction of his 1989 Canadian income tax payable under Part I of the Income Tax Act

(o) pursuant to subparagraph 110(1 )(f)(i) of the Income Tax Act, the appellant wishes to deduct from his Canadian taxable income the amount of the lump sum payment as an amount exempt from income tax in Canada by reason of Paragraph 1 of Article XVIII of the Canada-U.S. Income Tax Act Convention.

2. The parties further agree:

(a) that pursuant to subsection 63(a) of the Internal Revenue Code, in the case of an individual who elects to itemize his deductions for the taxable year, the term “taxable income" means gross income minus the deductions allowed by Chapter 1 of the Internal Revenue Code [other than the standard deduction as that expression is defined in subsection 63(c)];

(b) that the deduction provided by paragraph 402(e)(3) of the Internal Revenue Code

is one of the deductions allowed by Chapter 1 of the Internal Revenue Code;

(c) that pursuant to subsection 63(b) of the Internal Revenue Code, in the case of an individual who does not elect to itemize his deduction for the taxable year, the term “taxable income” means adjusted gross income minus the standard deduction and the deduction for personal exemptions provided in section 151 of the Internal Revenue Code;

3. The parties agree that the expression “taxable income” found in Paragraph 1 of Article XVII of the Canada-U.S. Income Tax Convention has the same meaning than the expression “taxable income" as defined in section 63 of the Internal Revenue Code when the "first-mentioned state” is the United States.

It should be noted that the effect on the appellant by making the election not to take standard deductions but to take itemized deductions was that the lump sum was taxed under a different system.

Appellant's position

The appellant submits that pursuant to paragraph 1 of Article XVIII of the Canada-U.S. Tax Convention (the "convention"), he is entitled to a complete exemption from taxation in Canada of his U.S. source pension income.

Paragraph 1 of Article XVIII, under the heading “Pensions and Annuities" reads:

Pensions and annuities arising in a contracting state and paid to a resident of the other contracting state may be taxed in that other state, but the amount of any such pension that would be excluded from taxable income in the first-mentioned state if the recipient were a resident thereof shall be exempt from taxation in that other state.

On interjecting geographical locations, this paragraph reads:

Pension and annuities arising in the U.S. and paid to a resident of Canada may be taxed in Canada, but the amount of any such pension that would be excluded from taxable income in the U.S., if the recipient were a resident thereof, shall be exempt from taxation in Canada.

The appellant submits that since the above provision in the convention says that if the U.S. pension is excluded from taxable income in the U.S., then Canada cannot tax that U.S. source of income. The respondent agreed in subparagraphs

(h) and (I) of paragraph 1 of the agreed statement of facts that the effect of the appellant's election, was that the lump sum pension was excluded from taxable income in the U.S.

Respondent's position

The respondent referred to the Vienna Convention on the Law of Treaties, and in particular to paragraphs 1 and 2 of Article 31, under the heading "General Rule of Interpretation”, which read:

1. A treaty shall be interpreted in good faith in accordance with the ordinary meaning to be given to the terms of the treaty in their context and in the light of its object and purpose.

2. The context for the purpose of the interpretation of a treaty shall comprise, in addition to the text, including its preamble and annexes:

(a) any agreement relating to the treaty which was made between all the parties in connexion with the conclusion of the treaty;

(b) any instrument which was made by one or more parties in connexion with the conclusion of the treaty and accepted by the other parties as an instrument related to the treaty.

The respondent further points out that attached to the convention is such an instrument referred to in paragraph 2(b), being the Technical Explanation of the the Canada—U.S. Convention (the “technical explanation”) of article XVIII of the convention together with an example.

The first paragraph under the heading "Article XVIII—Pensions and Annuities” is the technical explanation of the convention, and reads:

Paragraph 1 provides that a resident of a contracting state is taxable in that state with respect to pensions and annuities arising in the other contracting state. However, the state of residence shall exempt from taxation the amount of any such pension that would be excluded from taxable income in the state of source if the recipient were a resident thereof. Thus, if a $10,000 pension payment arising in a contracting state is paid to a resident of the other contracting state and $5,000 of such payment would be excluded from taxable income as a return of capital in the first-mentioned state if the recipient were a resident of the first-mentioned state, the state of residence shall exempt from tax $5,000 of the payment. Only $5,000 would be so exempt even if the first-mentioned state would also grant a personal allowance as a deduction from gross income if the recipient were a resident thereof. Paragraph 1 imposes no such restriction which respect to the amount that may be taxed in the state of residence in the case of annuities.

[Emphasis added.]

The first two sentences on interjecting geographical locations then read:

Paragraph 1 provided that a resident of Canada is taxable in Canada with respect to pensions and annuities arising in the U.S. However, Canada shall exempt from taxation the amount of any such pension that would be excluded from taxable income in the U.S. if the recipient were a resident thereof.

The respondent submitted that the election taken by the appellant not to take standard deductions and to itemize his deductions was a personal deduction. It was common ground that the election triggered a deduction so that the lump sum was excluded from his U.S. taxable income. It was also common ground that if the appellant had not made the election and taken the standard deductions, the lump sum would have been included in the appellant’s U.S. taxable income.

Analysis

Both counsel submitted that the convention and the technical explanation should be interpreted liberally and to give wide scope to the language in order to include all matters intended to be included. Also, the words used are to be given their ordinary meaning. I agree with this.

I am satisfied that the determination of this appeal rests on the characterization of the itemized deductions that the appellant took, in that are they to be considered as a "personal allowance”, as referred to in the example contained in the technical explanation or not.

There is no evidence before me whether a trust or an estate may make a similar election and obtain the itemized deductions. Failing such evidence, I must apply Canadian law. In Canada, prior to the amendments creating tax credits, instead of income deductions, an individual taxpayer had various exemptions from income, depending on his marital status and number of children being supported. These deductions were not available to trusts or estates. They were "personal allowances" and relate to the second $5,000 referred to in the technical explanation.

I believe that the taking of the itemized deductions amounted to a “personal allowance”, as described in the example in the first paragraph of the technical explanation, under the heading “Article XVIII—Pensions and Annuities", as set out above.

The appeal is dismissed with costs.

Appeal dismissed.