18 November 2009 External T.I. 2006-0188131E5 - Canada-U.S. Tax Treaty - Articles XII and XXII

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: Does the Treaty preclude Canada from imposing Part XIII withholding tax on royalties paid by a resident of Canada to a non-resident if those royalties are deemed, by Article XII(6) of the Treaty, not to arise in Canada?

Position: The Treaty precludes Canada from imposing withholding tax if the royalties are income of a resident of the United States

Reasons: See below

									2006-018813
XXXXXXXXXX 								D. Boychuk
(613) 948-5274
November 18, 2009 

Dear XXXXXXXXXX :

Re: Part XIII Tax - Royalties

We are writing in response to your letter of May 19, 2006, in which you requested our comments concerning the application of Part XIII of the Income Tax Act (the "Act") and the provisions of the Canada-United States Tax Convention (1980) (endnote 1) (the "Treaty") in the circumstances described below. We apologize for the delay in our reply.

The first situation described in your letter is as follows:

• Canco is a corporation resident in Canada that carries on business in the United States ("U.S.") through a permanent establishment situated therein;
• Dco is a corporation that carries on business in the U.S.;
• Dco is a resident of the U.S. for the purposes of the Treaty and is a "qualifying person" as defined in Article XXIX A(2) of the Treaty;
• Canco and Dco are "related" as that term is defined in subsection 251(2) of the Act;
• Dco enters into an agreement with Canco under which Dco grants a royalty to Canco for the right to use certain property exclusively in connection with Canco's business operations in the U.S.;
• Canco makes royalty payments to Dco pursuant to the agreement;
• The royalty payments are payments described in paragraph 212(1)(d) of the Act and in Article XII(4) of the Treaty;
• The royalty payments are not payments described in subparagraphs (a) to (d) of Article XII(3) of the Treaty;
• Pursuant to Article XII(6)(a) of the Treaty, the royalty payments are deemed to arise in the U.S. and not in Canada; and
• Dco is required to include the royalties in its income for U.S. tax purposes.

With respect to this situation, you have asked us whether the Treaty would apply to exempt the royalty payments from tax under Part XIII of the Act.

The second situation described in your letter concerns the application of subsection 212(13.1) and section 215 of the Act and Article XII of the Treaty in the following circumstances:

• Aco and Bco are Canadian resident corporations that carry on business in common through a Canadian general partnership ("Partnership");
• The Partnership carries on business in the U.S. through a permanent establishment situated therein;
• Fco is incorporated in and is resident in a country with which neither Canada nor the U.S. has an income tax convention;
• Fco is "related" to Aco and Bco, as that term is defined in subsection 251(2) of the Act;
• Fco enters into an agreement with the Partnership under which it the grants to the Partnership a royalty for the right to use certain property exclusively in the Partnership's business operations in the U.S.;
• The Partnership makes royalty payments to Fco pursuant to the agreement;
• The royalty payments are payments described in paragraph 212(1)(d) of the Act and in Article XII(4) of the Treaty;
• The royalty payments are not payments described in subparagraphs (a) to (d) of Article XII(3) of the Treaty;
• Pursuant to Article XII(6)(a) of the Treaty, the royalty payments are deemed to arise in the U.S. and not in Canada; and
• The royalty payments are subject to U.S. withholding tax at 30%.

With respect to this second situation, you have asked us whether the royalty payments are subject to tax under Part XIII of the Act and, if so, whether Aco and Bco could be held liable for withholding and remitting the tax.

Our Comments

Please note that it is not this Directorate's practice to comment on transactions involving specific taxpayers other than in the form of an advance income tax ruling. For more information about how to obtain an advance ruling, please refer to Information Circular 70-6R5, "Advance Income Tax Ruling", dated May 17, 2002. This Information Circular and other Canada Revenue Agency ("CRA") publications can be accessed on the CRA website, http://www.cra-arc.gc.ca. We are, however, prepared to provide the following general comments which we trust will be of some assistance.

Application of Part XIII of the Act

In the first fact situation, Canco, a person resident in Canada, is making payments described in paragraph 212(1)(d) of the Act, to a non-resident person. Accordingly, a tax of 25% of the gross amount of the royalty payments will be payable under Part XIII of the Act, subject to any relief provided by the Treaty.

In the second fact situation, a tax of 25% of the gross amount of the royalties will be payable under Part XIII of the Act if: (1) the Partnership is considered, in respect of the royalty payments, to be a person resident in Canada for the purposes of Part XIII, or (2) the royalties are considered to be paid by the members of the Partnership (i.e., Aco and Bco). For the reasons explained below, it is our view that, in the event Part XIII tax is payable, Fco (which is not a resident of Canada or the U.S.) is not entitled to any relief under the Treaty.

