21 December 2009 External T.I. 2009-0330491E5 - Article XXI Exemption

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: 1) Whether U.S.-resident non-profit organizations are exempt from Canadian taxation with respect to Canadian-source income and gains derived through a chain of fiscally transparent entities that are not residents of Canada. 2) Whether exemptions will apply to dividend and interest income paid by a taxable Canadian corporation to a partnership that holds the majority of its voting shares if the organizations indirectly hold a minority interest in that partnership through a chain of entities that are fiscally transparent for United States tax purposes (other than Canadian-resident entities). 3) If exemption applies to an income amount the non-profit organizations are considered to derive under Article IV(6), can the exemption be taken into account in determining the amount of required Part XIII withholdings. 4) Which information slip should be issued in such circumstances and to whom.

Position: 1) Generally yes. 2) Generally yes. 3) Exemption can be taken into account in determining Part XIII withholdings, but payor should exercise caution in this regard given prospect of liability for Part XIII taxes and the associated penalty if withholdings are insufficient. 4) The NR4 should be issued to the partnership.

Reasons: 1) Wording of provision, but provided income is exempt from tax in the United States, is not from carrying on a business and is not from a related person (other than related persons referred to in Articles XXI(1),(2) or (3). 2) The partnership's majority interest in the taxable Canadian corporation will not be attributed to the non-profit organizations.

								2009-033049
XXXXXXXXXX 							J. MacGillivray
(613) 957-2103
December 22, 2009

Dear Sir:

Re: Technical Interpretation Request - Limited Liability Company

We are writing in response to your letter of June 30, 2009 in which you requested our comments on the interpretation 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 context of the following hypothetical situation:

1. Two non-profit organizations, referred to herein as "USNPO1" and "USNPO2", are generally exempt from income taxation in the United States. USNPO1 and USNPO2 are both residents of the United States for the purposes of the Convention and "qualifying persons" within the meaning of Article XXIX-A of the Convention.

2. In accordance with Article XXI(1) of the Convention, income derived by USNPO1 and USNPO2, which would otherwise be subject to tax under the Income Tax Act (Canada), R.S.C. 1985, c. 1, as amended (the "Act"), is exempt from income tax in Canada to the extent such income is exempt from tax in the United States. Canadian-source interest, dividends, royalties and gains derived by USNPO1 and USNPO2 are therefore exempt from Canadian income tax, provided that such income or gains are not from carrying on a trade or business or from related persons who are not exempt from Canadian tax under Articles XXI(1) or (3).

3. USNPO1 and USNPO2 hold 99.8% and 0.2% membership interests, respectively, of a limited liability company formed under the laws of the State of Delaware ("USLLC1"). USLLC1 is the sole member of another limited liability company formed under the laws of the State of Delaware ("USLLC2").

4. USLLC2 holds more than 0.2%, but at all times less than 50%, of the limited partnership units of an investment fund structured as a limited partnership under the laws of the State of Delaware ("LP Fund"). None of the other partners of the LP Fund are related to USNPO1 or USNPO2.

5. The LP Fund acquires debt and shares in corporations that are residents of Canada and receives payments of interest and dividends from those corporations. The LP Fund could also realize capital gains from the disposition of taxable Canadian property on the sale of its interest in these corporations.

6. The LP Fund does not carry on business in Canada within the meaning of s. 2(3) and s. 253 of the Act.

7. None of USLLC1, USLLC2 and the LP Fund has elected to be treated as a corporation under United States domestic tax law. Each entity is thereby considered fiscally transparent for United States income tax purposes. USLLC1 and USLLC2 are each considered to be corporations for the purposes of the Act, while the LP Fund is fiscally transparent for the purposes of the Act. The Canadian-resident corporations in which the LP Fund invests are not considered to be fiscally transparent for both Canadian and United States income tax purposes.

8. The amount of any dividends or interest paid by the Canadian-resident corporations to LP Fund allocable to USLLC2 will be considered to be dividend income or interest income, as the case may be, derived by USNPO1 and USNPO2 for United States income tax purposes.

You have asked us to confirm that USNPO1 and USNPO2 will not be related to Canadian-resident corporations in which the LP Fund holds the majority of voting shares for the purposes of Article XXI of the Convention. In the event USNPO1 and USNPO2 are not related to such corporations, you have asked us to confirm that income received by LP Fund from these corporations and gains realized by the LP Fund from the disposition of shares of these corporations will be exempt from tax in Canada under Article XXI(1) of the Convention to the extent such income and gains are allocable to LLC2. Assuming income received by the LP Fund that is allocable to LLC2 is considered to be derived by USNPO1 and USNPO2 and is exempt from Canadian tax under Article XXI(1), you then ask whether the Canadian-resident payor is required to deduct, withhold, and remit tax under Part XIII of the Act with respect to that income. Finally, you ask whether a T5 information slip must be issued in the name of USNPO1 and USNPO2 with respect to the Canadian-source income that each organization is considered to derive through the LP Fund.

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 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.

Income derived by a religious, scientific, literary, educational or charitable organization (a "non-profit organization") resident in the United States that is a qualifying person under Article XXIX-A of the Convention shall be exempt from tax in Canada under Article XXI(1) of the Convention to the extent the income derived by the organization is exempt from tax in the United States. However, Article XXI(4) provides that the exemption from Canadian tax in Article XXI(1) will not apply to income derived by a non-profit organization from carrying on a trade or business or from a person related to the organization (other than another related non-profit organization or a related trust, company or other arrangement that is itself operated exclusively to earn income for the benefit of one or more non-profit organizations or trusts, companies or other arrangements described in Article XXI(2)).

