29 April 2004 External T.I. 2003-0025221E5 - Trusts under the Canada-US Convention

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: The application of the Canada-US convention to grantor trusts.

Position: Various issues, see memo

XXXXXXXXXX  							Sophie Chatel
								2003-002522
Attention:  XXXXXXXXXX 

April 29, 2004

Dear Sir:

Re: Treatment of Trusts Under the Canada-US Convention

This is in reply to your email of June 19, 2003 wherein you requested our views on the entitlement of a US "living trust" (the Trust) to benefits under the Canada - United States Income Tax Convention, 1980, as amended (the "Convention"). Our views were given to you verbally on December 18, 2003 but, in this letter, we provide you with more details.

You described your hypothetical situation as follows:

? The trust is a trust formed under the laws of California (the "Trust").

? Mr. X, a US citizen who has never resided in Canada, settled the Trust.

? Mr. X is a non-resident of Canada under the Income Tax Act (Canada) (the "ITA") and is a resident of the US under the Convention.

? Pursuant to the instrument establishing the Trust, Mr. X declared himself trustee of the Trust to hold the shares of a Canadian corporation ("Canco"). Under the terms of the Trust, Mr. X as settlor may transfer additional property or withdraw property from the Trust at any time.

? Mr. X is the sole beneficiary of all the income of the Trust (i.e. including gains from the disposition of property) and on Mr. X's death, Trust property will be distributed to beneficiaries specified in the Trust. All the beneficiaries of the Trust are residents of the US under the Convention.

? Mr. X may amend the beneficiaries specified in the Trust instrument at any time prior to his death, including removing a person as beneficiary, adding a person as beneficiary and changing the interests of beneficiaries.

? For US tax purposes, the Trust is a "grantor trust" under sections 671 to 679 of the Internal Revenue Code. As such, its income and gains are taxed in Mr. X's hands as "grantor".

? Canco is a Canadian-controlled private corporation. The value of the Canco shares is not derived principally from real property situated in Canada.

? Canco may declare and pay a dividend on the shares held by the Trust. Alternatively, the Trust may sell its shares of Canco.

You submitted that the Trust should be entitled to the benefits of the Convention, in particular Article X (Dividends) and Article XIII (Gains).

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.

I - Status of Grantor Trusts under the Convention

In the context of US grantor trusts, the question in respect of the application of the Convention is who could claim the benefit of the Convention: the trust, the beneficiaries, the grantor or the trustees?

To decide if the Trust could claim the benefit of the Convention, we must first determine whether the Trust is a "trust" under the Convention, or a disregarded entity, in which case we look through the trust.

The term "trust" is not defined in the Convention. Article 3 of the Income Tax Conventions Interpretation Act states:

3. Notwithstanding the provisions of a convention or the Act giving the convention the force of law in Canada, it is hereby declared that the law of Canada is that, to the extent that a term in the convention is

(a) not defined in the convention,

(b) not fully defined in the convention, or

(c) to be defined by reference to the laws of Canada,

that term has, except to the extent that the context otherwise requires, the meaning it has for the purposes of the Income Tax Act, as amended from time to time, and not the meaning it had for the purposes of the Income Tax Act on the date the convention was entered into or given the force of law in Canada if, after that date, its meaning for the purposes of the Income Tax Act has changed.

Consequently, "except to the extent that the context otherwise requires", the word "trust" when used in the Convention has the meaning it has under the ITA.

Subsection 104(1) of the ITA provides (in general terms) that in situations where the trustee could reasonably be considered to act as agent for all the beneficiaries, the arrangement will be deemed not to be a trust for almost all purposes of the Act. As a result, in a particular earlier case, we took the position that a certain grantor trust was not a "trust" for the purpose of the ITA. We reached this conclusion because in that case the trustee could not act independently (the trustee had to act on the instructions delivered by the beneficiary/settlor for all significant decisions) and, even if the trust was irrevocable, the settlor could obtain the return of the property. However, we do not possess sufficient information in respect of the Trust in your situation to decide on that point.

II - Hypothesis 1: The Trust Is a Separate Person

If the Trust is a "trust" for the purposes of the ITA, we would generally apply the Convention to the Trust and not to the beneficiary. The first step would be to decide whether the Trust is a "resident of a Contracting State" under Article 4 of the Convention.

Article 4(1) of the Convention states:

For the purposes of this Convention, the term "resident" of a Contracting State means any person that, under the laws of that State, is liable to tax therein by reason of that person's domicile, residence, citizenship, place of management, place of incorporation or any other criterion of a similar nature, but in the case of an estate or trust, only to the extent that income derived by the estate or trust is liable to tax in that State, either in its hands or in the hands of its beneficiaries. [...] [Emphasis added]

We are of the view that, in the case of the Canada-US Convention, a trust is entitled to treaty benefits to the extent that its worldwide income is taxed in the US in its hands or in the hands of its US resident beneficiaries.

Article X (Dividends)

According to paragraph 1 of Article X of the Convention, dividends paid by a Canadian company to a US resident may be taxed in the US. Paragraph 2 provides however that such dividend may also be taxed in Canada, but if a resident of the US is the beneficial owner of such dividend, the tax so charged shall not exceed 15%.

We would conclude that under your situation the dividend from Canco is both paid to a US resident and beneficially owned by a US resident. Consequently, we are of the view that the reduced withholding rate of 15% would apply.

Article XIII (Gains)

Where the value of the shares of a company resident in Canada is not derived principally from real property situated in Canada, paragraph 4 of Article XIII of the Convention generally provides that the gain shall be taxable only in the State of which the alienator is a resident.

If the Trust is the "alienator" of the Canco shares the gain is exempt from taxation in Canada. (See our comments on Article XIII under the second hypothesis below)

III - Hypothesis 2: the Trust is Disregarded

If the Trust is not a "trust" for the purposes of the ITA and is a disregarded entity in the US, we would not look at the Trust to apply the treaty.

It is our view that Mr. X is entitled to the dividend and, upon the sale of the Canco shares, Mr. X should be regarded as the "alienator" and, consequently, Mr. X as a US resident for the purposes of the Convention may claim the benefits of both Articles X and XIII of the Convention.

Conclusion

Under your situation, whether we look through the Trust or not, we would arrive to the same result and grant treaty benefits on both the dividend and the capital gain.

We hope our comments are of assistance. If you have any questions please do not hesitate to contact us.

Yours truly,

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