25 February 2010 External T.I. 2008-0302321E5 - Article XXI(2) Canada-Israel Treaty

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: Whether an Israeli resident individual which benefits from a tax holiday in Israel is entitled to the benefit of paragraph 2 of Article XXI of the Canada-Israel Treaty (i.e. reduced withholding rate of 15%) on income arising in Canada from an estate or trust?

Position: No

Reasons: See below

XXXXXXXXXX 								2008-030232
									Angelina Argento
February 25, 2010

Dear XXXXXXXXXX ,

Re: Paragraph 2 of Article XXI of the Canada-Israel Income Tax Convention (the "Treaty")

This is in response to your email sent on December 2, 2008 wherein you inquired whether an individual who is a new immigrant of Israel and who is granted an exemption from paying Israeli income tax for the first few years of residence in Israel, is entitled to the benefit of paragraph 2 of Article XXI of the Treaty (i.e. reduced withholding rate of 15%) on income arising in Canada from an estate or trust.

OUR COMMENTS

Written confirmation of the 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 submitted in the manner set out in Information Circular 70-6R5, Advance Income Tax Rulings, dated May 17, 2002. Where the particular transactions are completed, the inquiry should be addressed to the relevant Tax Services Office. However, we have considered your situation and provide the general comments set out below.

Paragraph 2 of Article XXI of the Treaty

Paragraph 2 of Article XXI of the Treaty provides as follows:

"However, if such income is derived by a resident of a Contracting State from sources in the other Contracting State, such income may also be taxed in the State in which it arises, and according to the law of that State. However, in the case of income from an estate or trust, the tax so charged shall, provided that the income is taxable in the Contracting State in which the recipient resides, not exceed 15 per cent of the gross amount of the income." (Emphasis added).

Residence for purposes of the Treaty

In order to qualify for the benefits under the Treaty, the individual must be considered a resident of Israel for the purposes of Treaty. To be a resident of Israel, the individual must be "liable to tax" in Israel by virtue of a criterion referred to in the residence article of the Treaty. In particular, paragraph 1 of Article IV of the Treaty states as follows:

"For the purposes of this Convention, the term "resident of a Contracting State" means any person who, under the law of that State, is liable to taxation therein by reason of his domicile, residence, place of management or any other criterion of a similar nature."

As stated in Income Tax Technical News Issue No. 35, dated February 26, 2007 ("ITTN #35"), it has been the long-standing position of the Canada Revenue Agency ("CRA") that, to be considered "liable to tax" for the purposes of the residence article of our treaties, a person must be subject to the most comprehensive form of taxation as exists in the relevant country. For Canada, this generally means full tax liability on worldwide income. This is supported by the comments found in the Supreme Court decision The Queen v. Crown Forest Industries Ltd et al (95 DTC 5389) as well as the Commentary to Article IV of the OECD Model.

However, we also stated in ITTN #35 that this does not necessarily mean that a person must pay tax to a particular jurisdiction. There may be situations where a person's worldwide income is subject to a Contracting State's full taxing jurisdiction but that state's domestic law does not levy tax on a person's taxable income or taxes it at low rates. In these cases, the CRA will generally accept that the person is a resident of the other Contracting State unless the arrangement is abusive (e.g. treaty shopping where the person is in fact only a "resident of convenience").

It is our understanding that pursuant to the Israel Income Tax Ordinance ("Israeli Ordinance"), Israeli income tax is imposed on the worldwide income of Israeli residents (endnote 1) at rates which are comparable to Canadian tax rates. It is also our understanding that pursuant to the Israeli Ordinance, a new resident ("NR")" is liable to tax in Israel on the basis of residency; however the NR is granted an exemption from Israeli income tax during the first ten years following the date on which the individual became an Israeli resident. This exemption applies to income (either passive or active) produced or accrued outside Israel or sourced in assets situated outside Israel. A NR is an individual who was not a resident of Israel and became a resident of Israel. NRs may waive the exemption in whole or in part.

Since, but for the exemption, the NR would be subject to Israeli tax on the most comprehensive basis of taxation that exists in Israel (i.e. worldwide taxation), we are of the view that the NR would be considered a resident of Israel within the meaning of Article IV of the Treaty.

We also understand that a NR has the right to elect not to be considered an Israeli resident for Israeli tax purposes during one year, beginning on the date of immigration to Israel, provided that such individual submits a written election/notice to the Israeli assessing officer within 90 days after the individual's arrival in Israel. We are of the view that if the NR makes this election and is deemed not resident in Israel under the provisions of the Israel Ordinance, for the relevant period (i.e. during the first year after their immigration to Israel), the NR would not be "liable to tax" in Israel "by reason of domicile, residence, place of management or any other criterion of a similar nature" for purposes of Article IV(1) of the Treaty and accordingly, would not benefit from the Treaty.

Meaning of "income is taxable in the Contracting State in which the recipient resides"

The issue in Article XXI is whether or not the particular income in question must actually be taxed in the recipient's State of Residence in order to be considered "income (that) is taxable in the Contracting State in which the recipient resides" as stipulated in paragraph 2 of Article XXI of the Treaty. In other words, does the word "taxable" mean "actually taxed" or simply "liable to tax" in the recipient's State of Residence?

Interpreting the limiting words "provided that the income is taxable in the Contracting State in which the recipient resides" (as stipulated in paragraph 2 of Article XXI of the Treaty) in the same manner as "liable to tax" in paragraph 1 of Article IV of the Treaty, would render the limiting words in paragraph 2 of Article XXI meaningless. That is, the Treaty benefit (i.e. the reduced 15% Canadian withholding tax rate) would always be granted (regardless of whether the income is exempt from Israel tax or subject to tax in Israel). Such interpretation would be contrary to the principles of statutory interpretation.

It is our position that for the purposes of paragraph 2 of Article XXI of the Treaty, it does not suffice that a person is considered "liable to tax" for the purposes of Article IV of the Treaty. Instead, for the purposes of paragraph 2 of Article XXI of the Treaty, only income which is included in the computation of taxable income for Israeli tax purposes and thus, subject to tax in Israel, can benefit from the reduced 15% Canadian withholding tax. Accordingly, we are of the view that a NR (who has not made the election to be considered a non-resident of Israel for tax purposes during the first year after the date of immigration to Israel) is not entitled to the benefit of paragraph 2 of Article XXI of the Treaty on income arising in Canada from an estate or trust for the duration of the 10 year exemption (notwithstanding that the individual is considered a resident of Israel for the purposes of Article IV of the Treaty).

We distinguish the present situation from the one in Technical Interpretation Document 9108375 dated April 17, 1991, which deals with income received by a charity - an entity that is generally treated as being entitled to treaty benefits notwithstanding that it may be entitled to an exemption from taxation in its state of residence. This context does not exist when considering the application of paragraph 2 of Article XXI of the Treaty to individuals. The absence of such context precludes us from moderating our view that there is an expectation that the particular item of income received by an individual should be included in the computation of taxable income in the state of the individual's residence in order to benefit from the reduced rate of tax.

As stated in paragraph 22 of Information Circular 70-6R4, the above comments do not constitute an income tax ruling and accordingly are not binding on the Canada Revenue Agency in respect of any particular situation.

Yours truly,

Olli Laurikainen, C.A.

For Director
International & Trusts Division
Income Tax Rulings Directorate
Legislative and Regulatory Affairs Branch

ENDNOTES

1 It is our understanding that an individual will be considered an Israeli resident if the individual's center of life is in Israel.