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.
XXXXXXXXXX 2007-025702
Angelina Argento
July 16, 2008
Re: Proposed Limitation on Benefits Provision in Fifth Protocol to the Canada-Unites States Income Tax Convention
This is in reply to your letter dated December 3, 2007 regarding the above-mentioned matter.
FACTS
1. EU Corp is a corporation resident in a country within the European Union for the purposes of the Income Tax Act (Canada) (the "Act").
2. Entities related to EU Corp for the purposes of the Act carry on a XXXXXXXXXX business in EU Corp's country of residence (the "EU Opcos").
3. EU Corp owns all of the issued and outstanding shares of a number of foreign subsidiaries, including all of the issued and outstanding shares of US Holdco.
4. US Holdco is: (i) a corporation resident in the United States for the purposes of the Act and Article IV of the Fifth Protocol signed on September 21, 2007 amending the 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 (the "Treaty"); and (ii) not a disregarded entity for U.S. income tax purposes.
5. US Holdco's activities relate primarily to: (i) holding both the issued and outstanding shares, representing voting control, of a US subsidiary ("U.S. Co"), and all of the issued and outstanding shares of a Canadian corporation ("Can ULC")' and (ii) providing XXXXXXXXXX services to U.S. Co and the US Opcos (as defined below).
6. US Co, in turn, owns US subsidiaries (the "US Opcos") that carry on a XXXXXXXXXX business in the U.S. U.S. Co and each US Opco are resident in the U.S. for the purposes of the Act and Article IV of the Treaty.
7. None of US Co or the US Opcos is a disregarded entity for U.S. income tax purposes.
8. The XXXXXXXXXX business of the US Opcos is comparable in nature to the XXXXXXXXXX business of the EU Opcos.
9. Can ULC is: (i) an unlimited liability company, formed under the laws of the Province of XXXXXXXXXX ; (ii) resident in Canada for the purposes of the Act and the Treaty; and (iii) a disregarded entity for U.S. income tax purposes.
10. Can ULC's activities relate to the holding of shares of US Co. All or substantially all of Can ULC's income is derived from dividends paid by US Co (essentially out of dividends received by US Co from the US Opcos).
11. Upon Can ULC receiving a dividend on its shares of US Co, Can ULC generally would pay a dividend in an equivalent amount on its common shares to US Holdco.
12. None of the shares of EU Corp, the EU Opcos, US Holdco, Can ULC, US Co, or the US Opcos is listed on a recognized stock exchange as that term is defined in proposed clause 5(f) of Article XXIX A of the Treaty.
13. Neither US Holdco, nor EU Corp, will be a "qualifying person" as defined in proposed paragraph 2 of Article XXIX A of the Treaty.
14. Can ULC is currently debt free and has since its inception been debt free.
ISSUE
Is the applicable rate of Canadian withholding tax in respect of the dividends paid by Can ULC to US Holdco subsequent to the date on which Article XXIX A of the Treaty enters into force (yet, prior to the date on which paragraph 7 of Article IV of the Treaty enters into force) limited to 5% on the basis of paragraph (2)(a) of Article X of the Treaty?
In considering this issue we are not opining on whether US Holdco, US Co or US Opcos are each resident of the U.S. under Article IV of the Treaty. We are also not opining on whether the trade or business of US Co is substantial in relation to the activity carried on in Canada by Can ULC (which gives rise to the dividend income in respect of which US Holdco claims benefits under the Treaty.
Written confirmation of the income tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request as described in Information Circular 70-6R5 dated May 17, 2002 issued by the Canada Revenue Agency. A fee is charged for this service. Although we are unable to provide any comments with respect to your particular fact situation otherwise than in the form of an advance income tax ruling, the following general comments may be of assistance.
Provisions of the Fifth Protocol of the Canada-U.S. Treaty
The Fifth Protocol (which was signed on September 21, 2007) (the "Protocol") amends Treaty. In particular, the Protocol amends Article IV (Residence) of the Treaty by adding proposed new paragraph 7, which states as follows:
"An amount of income, profit or gain shall be considered not to be paid to or derived by a person who is a resident of a Contracting State where:
(b) The person is considered under the taxation law of the other Contracting State to have received the amount from an entity that is a resident of that other State, but by reason of the entity being treated as fiscally transparent under the laws of the first-mentioned State, the treatment of the amount under the taxation law of that State is not the same as its treatment would be if that entity were not treated as fiscally transparent under the laws of that State."
