13 July 2009 External T.I. 2009-0318701E5 - Article X(2) and Tiered Partnerships

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: Application of ownership test in Article X(2)(a) of Convention, as amended by the Fifth Protocol, to dividends paid by a Canadian corporation to a partnership where a portion of the dividends is considered to be derived by a company that is a resident of the United States through another partnership that is a partner of the recipient partnership.

Position: In the circumstances described, the U.S.-resident company will be considered to own more than 10% of the voting shares of the corporation paying the dividend.

Reasons: The recipient partnership holds all of the shares of the Canadian corporation paying the dividend. As the U.S.-resident company is a partner of a partnership (the "top-tier partnership") that is a partner of the recipient partnership, the U.S.-resident company will be considered to have an ownership interest in the recipient partnership in proportion to its interest in the top-tier partnership. As the U.S.-resident company holds a 99.99% interest in the top-tier partnership, which in turn holds a 99.99% interest in the recipient partnership, the U.S.-resident company's ownership interest in the recipient partnership will be 99.98%, and therefore the U.S.-resident company will be considered to own 99.98% of the dividend payer's shares for the purposes of Article X(2)(a).

								2009-031870
XXXXXXXXXX 							J. MacGillivray
(613) 957-2053
July 13, 2009

Dear Madam:

Re: Article X(2) and Tiered Partnerships

We are writing in response to your e-mail of April 25, 2009, in which you have requested our views with respect to the application of Article X(2) of 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 by the Fifth Protocol signed on September 21, 2007 (the "Convention") in the following scenario:

• USco is a corporation incorporated under the laws of the United States. USco is not a fiscally transparent entity for United States income tax purposes. USco is a resident of the United States under Article IV of the Convention and a "qualifying person" under Article XXIX-A(2) of the Convention.
• USco is a limited partner of USLP1, which is a limited partnership established under the laws of the State of Delaware. USco's interest in USLP1 accords to USco a 99.99% share in USLP1's income and capital. Another United States entity is the general partner of USLP1, having a 0.01% interest in USLP1. USLP1 is a fiscally transparent entity for United States income tax purposes.
• USLP1 is a limited partner of USLP2, which is a limited partnership established under the laws of the State of Delaware. USLP1's interest in USLP2 accords to USLP1 a 99.99% share in USLP2's income and capital. Another United States entity is the general partner of USLP2, which holds a 0.01% interest in USLP2. USLP2 is a fiscally transparent entity for United States income tax purposes.
• USLP2 owns 100% of the shares of Canco, which is a "taxable Canadian corporation" and a "private corporation", within the meaning of those terms as defined in subsection 89(1) of the Income Tax Act (Canada) (the "Act").

You have advised that when Canco pays a dividend to USLP2, USco will be considered, for U.S. federal income tax purposes, to have received dividend income from Canco in proportion to USco's indirect percentage interest in Canco of 99.98%. Therefore, such portion of the dividends paid by Canco will be considered to be derived by USco for the purposes of the Convention.

You have asked us to comment on whether USco would be considered to own at least 10% of the shares of Canco for the purposes of Article X(2) of the Convention in order to determine the taxes that will be exigible under Part XIII of the Act from dividends that Canco will pay to USLP2.

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 a ruling, please refer to Information Circular 70-6R5, "Advance Income Tax Ruling", dated May 17, 2002. This Information Circular can be accessed on the Canada Revenue Agency's 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.

Pursuant to subsection 212(2) of the Act, each non-resident person shall pay a tax of 25% on every amount that a corporation resident in Canada pays or credits, or is deemed by Part I or Part XIV of the Act to pay or credit, to the non-resident person as, on account or in lieu of payment of, or in satisfaction of a taxable dividend (other than a capital gains dividend within the meaning assigned by subsection 130.1(4), 131(1) and 133(7.1)) or a capital dividend. Subsection 215(1) requires a corporation resident in Canada that pays a dividend to a non-resident person to deduct, withhold and remit the amount of the tax owing by the non-resident recipient under subsection 212(2) in respect of the dividend. For this purpose, paragraph 212(13.1)(b) deems a partnership that is not a "Canadian partnership", as defined in section 102, to be a non-resident person. Accordingly, where a corporation resident in Canada pays a taxable dividend (other than a capital gains dividend) or a capital dividend to a partnership that is not a Canadian partnership (i.e., a partnership with a partner that is not a resident of Canada for the purposes of the Act), the corporation must deduct, withhold and remit 25% of the amount of the dividend on account of taxes imposed pursuant to subsection 212(2).

