30 January 2002 External T.I. 2001-0106695 - Subs. 219(5.3);Article X of Canada-US Treaty

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 CCRA.

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

Principal Issues:

Whether a non-resident insurer who defers branch tax under subsection 219(5.2) should treat a deemed dividend under subsection 219(5.3), which is a recovery of the branch tax deferred, as a dividend or as branch tax for purposes of Article X of the Canada-US Tax Convention. Paragraph 2 of Article X of the Convention generally provides for withholding taxes on dividends of up to 15% (in the absence of 10% share ownership), while paragraph 6 of Article X specifically provides that branch taxes must be limited to 5% in all cases.

Position:

The better view is that paragraph 2 of Article X applies.

Reasons: The Technical Notes to subsection 219(5.3) identify the collection mechanism for deferred branch tax for non-resident insurers as Part XIII tax. It is up to the taxpayer to decide, when the Canadian corporation is incorporated, whether to pay branch tax immediately (to take advantage of the 5% rate or the $500,000 exemption) or to effectively defer that branch tax and pay withholding tax at a later time on any dividends (including deemed dividends). This is consistent with the scheme of the Act for non-residents who are not insurers and who incorporate a Canadian branch. This is also consistent with the general premise that, upon incorporating any type of business, an important consideration is that business profits must be paid out in the future as dividends.

XXXXXXXXXX 	2001-010669
		Eliza Erskine
Attention:  XXXXXXXXXX 

January 30, 2002

Dear Sirs:

Re: Interaction of Subsection 219(5.3) of the Income Tax Act (the "Act") with Article X of the Canada-United States Tax Convention (the "Convention")

This is in reply to your facsimile of October 19, 2001, requesting our views with respect to whether paragraph 2 or paragraph 6 of Article X of the Convention would apply with respect to the Canadian withholding tax on a deemed dividend arising pursuant to subsection 219(5.3) of the Act. We also acknowledge our telephone conversation with you of October 18, 2001 (Erskine/XXXXXXXXXX). In this letter, all references to Article X are references to the Convention and all references to provisions other than Article X are references to the Act, unless otherwise specified.

In your facsimile, you take the position that the better view is that paragraph 6 of Article X is the applicable provision in the situation outlined above. You note that paragraph 6 of Article X specifically applies to what is commonly referred to as "branch tax", whereas paragraph 2 of Article X is intended to apply to dividends. You suggest that as the deemed dividend that arises pursuant to subsection 219(5.3) of the Act is intended to provide Canada with a method for collecting branch tax from a non-resident insurance company that has previously deferred payment of that tax pursuant to subsection 219(5.2), paragraph 6 of Article X should be applicable. You note that paragraph 6 of Article X limits branch tax to 5% in all cases, whereas paragraph 2 of Article X only reduces withholding tax on dividends to 5% where the shareholder owns at least 10% of the voting stock of the corporation paying the dividend (the "Payer Corporation"). As subsection 219(5.3) may apply at a time when the non-resident insurance company no longer owns 10% of the voting stock of the Payer Corporation, branch tax that
ordinarily would be reduced to 5% under paragraph 6 of Article X (i.e., if it had been paid immediately), may effectively be reduced to only 15% if the deemed dividend is treated as a dividend to which paragraph 2 of Article X applies. You take the position that this would be contrary to the object and spirit of the Convention, and paragraph 6 of Article X in particular.

Our Comments

The situation outlined in your facsimile to us appears to relate to an actual proposed or completed transaction. We note that written confirmation of the tax implications arising from particular transactions are given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request. Where the particular transactions are completed, the inquiry should be addressed to the relevant Tax Services Office.

Generally, a non-resident insurance company is not liable for branch tax under subsection 219(1), in respect of its business carried on in Canada, by virtue of subsection 219(4). However, when a non-resident insurance company ceases to carry on all or substantially all of an insurance business in Canada, it becomes liable for a special branch tax pursuant to subsection 219(5.1). This special branch tax may be deferred pursuant to subsection 219(5.2), as long as an election is made and certain conditions are met. Among other things, in order to elect under subsection 219(5.2), the non-resident insurance company must have transferred its business carried on in Canada to a "qualified related corporation", as defined in subsection 219(8). If the "qualified related corporation" ceases to be a "qualified related corporation" of the non-resident insurance company at any time in a taxation year, subsection 219(5.3) will apply such that the non-resident insurance company will be deemed to have been paid a dividend in an amount that is generally equal to the amount of branch tax previously deferred under subsection 219(5.2).

