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: Would paragraph 212(13.1)(a) apply to the situation described in the letter?
Position: No. However, it does not mean that Part XIII tax is not exigible.
Reasons: No Canadian source income earned by the partnership. Depending on the facts of a particular situation, the Canadian partners may be considered to be the payers of the interest paid by the partnership to a non-resident person.
XXXXXXXXXX 2003-003923
May 25, 2004
Dear XXXXXXXXXX:
Re: Paragraph 212(13.1)(a) of the Income Tax Act (the "Act")
We are writing in reply to your letter of September 15, 2003 in which you requested a technical opinion on your view that paragraph 212(13.1)(a) of the Act would not apply to the interest paid by a partnership to a U.S. financial institution as described in the following situation outlined in your letter.
Situation
1. LP is a limited partnership organized in the U.S.
2. Canco is a corporation resident in Canada and is a limited partner in LP. Canco has a permanent establishment in the U.S. and is subject to taxation in the U.S. All of the partners in LP are residents of Canada.
3. LP's business is investing in non-Canadian securities, from which it receives dividend and other investment income. All of LP's activities are conducted outside of Canada and none of its income is from sources in Canada.
4. LP has borrowed a substantial amount from a U.S. financial institution for the purpose described in 3 above.
The situation outlined in your letter appears to relate to an actual situation involving identifiable taxpayers. Accordingly, the applicable Tax Services Office should be consulted with respect to the income tax liabilities of such taxpayers. As you are aware, written confirmation of the tax implications arising out of a particular fact situation involving transactions which are seriously contemplated are given by this Directorate only where the circumstances or events are the subject matter of an advance income tax ruling request. However, we can offer the following general comments.
It is a question of fact whether, in the situation outlined above, Canco has a permanent establishment in the U.S. In this regard, it is not clear whether your statement that Canco has a permanent establishment in the U.S. is merely due to the fact that Canco is a limited partner in LP or that Canco itself has a permanent establishment in the U.S apart from its interest in LP.
It is also a question of fact whether investing in securities (Canadian or non-Canadian) in the U.S. by LP constitutes a business carried on in the U.S. by LP. Depending on the facts of a particular situation, income from investments in securities could be considered to be income from property. If LP is involved in holding portfolio investments, depending on other factors, it may not be considered to be carrying on a business1 and, more importantly, as having a permanent establishment in the U.S. as the term "permanent establishment" is defined as a fixed place of business through which the business is wholly or partly carried on.
Furthermore, it is a question of fact whether LP's substantial borrowing was in connection with the permanent establishment (if LP has such a permanent establishment) that LP has in the U.S. for the purposes of the second sentence in paragraph 6 of Article XI of the Canada-United States Income Tax Convention (the "Convention"). The second sentence of paragraph 6 of Article XI may come into play where, on a look-through basis, a Canadian resident partner (e.g., Canco) is considered to have paid the interest on the borrowed money (see comments below).
Having said all the above, notwithstanding whether Canco or LP has or does not have a permanent establishment in the U.S., we agree with you that paragraph 212(13.1)(a) of the Act would not apply to the situation outlined above to deem LP to be a person resident in Canada because LP does not appear to have any income from sources in Canada. However, this does not mean that withholding taxes under Part XIII of the Act would not be exigible in respect of the interest paid by LP to the U.S. financial institution.
Depending on the facts of a particular situation, taking into consideration the foreign law under which the partnership was formed and the terms and conditions of the partnership agreement and of the loan agreement, the partners may be considered to be the payers of the interest on the debts of the partnership. In other words, depending on the facts of a particular situation, one can look through the partnership to the partners as the persons who owe the debts of the partnership and who pay the interest on such debts. If this occurs, since at least one of the partners of LP is a Canadian resident and the interest is paid to a U.S. person, Part XIII tax is exigible, unless such payment is exempt from Canadian taxation under a provision of the Act (such as subparagraph 212(1)(b)(vii)) or the Convention. In this regard, Canadian jurisprudence generally supports the look-through approach where subsection 96(1) of the Act is not applicable.
Where the facts of a particular situation supports a look-through approach so that a Canadian resident partner is considered to have paid the interest, the first sentence of paragraph 6 of Article XI of the Convention applies so that such interest is deemed to arise in Canada for purposes of Article XI. Generally, under these circumstances, the Canada Revenue Agency ("CRA") is of the opinion that the second sentence of paragraph 6 of Article XI of the Convention would not apply to re-source such interest to the U.S. unless the CRA is convinced that (i) investing in non-Canadian securities constitutes a business carried on by LP through a permanent establishment in the U.S., (ii) the debt owing to the U.S. financial institution was incurred in connection with such permanent establishment, and (iii) the interest paid on such debt was borne by such permanent establishment. These are all fact-related issues that have to be determined on a case-by-case basis.
A determination of the issues involved in the situation outlined in your letter would require a full disclosure and examination of all the facts and circumstances of the situation. Such an examination could only be done in the context of an advance income tax ruling request.
We trust you will find the above to be of assistance.
Yours truly,
Jim Wilson
Section Manager
for Division Director
International and Trusts Division
Income Tax Rulings Directorate
Policy and Planning Branch
ENDNOTES
1 We recognize that the Canadian Courts have been fairly generous in accepting various arrangements between two or more persons as being formed with a view to carrying on business for profits and thus as partnerships for purposes of provincial partnership law. However, the test for what constitutes "carrying on business" for Canadian partnership law purposes or, possibly, for foreign partnership law purposes, is clearly less stringent than the test under the Act for determining the nature of a potential source of income (i.e., business versus property).
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