11 March 2010 External T.I. 2009-0346291E5 - Article IV(7)(b) of the Canada-U.S. Tax Convention

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 Article IV(7)(b) of the Convention apply in the scenarios described below?

Position: See response

XXXXXXXXXX 								2009-034629
									Katharine Skulski
March 11, 2010 

Dear XXXXXXXXXX :

Re: Article IV(7)(b) of the Canada-United States Tax Convention (1980) (the "Treaty")

This is in response to your letter of November 2, 2009 concerning the application of Article IV(7)(b) of the Treaty in the scenarios described below:

Scenario 1

USCo is a resident of the United States for the purposes of the Treaty. USCo owns all of the shares of an unlimited liability company ("ULC") that is resident in Canada for purposes of the Income Tax Act (Canada) (the "Act") and a resident of Canada for the purposes of the Treaty. The ULC is a disregarded entity under the taxation laws of the United States and, therefore, is fiscally transparent under those laws.

You have asked us whether Article IV(7)(b) would apply to any gains realized by USCo from a disposition, after 2009, of the shares of the ULC to an arm's length purchaser. You also asked us whether Article IV(7)(b) would apply to income or gains that may be realized by USCo as a consequence of a redemption, after 2009, of a portion of the shares of the ULC held by USCo.

Scenario 2

USCo1 is a resident of the United States for the purposes of the Treaty. USCo1 owns 50% of the issued and outstanding shares of an unlimited liability company ("ULCo") that is resident in Canada for purposes of the Act and a resident of Canada for the purposes of the Treaty. USCo2 owns the other 50% of the shares of the ULCo. ULCo is treated as a partnership under the taxation laws of the United States and, therefore, is fiscally transparent under those laws.

You have asked us whether Article IV(7)(b) would apply to any income or gains realized by USCo1 from a disposition of shares of ULCo, after 2009, to a person that does not deal at arm's length with USCo1. You also asked us whether Article IV(7)(b) would apply to income or gains realized by USCo1 as a consequence of a redemption, after 2009, of a portion of the shares of ULCo held by USCo1.

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 Rulings", dated May 17, 2002. This Information Circular and other Canada Revenue Agency ("CRA") publications can be accessed on the CRA website at http://www.cra-arc.gc.ca. We are, however, prepared to provide the following general comments which we trust will be of some assistance.

Article IV(7)(b) of the Treaty provides that:

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.

In our view, where a resident of the United States realizes a gain from the disposition of taxable Canadian property, the resident will be considered, by reason of Article IV(7)(b), not to have derived the gain for the purposes of the Treaty, if the resident receives the proceeds of disposition from a Canadian-resident entity that is fiscally transparent for United States tax purposes and, by reason of that fiscal transparency, the treatment of the disposition for United States tax purposes is not the same as it would be if the Canadian-resident entity were not fiscally transparent.

The assessment of whether the treatment of an amount referred to in Article IV(7)(b) is not the same is made with reference to the quantum and character of the amount and the timing of the inclusion (if any) of the amount in the income of the resident under the taxation laws of the United States. Our views on the meaning of "same treatment" are set out in document 2009-031849.

Scenario 1

In Scenario 1, Article IV(7)(b) would not apply to a gain realized by USCo from the disposition of the shares of ULC to the arm's-length purchaser unless the purchaser is a resident of Canada and by reason of the purchaser being fiscally transparent under the laws of the United States, the United States tax treatment of the disposition is not the same as its treatment would be if the purchaser were not fiscally transparent.

Where shares of ULC held by USCo are redeemed, Article IV(7)(b) would apply to treat any dividend deemed to be paid by ULC to USCo under the Act as not having been paid to USCo for purposes of the Treaty. In such circumstances, it is our understanding that the fiscal transparency of ULC causes the redemption to be disregarded for United States tax purposes. On the other hand, if ULC were not fiscally transparent, the redemption proceeds would, for United States tax purposes, be treated as a dividend and/or a reduction of capital on the shares of ULC. For similar reasons, Article IV(7)(b) would also apply to any gain realized by USCo on the redemption of the shares of ULC (which gain would occur if the "paid-up capital" of the redeemed shares exceeded the adjusted cost base of those shares to USCo).

Scenario 2

In Scenario 2, USCo1 could realize a gain on the sale of the shares of ULCo and, depending on the circumstances, be deemed to have received a dividend pursuant to section 212.1 of the Act. In these circumstances, Article IV(7)(b) will not apply unless the purchaser is a resident of Canada and by reason of the purchaser being fiscally transparent under the laws of the United States, the United States tax treatment of the disposition is not the same as its treatment would be if the purchaser were not fiscally transparent.

Where shares of ULCo held by USCo1 are redeemed, Article IV(7)(b) would apply to treat any dividend deemed to be paid by ULCo to USCo1 under the Act as not having been paid to USCo1 for purposes of the Treaty. In such circumstances, it is our understanding that the redemption proceeds would be treated, for United States tax purposes, as a distribution from a partnership whereas the redemption proceeds would be treated as a dividend and/or a reduction of capital on the shares of ULCo if ULCo were not fiscally transparent. For similar reasons, Article IV(7)(b) would also apply to any gain realized by USCo1 on the redemption of the shares of ULCo (which gain would occur if the "paid-up capital" of the redeemed shares exceeded the adjusted cost base of those shares to USCo1).

We trust that these comments will be of assistance.

Yours truly,

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