An amount of income, profit or gain will be considered to be derived by a non-profit organization resident in the United States under Article IV(6) of the Convention if, under United States income tax laws, the organization would be considered to derive the amount through a fiscally transparent entity that is not a resident of Canada, provided that the United States income tax treatment of the amount would be the same had the organization derived the amount directly. Where a non-profit organization is considered to derive an amount of Canadian-source income (including dividends and interest) or gains through one or more fiscally transparent entities that are not residents of Canada, the non-profit organization will be considered to derive the amount for the purposes of applying Article XXI, provided that the treatment of the amount for United States tax purposes is the same as its treatment would be had the organization derived the income directly.

Accordingly, where a non-profit organization resident in the United States is considered under United States taxation laws to derive Canadian-source income or gains through holdings in one or more tiers of fiscally transparent limited liability companies or partnerships, the income or gains will, subject to Article XXI(4), be eligible for the exemption in Article XXI(1). However, where an amount of Canadian-source income or gain is received from a Canadian-resident entity that is fiscally transparent for United States income tax purposes, the organization will not be considered to derive the amount pursuant to Article IV(7)(b) if the United States income tax treatment of the amount is different than the treatment would be if the Canadian-resident entity were not fiscally transparent.

The definition of "related person" in section 251 of the Act will be applied to determine if a person is related to a non-profit organization for the purpose of Article XXI(4). Where a fiscally transparent entity through which a non-profit organization derives income holds de jure control of a corporation, the CRA will not attribute the relationship between the entity and the corporation to the non-profit organization in determining whether income paid by the corporation is income from a related person under Article XXI(4). Instead, where the conditions of Article IV(6) of the Convention are satisfied in respect of an amount derived by a non-profit organization through a fiscally transparent entity (or through multiple tiers of fiscally transparent entities), the CRA will determine whether the non-profit organization is related to a corporation controlled by the entity on the same basis that would be applied to determine if a shareholder of a corporation were related to a subsidiary of the corporation.

We would therefore not consider a non-profit organization to be related to a corporation for Article XXI purposes solely because the organization is a minority partner of a partnership (or is related to such a minority partner) that holds a majority of the voting shares of the corporation. Assuming that a non-profit organization in such circumstances could not otherwise be considered to be related to the corporation in which the partnership holds majority voting power, the non-profit organization's share of interest or dividends paid or credited to the partnership by the corporations will be exempt from tax under Part XIII of the Act to the extent that income is derived by the non-profit organization for United States income tax purposes. In addition, the non-profit organization's share of gains realized by the partnership from a disposition of shares of the corporation will be exempt from tax under the Act to the extent those gains are derived by the non-profit organization for United States income tax purposes.

Pursuant to paragraph 212(13.1)(b) of the Act, where a person resident in Canada pays or credits an amount to a partnership (other than a Canadian partnership as defined in section 102), the partnership shall, for the purposes of Part XIII of the Act (other than section 216), be deemed to be a non-resident person. Consequently, a Canadian-resident corporation that pays or credits interest or dividends subject to tax under Part XIII of the Act to a partnership that is not a Canadian partnership is required under subsection 215(1) to deduct or withhold 25% from the amount paid or credited. The corporation is then required to remit the amount deducted or withheld forthwith to the Receiver General on behalf of the partnership and to submit with the remittance a statement in prescribed form.

Where income is paid or credited to an entity that is fiscally transparent for United States tax purposes (other than an entity that is a resident of Canada) and an amount in respect of that income is considered to be derived by a non-profit organization through one or more such entities under the Convention, the amount so derived that is exempt from tax in Canada by virtue of Article XXI of the Convention may be excluded in determining the amount to be withheld or deducted from the payment (or amount credited) under Part XIII of the Act. However, in the event a person fails to deduct or withhold an amount required by section 215 of the Act from an amount paid or credited, that person becomes liable to pay as tax under Part XIII on behalf of the non-resident person the whole of the amount that should have been deducted or withheld. In addition, that person is liable to a penalty under subsection 227(8) of 10% of the amount that should have been deducted or withheld or, where at the time of the failure to deduct or withhold the appropriate amount, a penalty under subsection 227(8) was payable by the person in respect of an amount that should have been deducted or withheld during the year, and the failure was made knowingly or under circumstances amounting to gross negligence, 20% of the amount.

Before deciding to reduce the amount of Part XIII deductions or withholdings from a payment of this nature, any person responsible for deducting or withholding amounts on account of Part XIII tax is advised to obtain sufficient information to ascertain the particular amount that will be considered to be derived by the non-profit organization and exempted from Canadian tax under the Convention. A non-profit organization could provide the responsible person with information that would illustrate how the non-profit organization is considered to derive the income amount to be paid for the purposes of the Convention and provide certifications in respect of that information. In this regard, a non-profit organization could present the responsible person with the information asked for in Draft Form NR301, Declaration of Benefits Under a Tax Treaty for a Non-Resident Taxpayer, Draft Form NR302 Declaration of Benefits Under a Tax Treaty for a Partnership With Non-Resident Partners and/or Draft Form NR303, Declaration of Benefits Under a Tax Treaty for a Hybrid Entity and certify the correctness of that information to the responsible person

Finally, where a person resident in Canada pays or credits an amount of interest or dividends to a partnership (other than a Canadian partnership), or is deemed to do so under Part I or Part XIII of the Act, the person is required to issue a Form NR4 Statement of Amount Paid or Credited to Non-Residents of Canada to the partnership on or before the last day of March following the calendar year in which the amount is paid or credited. This procedure applies notwithstanding that a resident of the United States is considered to derive the amount of income paid or credited to the partnership (or a portion of the amount paid) by virtue of Article IV(6) of the Convention. For more information concerning the completion of NR4 information slips, please consult Guide T4061, NR4 - Non-Resident Tax Withholding, Remitting and Reporting.

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