The Technical Notes to subsection 219(5.3) comment that this provision

"provides for the collection of the branch tax that was deferred under new subsection 219(5.2). All or a portion of the deferred branch tax will be collected where a qualified related corporation of a non-resident insurer ceases to be such a corporation. ... The collection is effected by deeming a dividend to have been paid to the non-resident insurer that is subject to withholding tax at a rate of 25 % under Part XIII of the Act."

Generally, a dividend that is deemed to be paid to a taxpayer under the Act is treated as a dividend to the taxpayer for purposes of the Act and the Convention. The essential nature of the dividend as a dividend is not affected by the underlying nature of the amount that it may be said to "replace". As indicated in the Technical Notes, although the dividend in this case replaces an amount that would have been subject to branch tax, but for an election under subsection 219(5.2), the dividend is intended to be taxed as a dividend under Part XIII of the Act. Therefore, it is our position that the better view is that paragraph 2 of Article X, rather paragraph 6 of Article X, applies to this dividend.

We are also of the opinion that both the scheme of the Act and the scheme of Article X support our views on this matter. Generally, a non-resident corporation (who is not an insurance company), which is operating a business in Canada through a branch, is subject to branch tax pursuant to paragraphs 219(1)(f) and (l) upon the incorporation of that branch. The operation of subparagraphs 219(1)(l)(ii) and (iii) effectively provide for a deferral of the branch tax otherwise payable in a manner that is similar to the deferral of branch tax provided to non-resident insurance companies under subsection 219(5.2). Under paragraph 219(1)(l), the non-resident corporation must decide how much non-share consideration to take back upon incorporating its Canadian business; this amount will determine how much branch tax is payable at that time. If the non-resident corporation elects to take back no non-share consideration (and there is only a nominal increase in the paid-up capital of the new corporation), then no branch tax will be payable; however, any future dividends paid to the non-resident corporation by the new Canadian corporation will be subject to tax under Part XIII of the Act. Clearly, had the non-resident corporation elected to take back non-share consideration upon incorporating its Canadian branch, the amount of that non-share consideration would be subject to branch tax. In the case of a non-resident corporation that was resident in the United States, this branch tax would be reduced from 25% to 5% pursuant to paragraph 6 of Article X. Moreover, the non-resident corporation would be eligible for the $500,000 one-time exemption from branch tax available to residents of the United States pursuant to subparagraph 6(d) of Article X. Therefore, it is up to the non-resident corporation to decide, at the time that the Canadian branch is incorporated, whether it is more favourable for retained profits to be taxed as current branch profits (which may be eligible for the $500,000 exemption) or as future dividends (with branch tax being effectively deferred until such time as those dividends are actually paid). At the time of this decision, the non-resident corporation must take into account that any future change in ownership of the shares of the newly-incorporated branch may affect the amount of withholding tax payable pursuant to Part XIII of the Act as modified by paragraph 2 of Article X of the Convention (i.e., under Article X as it currently reads, the applicable withholding rate may increase from 5% to 15%).

In our view, there is little or no difference between the situation of non-resident insurance companies who are subject to branch tax under subsection 219(5.1) and other non-resident corporations who are subject to branch tax under paragraphs 219(1)(f) and (l). In both cases, it is up to the non-resident taxpayer to decide whether to take advantage of the reduced rate of branch tax provided under paragraph 6 of Article X or, instead, to benefit from deferring any or all of the branch tax payable by electing to have branch profits treated as dividends subject to Part XIII rates, and paragraph 2 of Article X, at a later time. Although it is true that changes in share ownership subsequent to the incorporation of the branch may result in the tax on future dividends exceeding the branch tax that would have been payable at the time of incorporation, it is our view that this is a consequence that is foreseeable at the time that the non-resident insurance company elects to defer its branch tax payable. In conclusion, there is nothing inconsistent with the object and spirit of the Convention in paragraph 2, rather than paragraph 6, of Article X applying to dividends arising under subsection 219(5.3), as it is the decision of the taxpayer, not the taxing authority, to have such amounts subjected to the dividend regime, rather than the branch tax regime, of the Act and the Convention. This is a tax planning matter, and it is open to the taxpayer to determine which regime is most favourable to him or her.

The above comments represent our general views with respect to the above-noted subject matter. These comments do not constitute an advance income tax ruling and, therefore, are not binding on the Canada Customs and Revenue Agency, as described in paragraph 22 of Information Circular 70-6R4. Furthermore, nothing in these comments should be construed as an opinion regarding the specific tax treatment of a particular taxpayer.

We trust that the above comments will be of some assistance to you.

Yours truly,

Jim Wilson
for Director
International and Trusts Division
Income Tax Rulings and Interpretations Directorate