26 March 2002 External T.I. 2002-0124145 - U.S. Estate Tax and FTC

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 there is any provision in the Canada-United States Income Tax Convention to deal with a situation where U.S. estate tax is imposed upon a distribution of property by a qualified domestic trust to the spouse?

Position: Yes.

Reasons: See subparagraph 3(g) of Article XXVI of the Convention.

XXXXXXXXXX 2002-012414
S. Leung
March 26, 2002

Dear XXXXXXXXXX:

Re: United States Estate Tax and Foreign Tax Credit

We are writing in reply to your letter of February 14, 2002, in which you requested our comments on whether there is any provision in the Canada-United States Income Tax Convention (the "Convention") to deal with the issue of potential double taxation in the hypothetical situation described in your letter.

The Hypothetical Situation

An individual who was a U.S. citizen resident in Canada died and left certain property in a spousal trust described in subsection 70(6) of the Income Tax Act (the "Act"). The spousal trust also qualifies as a qualified domestic trust ("QDOT") for U.S. tax purposes. Before the spouse dies, the trustees cause the trust to sell assets of the trust resulting in the trust paying Canadian income tax on the taxable capital gain realized on the disposition of the assets. The trust, in a subsequent year, then distributes capital to the beneficiary (i.e., the spouse). U.S. estate tax is exigible as a result of such distribution by the trust to the spouse.

It is your view that paragraph 6 of Article XXIX B of the Convention does not seem to apply because Canadian foreign tax credits are only granted under that paragraph for U.S. estate taxes imposed either upon the death of the taxpayer or upon the death of his surviving spouse. In the situation outlined above, the U.S. estate tax is imposed upon the distribution of property from the trust to the spouse. You requested our opinion as to whether your view is correct in this regard and whether there is any provision in the Convention that will allow some sort of credits so as to avoid double taxation.

Our Comments

It is our understanding that to qualify as a QDOT at least one of the trustees of the QDOT must be an individual citizen of the U.S. or a domestic corporation of the U.S. If a QDOT has only one trustee (e.g., the sole trustee is a U.S. citizen who is not a resident of Canada), or if it has more than one trustee and a majority of the trustees are resident in the U.S. and not resident in Canada, generally such a QDOT is not a trust described in subsection 70(6) of the Act because the trust is not resident in Canada immediately after the time the property vested indefeasibly in the trust. Generally a trust is resident where its trustee or trustees are resident. Consequently, such a QDOT would not be considered resident in Canada unless the special provision of paragraph 5 of Article XXIX B of the Convention applied. It should also be noted that to qualify as a subsection 70(6) trust, the trust must be created by the deceased taxpayer's will. It is our understanding that this is not an absolute requirement for a QDOT. Therefore, if the trust in the hypothetical situation was not created by the deceased taxpayer's will, the rollover provisions described in subsection 70(6) of the Act would not be applicable. In the hypothetical situation noted above, we have, therefore, assumed that the sole trustee or the majority of the trustees of the QDOT are resident in Canada and that the trust was created by the taxpayer's will such that the QDOT also qualifies as the spousal trust described in subsection 70(6) of the Act.

We agree with your view that paragraph 6 of Article XXIX B of the Convention would not apply to the situation outlined above where the U.S. estate tax is imposed upon the distribution of property by the trust to the spouse, not upon the death of the taxpayer or his surviving spouse.

However, we feel that the provision of subparagraph 3(g) of Article XXVI of the Convention may have application to the case at hand. That subparagraph states:

"3. The competent authority of the Contracting States shall endeavor to resolve by mutual agreement any difficulties or doubts arising as to the interpretation or application of the Convention. In particular, the competent authorities of the Contracting States may agree:

...

(g) to provide relief from double taxation resulting from the application of the estate tax imposed by the United States or the Canadian tax as a result of a distribution or disposition of property by a trust that is a qualified domestic trust within the meaning of section 2056A of the Internal Revenue Code, or is described in subsection 70(6) of the Income Tax Act or is treated as such under paragraph 5 of Article XXIX B (Taxes Imposed by Reason of Death), in cases where no relief is otherwise available; or"

It appears that the negotiators of the Third Protocol to the Convention have realized that none of the provisions in Article XXIX B of the Convention would deal with a situation where U.S. estate tax is imposed upon the distribution of property by the trust. Therefore, they added subparagraph 3(g) of Article XXVI to the Convention at the same time Article XXIX B was added so as to have the competent authorities of Canada and the United States deal with double taxation issues similar to the situation outlined in your letter.

Even though we have not been provided the necessary details of your situation which would allow us to comment with certainty, alternatively, the trustees of the trust may elect under subsection 70(6.2) of the Act not to have subsection 70(6) apply. Hence, Canadian tax would be exigible on the deemed disposition of property on death. At the same time the trust may, if permissible in the U.S., disqualify itself to be a QDOT such that U.S. estate tax is exigible upon the death of the taxpayer. In this event, although both Canadian income tax and U.S. estate tax would not be deferred (i.e., payable at the time of death of the taxpayer), depending on the circumstances (e.g., if the property in question is property situated in the U.S. and the estate tax would have been payable if the individual was not a citizen or former citizen of the U.S.), there may not be any double taxation as paragraphs 6 and 7 of Article XXIX B of the Convention would apply to provide credits for both taxes.

We trust you will find the above to be of assistance.

As stated in paragraph 22 of Information Circular 70-6R4 dated January 29, 2001, the opinions expressed in this letter are not rulings and are consequently not binding on the Canada Customs and Revenue Agency.

Yours truly,

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

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