Paragraph 212(13.1)(a) of the Act applies, for the purposes of Part XIII of the Act (other than section 216), to deem a partnership to be a person resident in Canada in respect of an amount where:

• the partnership pays or credits the amount to a non-resident person; and
• the amount is, or would be if section 21 did not apply, deductible in computing the income or loss of the partnership from a source in Canada.

Provided that the royalties described in the second fact situation are not deductible in computing income from a source in Canada, paragraph 212(13.1)(a) would not apply. However, where the members of the Partnership (i.e., Aco and Bco) are liable for the payment of the royalties under the laws of the jurisdiction governing the Partnership, the partnership agreement, or under the agreement governing the payment of the royalties, the members would be considered to be the payers of the royalties. Thus, Aco and Bco may be liable, pursuant to section 215 of the Act, for withholding and remitting tax under Part XIII in circumstances where paragraph 212(13.1)(a) does not apply.

Relevant Provisions of the Treaty

(a) Article XII - Royalties

Article XII of the Treaty confirms the right of a Contracting State to tax royalties paid to a resident of that State (paragraph 1) and limits the right of the "source" State (the State where the royalties arise) to impose tax on such payments (paragraphs 2 and 3). Paragraph 2 of Article XII states that royalties may be taxed in the Contracting State in which they arise but if a resident of the other Contracting State is the beneficial owner of such royalties, the tax so charged shall not exceed 10 per cent of the gross amount of the royalties. Paragraph 3 of Article XII states that, notwithstanding the provisions of paragraph 2, certain types of royalties arising in a Contracting State and beneficially owned by a resident of the other Contracting State shall be taxable only in that other State (i.e., exempt from withholding tax).

Subparagraph 6(a) of Article XII establishes rules to determine where the royalties described in that Article are considered to arise. It provides:

For the purposes of this Article,

(a) royalties shall be deemed to arise in a Contracting State when the payer is a resident of that State. Where, however, the person paying the royalties, whether he is a resident of a Contracting State or not, has in a State a permanent establishment in connection with which the obligation to pay the royalties was incurred, and such royalties are borne by such permanent establishment, then such royalties shall be deemed to arise in the State in which the permanent establishment is situated and not in any other State of which the payer is a resident;

In addition, paragraph 8 of Article XII restricts the right of a Contracting State to impose tax on royalties paid by a resident of the other Contracting State. It provides:

Where a resident of a Contracting State pays royalties to a person other than a resident of the other Contracting State, that other State may not impose any tax on such royalties except insofar as they arise in that other State or insofar as the right or property in respect of which the royalties are paid is effectively connected with a permanent establishment situated in that other State.

(b) Article XXII - Other Income

Paragraph 1 of Article XXII of the Treaty applies in circumstances where an item of income of a resident of Canada or the U.S. is not dealt with in another Article of the Treaty. It provides:

Items of income of a resident of a Contracting State, wherever arising, not dealt with in the foregoing Articles of this Convention shall be taxable only in that State, except that if such income arises in the other Contracting State it may also be taxed in that other State.

Analysis

The provisions of Article XII (paragraphs 2 and 3) that limit the taxation of royalties by the "source" state apply if the royalties arise in one of the Contracting States (e.g., Canada) and are beneficially owned by a resident of the other Contracting State (e.g., United States). Neither of these provisions applies to the royalties payments in the fact situations described above. In the first situation, the royalties are considered to arise in the U.S. and are beneficially owned by a resident of the U.S. In the second situation, the royalties are considered to arise in the U.S. and are beneficially owned by a resident of a country with which neither Canada nor the U.S. has a tax convention.

To the extent that Article XII(6) applies to the fact situations described above, it only applies to deem the royalty payments to arise in the U.S. Article XII does not limit the taxation of the royalty payments by either State. In these circumstances, we would consider the royalty payments to be income described in Article XXII(1) of the Treaty (i.e., income of a resident of a Contracting State that is not dealt with in the foregoing Articles of the Treaty). In our view, Article XXII(1) would apply, to preclude Canada, in the first situation, from imposing tax under Part XIII of the Act on the royalties paid by Canco to Dco. However, Article XXII(1) would not apply in the second situation since the royalties are not income of a resident of one of the Contracting States. Thus, with respect to the second situation, Canada would not be precluded from imposing tax under Part XIII of the Act on the royalty payments to Fco even though the U.S. may also impose its withholding tax.

We trust that these comments are of some assistance.

Yours truly,

Daryl Boychuk
Manager, International Tax Section I
International and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
ENDNOTES

1 Convention Between Canada and the United States of America with Respect to Taxes on Income and on Capital Signed on September 26, 1980, as Amended by the Protocols Done on June 14, 1983, March 28, 1984, March 17, 1995, July 29, 1997 and September 21, 2007.