However, where an income tax treaty or convention specifies a lower rate of Canadian tax that may be imposed in respect of the dividend, paragraph 10(6)(a) of the Income Tax Application Rules provides that the reference to the rate of 25% in subsection 212(2) shall be read as a reference to the lower rate in the treaty or convention. Where a corporation resident in Canada pays a dividend to a partnership and a partner of the partnership is a resident of a country for the purposes of the tax treaty between Canada and that country, it has been the position of the Canada Revenue Agency ("CRA") that, for the purposes of applying the provisions of the tax treaty concerning the taxation of dividends, the partner of the partnership can be considered the beneficial owner of a portion of the dividend to the extent of the partner's share of the dividend, and this portion of the dividend would be considered to be paid or credited to the partner. Accordingly, the corporation paying the dividend may withhold at the lower rate of tax specified in the treaty or convention in respect of the portion of the dividend beneficially owned by the partner.

In the context of the Convention, as it read prior to the enactment of the Fifth Protocol signed on September 21, 2007 (the "Fifth Protocol"), where a partner of a partnership was a company resident in the United States for the purposes of the Convention, it was the position of the CRA that the reduced rate of tax in Article X(2)(a) would not apply with respect to dividends beneficially owned by the company if the dividends were paid to the partnership unless the company directly owned at least 10% of the dividend payer's voting stock. In this regard, the CRA's position was that, as a matter of partnership law, one could not conclude that a partner of a partnership owned any particular property of the partnership, including a share of the capital stock of a corporation held by the partnership. It followed that a partner could not be considered to own a particular percentage of the shares of the corporation paying the dividend in determining whether the reduced rate of tax in Article X(2)(a) could apply to the portion of the dividend beneficially owned by the partner. Therefore, the rate of withholding tax eligible pursuant to subsection 212(2) in respect of that portion of the dividend was 15% by virtue of Article X(2)(b) of the Convention, as it read prior to the enactment of the Fifth Protocol.

With the enactment of the Fifth Protocol, Article X(2)(a) now provides that a company that is a resident of the United States, which beneficially owns dividends paid by a corporation resident in Canada, will be considered to own the voting stock of the corporation resident in Canada owned by an entity that is considered fiscally transparent under the laws of the United States, but not considered resident in Canada, in proportion to the company's ownership interest in the entity. Consequently, where a partnership that is fiscally transparent under United States domestic tax laws holds 100% of the shares of a corporation resident in Canada, a company that is a resident of the United States holding a 20% interest in the partnership will generally be considered to own 20% of the shares of the corporation resident in Canada for the purposes of applying Article X(2)(a) in respect of any dividends paid by the corporation resident in Canada to the partnership which are considered to be beneficially owned by the partner.

In the circumstances you have asked us to consider, it would be necessary to conclude that USco holds an ownership interest in USLP2 in order to attribute ownership of the shares of Canco to USco for the purposes of Article X(2). The term "ownership interest" is not defined in the Convention; however, this term would clearly encompass equity interests typically associated with fiscally transparent entities, such as partnership interests, membership interests in limited liability companies and shares of companies or corporations. In our view, where a United States-resident company derives dividend income that is beneficially owned by the company and the income is derived as a consequence of the payment of a dividend by a corporation resident in Canada to a fiscally transparent entity (the "recipient entity"), the United States-resident company will also be considered to have an ownership interest in the recipient entity for the purposes of Article X(2)(a) where the ownership interest is held through another entity (other than an entity that is a resident of Canada) considered fiscally transparent under United States domestic tax laws. In such cases, the determination of the company's ownership interest in the recipient entity will be a question of fact.

In the circumstances you have asked us to consider, we are of the view that USco would be considered to hold an ownership interest in USLP2 by virtue of holding a partnership interest in USLP1. USco's proportionate interest in USLP2 would be equal to 99.99% of the 99.99% partnership interest USLP1 holds in USLP2, with the result that USco would be considered to own approximately 99.98% of the shares of Canco for the purposes of applying Article X(2)(a) to the portion of any dividends paid by Canco that are considered to be beneficially owned by USco.

In the foregoing scenario, it may be relatively straightforward for Canco to ascertain the degree of USco's ownership interest in USLP2 and the portion of the dividends that will be beneficially owned by USco in order to determine the portion of the dividends that are subject to the reduced rate of Part XIII dividend withholding tax. However, in other circumstances, the payer of the dividends may not be able to make such determinations. In such cases, withholding taxes on dividends paid to the partnership should be deducted at the full Part XIII withholding rate of 25%. In such cases, it will be necessary to apply for a refund of the taxes withheld in excess of the applicable rate under the Convention.

Our comments are provided in accordance with the practice outlined in paragraph 22 of Information Circular IC-70-6R5.

Yours truly,

for Director
International and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch