2014 Ruling 2013-0491331R3 - Introduction of a partnership and Art.IV(7)(b)

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 Article IV(7)(b) applies to a subsection 84(1) deemed dividend. 2. Whether Article IV(7)(b) applies to interest payments from a fiscally transparent ULC to a U.S. limited partnership, where the partners of the limited partnership are a U.S. resident S-Corporation and a U.S. resident shareholder of the S-Corporation. 3. Whether 245(2) applies to the proposed transactions.

Position: 1. No. 2. No. 3. Not in these circumstances.

Reasons: 1. Article IV(7)(b) does not apply because the deemed dividend is subject to the same treatment under the taxation laws of the United States as it would be if the dividend payer were not fiscally transparent. 2. The U.S. resident S-Corporation is required to include the interest in the computation of its United States income tax liability for U.S. federal income tax purposes. 3. Does not frustrate or defeat the underlying purpose/rationale of Article IV(7)(b), provided the full income of ULC and ULC-2 is subject to tax in the U.S. on a current basis.

XXXXXXXXXX
2013-049133

XXXXXXXXXX, 2014

Dear XXXXXXXXXX:

Re: XXXXXXXXXX
Advance Income Tax Ruling Request

We are writing in response to your original letter of XXXXXXXXXX, with supplemental information provided on XXXXXXXXXX, and as further amended on XXXXXXXXXX, in which you requested an Advance Income Tax Ruling ("Ruling") on behalf of the above named taxpayers. We also acknowledge the information provided in subsequent e-mail correspondence, and in the course of various telephone conversations (XXXXXXXXXX) in connection with your request.

We understand that, to the best of your knowledge and that of the taxpayers involved, none of the issues involved in the Ruling request are:

(i) in an earlier return of the taxpayers or persons related to the taxpayers;

(ii) being considered by a Tax Services Office or Taxation Centre in connection with a previously filed tax return of the taxpayers or persons related to the taxpayers;

(iii) under objection by the taxpayers or persons related to the taxpayers;

(iv) before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has not expired; or

(v) the subject of a Ruling previously issued by the Income Tax Rulings Directorate.

Unless otherwise stated, all statutory references herein are to the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.), as amended (hereinafter referred to as the "Act") and conditions used herein that are defined in the Act have the meaning given in such definition unless otherwise indicated. Unless otherwise noted, all references to monetary amounts are in Canadian dollars.

Our understanding of the facts, proposed transactions and the purpose of the proposed transactions is as follows:

Definitions

In this letter, the following terms have the meanings specified below:

• "accrued unpaid interest" means interest payable pursuant to the U.S. Note at the time of the Proposed Transactions;
• "arm's length" has the meaning assigned by section 251;
• "capital account" in respect of the share capital of a corporation has the meaning assigned by the statute by which the corporation is governed;
• "XXXXXXXXXX" means the Companies Act (XXXXXXXXXX), as amended;
• "CRA" means the Canada Revenue Agency;
• "IRC" means the U.S. Internal Revenue Code of 1986, 26 U.S.C., as amended;
• "FMV" means the fair market value, being the highest price available in an open and unrestricted market between informed prudent parties acting at arm's length and without compulsion to act, expressed in terms of cash;
• "General Partner" means U.S. Parent;
• "IRS" means the Internal Revenue Service (United States);
• "Limited Partner" means a U.S. individual who qualifies as a resident of the United States for purposes of the U.S. Treaty;
• "LOB" means Article XXIX-A Limitation on Benefits provision of the U.S. Treaty;
• "LP" means the proposed limited partnership to be formed under the laws of XXXXXXXXXX;
• "PUC" means paid-up capital which has the meaning assigned by subsection 89(1);
• "paragraph" means a numbered paragraph in this letter;
• "principal amount" has the meaning assigned by subsection 248(1);
• "private corporation" has the meaning assigned by subsection 89(1);
• "Related persons" has the meaning assigned by subsection 251(2);
• "S Corporation" means a corporation that has made a valid election under the IRC to be taxed in accordance with Subchapter S of Chapter 1 of the IRC;
• "taxable Canadian corporation" has the meaning assigned by subsection 89(1);
• "ULC" means XXXXXXXXXX;
• "ULC-2" means XXXXXXXXXX;
• "United States" or "U.S." means the United States of America;
• "U.S. Note " means the interest-bearing promissory note in the principal amount of USD$XXXXXXXXXX issued by ULC to U.S. Parent and maturing on XXXXXXXXXX, as described in paragraph 7 of this letter;
• "U.S. Parent" means XXXXXXXXXX;
• "U.S. Shareholders" means the U.S. resident individuals and trusts for the benefit of U.S. resident individuals, together owning all of the issued shares of U.S. Parent; and
• "U.S. Treaty" means Convention Between Canada and the United States of America With Respect to Taxes on Income and on Capital, signed on 26 September 1980, as amended by the protocols signed on 14 June 1983, 28 March 1984, 17 March 1995, 29 July 1997 and 21 September 2007.

Facts

1. ULC is an unlimited liability company formed under the laws of XXXXXXXXXX and is a taxable Canadian corporation and a private corporation for purposes of the Act. ULC is fiscally transparent or "disregarded" for U.S. federal income tax purposes and directly carries on the business operations in Canada, XXXXXXXXXX, of XXXXXXXXXX. ULC's business number is XXXXXXXXXX and it has a taxation year end of XXXXXXXXXX. The authorized share capital of ULC consists of XXXXXXXXXX common shares without nominal or par value. The issued share capital consists of XXXXXXXXXX common shares issued to U.S. Parent. The PUC of the common shares at the time of this letter is approximately $XXXXXXXXXX. The retained earnings of ULC at XXXXXXXXXX, were $XXXXXXXXXX. ULC is serviced by the XXXXXXXXXX Tax Services Office and Tax Centre.

2. ULC-2 is a wholly-owned subsidiary of ULC and an unlimited liability company formed under the laws of XXXXXXXXXX. It is a taxable Canadian corporation and a private corporation for purposes of the Act. ULC-2 is fiscally transparent or "disregarded" for U.S. federal income tax purposes and carries on business operations in the province of XXXXXXXXXX that are similar to those of ULC. ULC-2's business number is XXXXXXXXXX and it has a taxation year end of XXXXXXXXXX. ULC-2 is serviced by the XXXXXXXXXX Tax Services Office and Tax Centre.

3. U.S. Parent is a corporation formed under the laws of the U.S. State of XXXXXXXXXX. Headquartered in XXXXXXXXXX, U.S. Parent is recognized as one of the largest XXXXXXXXXX companies in North America. Founded in XXXXXXXXXX, U.S. Parent is a privately-held company XXXXXXXXXX. U.S. Parent is the sole shareholder of ULC and the beneficial owner of any dividends or other distributions on the shares of ULC.

4. U.S. Parent has elected under the IRC to be treated as an S Corporation such that for U.S. tax purposes, each of the shareholders of U.S. Parent will generally be required to include a proportionate share of U.S. Parent's income or loss, including the income of ULC and ULC-2, in the computation of that shareholder's taxable income under the IRC on an annual basis. As required under the IRC, in order for U.S. Parent to elect to qualify as an S Corporation, all of the shareholders must be U.S. resident individuals, or trusts whose beneficiaries are U.S. resident individuals.

5. U.S. Parent's business carried on in the United States is similar to the Canadian businesses of ULC and ULC-2, and the operations are profitable. U.S. Parent does not carry on business in Canada, and does not have a permanent establishment in Canada.

6. U.S. Parent is a qualifying person for purposes of Article XXIX-A(1) of the U.S. Treaty by reason of Article XXIX-A(2)(e). All of the U.S. Shareholders are qualifying persons for purposes of Article XXIX-A(1) of the U.S. Treaty by virtue of Article XXIX-A(2)(a) or (e), as appropriate.

7. The U.S. Note, which was issued by ULC on XXXXXXXXXX, has a principal amount of USD$XXXXXXXXXX which is due on XXXXXXXXXX, and bears interest on the outstanding principal balance calculated and payable monthly in arrears on the last day of each and every month at the rate of XXXXXXXXXX% per annum. Interest is payable at the same rate on any overdue interest. U.S. Parent has the right to assign the U.S. Note, which following any such assignment remains binding upon ULC. To date, accrued interest up to XXXXXXXXXX has been paid and withholding tax of 25% of the gross payment has been remitted to the CRA. Accrued unpaid interest at XXXXXXXXXX, is USD$XXXXXXXXXX. The proceeds of the U.S. Note were used by ULC to pay a dividend to U.S. Parent on XXXXXXXXXX. Since the coming into force of the Fifth Protocol to the U.S. Treaty, Article IV(7)(b) has applied to payments of interest made by ULC that are subject to Canadian domestic withholding tax due to the fiscally transparent status of ULC for U.S. federal income tax purposes. As a result of this status, the operations of ULC are treated as a branch of U.S. Parent, such that interest paid by ULC to U.S. Parent is ignored for U.S. federal income tax purposes, which is not the same treatment as would be the case if ULC were not fiscally transparent for U.S. federal tax purposes.

8. ULC and U.S. Parent maintain documentation supporting the arm's length nature of the terms and conditions of the U.S. Note, including the interest rate. Further, at all relevant times, ULC should meet the 1.5:1 debt to equity requirements such that there should not be interest expense denied for Canadian tax purposes under subsection 18(4) of the Act.

Proposed Transactions

9. U.S. Parent together with a U.S. resident individual shareholder of U.S. Parent will form LP in the U.S. under the partnership laws of the State of XXXXXXXXXX. The U.S. resident individual will be the Limited Partner and will have a XXXXXXXXXX% interest in the income of LP. U.S. Parent will be the General Partner and will have a XXXXXXXXXX% interest in the income of LP. LP will be treated as a partnership for U.S. tax purposes. LP will have a fiscal period end of XXXXXXXXXX.

10. U.S. Parent will assign the U.S. Note to LP as a contribution to partnership capital. Accrued unpaid interest thereon will either be paid in full prior to the assignment of the U.S. Note, or will remain a receivable of U.S. Parent. U.S. Parent's partnership capital account will increase by an amount equal to the FMV of the capital contribution made by U.S. Parent.

11. The Limited Partner will contribute cash equal to XXXXXXXXXX% of the FMV of the capital contribution made by U.S. Parent. The Limited Partner's capital will increase by an amount equal to the cash contribution.

12. ULC will pass a special resolution authorizing ULC to add $XXXXXXXXXX that is currently credited to ULC's retained earnings account to the capital account maintained in respect of the common shares of ULC. ULC will add the amount so authorized to the capital account. ULC will be deemed, pursuant to subsection 84(1) of the Act, to pay a dividend on its issued and outstanding common shares equal to the amount of the increase in the PUC of the common shares of ULC, and ULC's sole shareholder, U.S. Parent, will be deemed to receive a dividend equal to $XXXXXXXXXX, being the amount of that increase. ULC will remit the appropriate amount of taxes to the Receiver General pursuant to Part XIII of the Act in respect of the deemed dividend and U.S. Parent will agree to reimburse ULC for such amount.

13. After the capital account maintained in respect of the common shares of ULC has been increased as described in paragraph 12, U.S. Parent will pass a special resolution authorizing U.S. Parent to reduce the capital of ULC's common shares by an amount $XXXXXXXXXX. ULC will return that amount of capital to U.S. Parent by distributing cash and setting-off the amount owing by U.S. Parent to ULC in respect of the taxes remitted by ULC on U.S. Parent's behalf under Part XIII of the Act, as described in paragraph 12.

14. Subsequent to the completion of the Proposed Transactions described in paragraphs 9 through 11 above, interest payments made by ULC on the U.S. Note will be made to LP. LP can be expected to make regular distributions equal to its income (net of expenses, if any), and XXXXXXXXXX% of such net income will be distributable to U.S. Parent.

Additional Information

15. ULC and ULC-2 are unlimited liability corporations that are disregarded as entities separate from their respective owners for U.S. federal income tax purposes. Consequently, U.S. Parent is considered to be carrying on the business operations of ULC and ULC-2 through a branch in Canada, for U.S. federal income tax purposes, such that the income of ULC and ULC-2 is included in the earnings of U.S. Parent on a current basis for U.S. federal income tax purposes.

16. Notwithstanding that ULC will be deemed pursuant to subsection 84(1) of the Act to pay a dividend on its issued and outstanding common shares as a result of the proposed transaction described in paragraph 12, no amount of income, profit or gain will arise or will be recognized under the taxation laws of the U.S. as a result of that transaction. Similarly, no amount of income, profit or gain would arise or be recognized in the U.S. as a result of that transaction if ULC were not fiscally transparent under the taxation laws of the U.S.

17. For U.S. federal income tax purposes, interest on the U.S. Note will be reported as income of LP, and will be allocated as an item of income to the Limited Partner, and to the General Partner, in the same manner as the interest would be if ULC was not fiscally transparent under those laws. More specifically, the quantum and character of the interest income and its timing in the inclusion in the taxable income of Limited Partner and General Partner will be the same under the taxation laws of the U.S. as it would be if ULC was not fiscally transparent under those laws.

Purposes of the Proposed Transactions

18. The purpose of the Proposed Transactions in paragraphs 12 and 13 is to distribute retained earnings of ULC in a tax-efficient manner such that the distributions qualify for benefits under the U.S. Treaty. The purpose of the Proposed Transactions in paragraphs 9 and 10 is likewise to permit future interest payments on the U.S. Note to qualify for benefits under the U.S. Treaty.

Rulings Requested and Given

Provided that the preceding statements constitute a complete and accurate disclosure of all the relevant facts, the Proposed Transactions and the purposes of the Proposed Transactions, and provided further that the Proposed Transactions are carried out as described above, our Rulings are as follows:

A. To the extent that ULC is deemed to have paid, and U.S. Parent is deemed to have received a dividend pursuant to subsection 84(1) of the Act as a result of the Proposed Transaction described in paragraph 12 above, that dividend will be a taxable dividend described in paragraph 212(2)(a) of the Act.

B. For purposes of applying Article X of the U.S. Treaty, the dividend referred to in Ruling A above will be considered to be income as described in the definition of "dividends" in Article X(3) of the U.S. Treaty and subject to withholding tax under Part XIII of the Act at a rate of 5% pursuant to Article X(2)(a) of the U.S. Treaty.

C. For purposes of applying Article XI of the U.S. Treaty, interest payments made by ULC on the U.S. Note, as described in paragraph 14, will be considered to be income derived by U.S. Parent in proportion to its share of the income of LP, and exempt from withholding tax under Part XIII of the Act pursuant to Article XI(1) of the U.S. Treaty.

D. Article IV(7)(b) of the U.S. Treaty will not apply to treat the dividend referred to in Ruling B as not having been paid to or derived by U.S. Parent.

E. Article IV(7)(b) of the U.S. Treaty will not apply to treat the payment of interest on the U.S. Note referred to in Ruling C as not having been paid to or derived by U.S. Parent.

F. Subsection 245(2) of the Act will not apply to the Proposed Transactions, in and of themselves, to re-determine the tax consequences confirmed in the Rulings given.

The above-noted Rulings are based on the Act, the IRC and the U.S. Treaty in their present form and do not take into account any proposed amendments to the Act, the IRC or the U.S. Treaty which, if enacted, could have an effect on the Rulings provided herein.

Caveats

Except as expressly stated, this Ruling does not imply acceptance, approval or confirmation of any other income tax implications of the facts or proposed transactions described herein. For greater certainty, the Canada Revenue Agency has not confirmed or made any determination in respect of:

(a) whether U.S. Parent and U.S. Shareholders are each a "qualifying person" as defined in Article XXIX-A(2) of the U.S. Treaty;

(b) the determination of the paid-up capital or fair market value of any shares or other property referred to herein;

(c) the amount of any dividend that will be deemed to be paid by ULC as a consequence of the transaction described in paragraph 12;

(d) the amount of ULC's retained earnings;

(e) whether ULC or ULC-2 are fiscally transparent under the taxation laws of the United States;

(f) whether the deemed dividend resulting from the Proposed Transaction referred to in paragraph 12 is disregarded under the taxation laws of the United States or would be disregarded if ULC were not fiscally transparent under the taxation laws of the United States;

(g) the United States federal income tax consequences described in paragraphs 15 through 17;

(h) the application of subsection 18(4) of the Act in respect of any interest that is paid or payable on the U.S. Note;

(i) the application of subsection 247(2); and

(j) any tax consequences relating to the facts and Proposed Transactions described herein other than those described in the Rulings given above.

The above Rulings are based solely on the facts, the proposed transactions, purposes of the proposed transactions and additional information described above, and is subject to the limitations and qualifications set forth in Information Circular 70-6R5 issued on May 17, 2002. This Ruling is binding on the CRA provided that the Proposed Transactions are completed on or before XXXXXXXXXX.

Yours truly,

XXXXXXXXXX
Section Manager
For Division Director
International Section I
Income Tax Rulings Directorate
Legislative Policy & Regulatory Affairs Branch