5 September 2003 External T.I. 2003-0020015 - Interest in a UK Partnership & Rental Income

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: (1) Taxation of an interest in a UK partnership, and (2) Taxation of rental income from, and capital gain on the disposition of, a house located in Wales.

Position: See memo.

Reasons: See memo.

XXXXXXXXXX 								2003-002001

Attn: XXXXXXXXXX

September 10, 2003

Dear XXXXXXXXXX:

Re: Taxation of Foreign Source Income and Capital Gain

We are writing in reply to your email of May 23, 2003, in which you requested our interpretation of the application of the Canada-United Kingdom Income Tax Convention (1978) (the "Convention") to the following situation:

- The taxpayer is an individual, resident of Canada;

- The taxpayer moved from the UK to Canada during the year 2000;

- The taxpayer owns an interest in a partnership with two other persons;

- The partnership runs a golf course located in Wales (UK);

- The taxpayer also owned a house in Wales that he rented when he immigrated to Canada, until he sold it in 2002.

Your Questions

(1) You would like to know how the income from the partnership is treated in accordance with the Convention;

(2) You would like to know how the rental income from the house in Wales and the capital gain realized on the disposition are treated.

Our Comments

Written confirmation of the tax implications inherent in 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. However, we are prepared to provide the following general comments which may or may not apply to your situation.

Interest in a Partnership

A Canadian resident is taxable on his worldwide income under the Income Tax Act (Canada) (the "Act"). This income includes, where the taxpayer is a member of a UK partnership, the taxpayer's share of any income from that partnership computed in accordance with the rules in the Act.

Subject to any relief provided in the Convention, the UK may also tax a Canadian resident on income from sources in the UK. The UK taxes would be based on income as computed in accordance with UK domestic tax law.

Once the income of a taxpayer is determined under the Act, he can then turn to the provisions of the Convention for a relief. To alleviate double taxation, the Convention may provide that a portion of such income or gains derived from sources in the UK is exempt in Canada, or it may provide that Canada must allow a foreign tax credit ("FTC") for the taxes paid in the other Contracting State. In your example, the FTC provisions of the Convention do not enhance the FTCs that are already provided in the Act.

Except for the computation of income, a partnership is treated under the Act as a conduit with all income being taxed in the hands of its partners, while retaining its characteristics in respect to source and its nature. Therefore, where the partnership earns business income, the income from the partnership is treated as business income in the hands of its partners. Consequently, Article 7 (Business Profits) of the Convention applies with respect to business income derived by a Canadian resident taxpayer from a UK partnership. Under paragraph 1 of Article 7, a Canadian resident's business profits are taxable only in Canada (State of residency) unless there is a permanent establishment ("PE") in the UK. A partnership that carries on the business of a golf course would do so through a PE in the UK and, therefore, all the profits of a Canadian resident taxpayer attributable to the UK PE may be taxed in the UK.

The Act provides that a taxpayer may claim in his income tax return a FTC as computed under subsection 126(2) thereof for business income tax paid in the UK. If the UK tax paid on the partnership income cannot be fully credited under subsection 126(2) in a particular year, the excess could either be carried back three years or forward seven years and claimed in those other years provided the taxpayer was resident in Canada and had income from business carried on in the same country in the relevant year.

The House in Wales

A Canadian resident who derives property income from a rental property in the UK must report the income in his Canadian tax return.

Under Article 6 of the Convention, however, income from immovable property (e.g. a house) may also be taxed in the country where the property is located. However, in accordance with the Act, the taxpayer may claim in Canada a FTC as computed under subsection 126(1) thereof for the UK tax paid on the UK property income. If the UK tax paid on the property income cannot be fully credited under subsection 126(1), the excess could be deducted under subsection 20(12).

On the disposition of a house in the UK (immovable property), the taxpayer shall include in his income for taxation in Canada any capital gain that may have been realized. However, for the purpose of computing such gain in your example, paragraphs 128.1(1)(b) and (c) of the Act deemed the property to be disposed of at the time of the immigration and reacquired at fair market value, and, consequently, the adjusted cost base of the property is the fair market value of the property at the time of the immigration. Accordingly, the capital gain would generally be equal to the appreciation on the property after the immigration date in 2000, less any outlays or expenses incurred for the purpose of making the disposition. In your example, this gain would be included in the taxpayer's income for the 2002 taxation year.

Article 13 of the Convention provides that a capital gain from the alienation of immovable property may be taxed in the state where the property is located. Subsection 126(1) of the Act provides for a FTC in Canada for the tax paid in the UK on the disposition of a UK immovable property. However, the FTC is limited to the Canadian tax otherwise payable ("CTOP") that relates to the UK capital gain. The UK tax paid in excess of the CTOP would not be deductible under subsection 20(12) because this subsection applies in computing income from a business or property but not in computing a capital gain.

We trust our comments are helpful.

Yours truly,

Olli Laurikainen
Section Manager
for Division Director
International Section
Income Tax Rulings Directorate
Policy and Legislation Branch
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