The Protocol also amends Article X (Dividends) of the Treaty by deleting and replacing paragraph 2(a) by the following:
"However, such dividends may also be taxed in the Contracting State of which the company paying the dividends is a resident and according to the laws of the State; but if a resident of the other Contracting State is the beneficial owner of such dividends, the tax so charged shall not exceed:
(i) 5 per cent of the gross amount of the dividends if the beneficial owner is a company which owns at least 10 per cent of the voting stock of the company paying the dividends (for this purpose, a company that is a resident of a Contracting State shall be considered to own the voting stock owned by an entity that is considered fiscally transparent under the laws of that State and that is not a resident of the Contracting State of which the company paying the dividends is a resident, in proportion to the company's ownership interest in that entity;"
The Protocol also deletes the existing Limitation on Benefits ("LOB") provision of the Treaty (i.e Article XXIX A) and replaces it with a bilateral LOB. The relevant provision of the proposed LOB provision is paragraph 3 of Article XXIX A which provides as follows:
"Where a person is a resident of a Contracting State and is not a qualifying person, and that person or a person related thereto, is engaged in the active conduct of a trade or business in that State (other than the business of making or managing investments, unless those activities are carried on with customers in the ordinary course of business by a bank, an insurance company, a registered securities dealer or a deposit-taking financial institution), the benefits of this Convention shall apply to that resident person with respect to income derived from the other Contracting State in connection with or incidental to that trade or business (including any such income derived directly or indirectly by that resident person through one or more other persons that are residents of that other State), but only if that trade or business is substantial in relation to the activity carried on in that other State giving rise to the income in respect of which benefits provided under this Convention by that other State are claimed."
Entry into Force of the Fifth Protocol
Pursuant to paragraph 2(a) of Article 27 of the Protocol, once the Protocol enters into force, its provisions shall have effect, in respect of taxes withheld at source, for amounts paid or credited on or after the first day of the second month that begins after the date on which the Protocol enters into force. If the Protocol enters into force in September, 2008, proposed new paragraph 2(a) of Article X and paragraph 3 of Article XXIX A of the Treaty will have effect as of November 1, 2008.
However, pursuant to paragraph 3(b) of Article 27 of the Protocol, notwithstanding paragraph 2 of Article 27 of the Protocol, new paragraph 7 of Article IV (Residence) of the Treaty (as added by Article 2 of the Protocol) shall have effect as of the first day of the third calendar year that ends after the Protocol enters into force. If the Protocol is ratified in 2008, new proposed paragraph 7 of Article IV of the Treaty will have effect as of January 1, 2010.
Since Can ULC is treated under the Canadian taxation law as a corporation that is resident in Canada but is treated under U.S. taxation law as a disregarded entity, when clause 7(b) of Article IV of the Treaty comes into effect, the dividend paid by Can ULC to US Holdco will not be considered to be paid or derived by US Holdco. As a result, the dividend will not benefit from the Treaty and will bear Canadian withholding tax at the rate of 25% pursuant to subsection 212(2) of the Act.
The issue in the case at hand relates only to whether (prior to the time clause 7(b) of Article IV of the Treaty comes into effect), paragraph 3 of Article XXIX A (LOB) will apply to allow US Holdco to claim the benefits of Article X of the Treaty.
LOB
Paragraph 3 of XXIX A of the Treaty provides rule under which US Holdco (which is not a qualifying person under paragraph 2 of Article XXIX A) may claim benefits with respect to items of income that are connected with the active conduct of a trade or business in its State of Residence (i.e. the U.S.).
Under this paragraph, a resident of the U.S (US Holdco) deriving an item of income from the other Contracting State (dividend income from Can ULC) is entitled to benefits with respect to that dividend income if:
i. that person (US Holdco) or person related to that person is engaged in an active trade or business in the State where it is resident (the U.S.);
ii. the income in question (dividend income) is derived in connection with, or is incidental to, that U.S. trade or business;
iii. and the size of the active trade or business in the residence State (the U.S.) is substantial relative to the activity in the other State (Canada) that gives rise to the income for which benefits are sought.
Condition (i)
According to the facts, US Opcos carry on a XXXXXXXXXX business in the U.S. Furthermore, US Co and US Opco are resident in the U.S. for the purposes of the Act and Article IV of the Treaty. Pursuant to subparagraph 251(2)(b)(i) of the Act, US Opcos and US Holdco are related. Accordingly, this condition is satisfied since a person related to US Holdco (i.e. US Opcos) is engaged in an active trade or business in the State where US Holdco is resident (the U.S.).
Condition (ii)
According to the facts, all or substantially all of Can ULC's income is derived from dividends paid by US Co (essentially out of dividends received by US Co from the US Opcos). Furthermore, upon Can ULC receiving a dividend on its shares of US Co, Can ULC generally would pay a dividend in an equivalent amount on its common shares to US Holdco. Thus, according to the facts, the dividend income is actually the income from the US trade or business carried on by the US Opcos. Accordingly, this condition is satisfied.
Condition (iii)
According to the facts, Can ULC's primary activity relates to the holding of the shares of US Co. Thus, the size of US Opcos active trade or business in the U.S. is substantial relative to Can ULC's activity in Canada. Accordingly, this condition is satisfied.
As a result, we are of the opinion that US Holdco satisfies paragraph 3 of Article XXIX A (LOB) and can benefit from the reduced rate of Canadian withholding tax in Article X of the Treaty, provided that US Holdco satisfies the conditions in Article X of the Treaty.
for Director
International & Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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