14 July 2022 Internal T.I. 2020-0869441I7 - Article XVI(4) of Canada-US 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 the signing bonus paid to a professional athlete is an inducement payment as described by Article XVI(4) of the Canada-US Treaty.

Position: No.

Reasons: In this particular case, the signing bonus is contractually linked with the requirement to perform employment services and as such, is a payment for employment services.

      David Papineau					HEADQUARTERS
      Team Leader						Income Tax Rulings
      Special Examinations				Directorate
      XXXXXXXXXX						Kanwal Graham 

								2020-086944

Signing bonus for professional athlete

This is in reply to your request regarding payments received by professional non-resident athletes and the application of Article XVI(4) of the Canada-U.S. tax treaty (“Treaty”).

In particular, you have asked for our opinion as to whether a particular amount, identified as a signing bonus in the relevant written agreement (“Bonus”), is an amount described in Article XVI(4) of the Treaty.

The facts as we understand them, from the example you provided to us, can be summarized as follows:

1. An individual professional athlete (“Taxpayer”) was a resident of the United States (“U.S.”) and a non-resident as defined under subsection 248(1) of the Income Tax Act (“Act”) when he signed a multi-year contract (“Contract”) with a Canadian sports team (“Team”) XXXXXXXXXX.

2. Under the Contract, the Taxpayer agreed to give services and play in all games of the Team, to report to training camp, to keep in good physical condition and to play only for the Team.

3. The Contract provided that it, along with the related collective Agreement (“Agreement”) XXXXXXXXXX, formed the entire agreement between the Taxpayer and the Team.

4. The terms of the Contract provided that the Taxpayer was to receive the following amounts:

(a) a salary, payable in semi-monthly installments, of XXXXXXXXXX in the first year and XXXXXXXXXX in each of the subsequent XXXXXXXXXX years (for a total of XXXXXXXXXX over the term of the Contract); and

(b) a “Signing Bonus” totaling XXXXXXXXXX, payable in annual installments on XXXXXXXXXX of each year of the Contract, XXXXXXXXXX.

5. The period from XXXXXXXXXX is a “XXXXXXXXXX Sport Year”, as defined in the Agreement. In accordance with the Contract, if during a XXXXXXXXXX Sport Year the Taxpayer breached the Contract, voluntarily retired, withheld XXXXXXXXXX services (including a refusal to report, practice or play) or left the Team without its consent, the Taxpayer would only be entitled to a pro rata portion of the Bonus. XXXXXXXXXX. In such a case, the Taxpayer would be required to repay the portion of the Bonus, if any, that had been received by the Taxpayer in the XXXXXXXXXX Sport Year but to which the Taxpayer was not entitled.

6. XXXXXXXXXX.

7. The Taxpayer received the first installment of XXXXXXXXXX Bonus on XXXXXXXXXX for the first XXXXXXXXXX Sport Year. The Taxpayer became resident in Canada at the end of XXXXXXXXXX.

8. The Taxpayer filed a Canadian tax return for the XXXXXXXXXX taxation year on the basis that the XXXXXXXXXX amount of the Bonus received in that year XXXXXXXXXX before becoming resident in Canada was an inducement payment as described in Article XVI(4) of the Treaty, and was therefore taxable at a rate of 15%.

Our Comments

Treaty provisions

Article XVI of the Treaty pertains to artists and athletes; paragraph 4 of that Article states the following:

“4. Notwithstanding the provisions of Articles VII (Business Profits) and XV (Income from Employment) an amount paid by a resident of a Contracting State to a resident of the other Contracting State as an inducement to sign an agreement relating to the performance of the services of an athlete (other than an amount referred to in paragraph 1 of Article XV (Income from Employment)) may be taxed in the first-mentioned State, but the tax so charged shall not exceed 15 per cent of the gross amount of such payment.”

In respect of services of an athlete, Article XVI(4) of the Treaty limits the tax payable on an amount that is an inducement to sign an agreement (that is, a signing bonus), other than an amount referred to in Article XV(1), to 15% of the amount. Article XV of the Treaty pertains to income from employment, and paragraph 1 of that Article states the following:

“1. Subject to the provisions of Articles XVIII (Pensions and Annuities) and XIX (Government Service), salaries, wages and other remuneration derived by a resident of a Contracting State in respect of an employment shall be taxable only in that State unless the employment is exercised in the other Contracting State. If the employment is so exercised, such remuneration as is derived therefrom may be taxed in that other State.”

The exception in Article XVI(4) to an amount described in Article XV(1) makes it clear that only amounts in respect of an “inducement to sign an agreement,” and not any amounts that are compensation for employment, are afforded the application of Article XVI(4).

Meaning of signing bonus

The terms “inducement” and “signing bonus” are not defined in the Act or the Treaty. The CRA previously commented in document 9819311 that a signing bonus is an amount paid to induce an athlete to sign a player contract, and that such amount should not be dependent upon the athlete actually playing for the team.

One Canadian tax case, Nikolai Khabibulin v Her Majesty The Queen [2000 DTC 1426], dealt with whether an amount paid to a professional athlete was a signing bonus and the treatment thereof under a tax treaty. The issue in that case was summarized as follows by the Tax Court of Canada (“Court”):

“The Appellant reported his income for the 1994 taxation year on the basis that the amount paid to him as the first instalment of his signing bonus was exempt from taxation by reason of the Treaty and subparagraph 110(1)(f)(i) of the Income Tax Act (the Act). The Minister of National Revenue (the Minister) assessed the Appellant on the basis that the Treaty, while applying to his salary for the year, does not apply to the signing bonus, which therefore forms part of his income taxable in Canada.”

The Khabibulin case involved the application of the former Canada-U.S.S.R. treaty under which an exemption from Canadian income tax applied to the salary, but not an inducement payment, of the non-resident in Canada. The Crown argued in Khabibulin that the disputed amount was an inducement payment, hence taxable in Canada, on the basis that the way the payments are characterized should be consistent with what the contract provides for:

“Counsel for the Crown takes the position that the words “signing bonus” in the contract are clear, and that the payment must take its character from them. For this reason, he says, it falls to be taxed under subparagraph 115(2)(c.1)(i), which specifically brings such bonuses into income. This is said to distinguish it from amounts paid as remuneration from the Appellant’s employment as a hockey player.”

The Court rejected that approach and stated that “surrounding circumstances” also need to be examined in making that determination:

“The correct approach to the characterization of the July 1994 payment is to be found in the Supreme Court’s judgment in Curran v. M.N.R [59 DTC 1247].”

The issue involved in that latter case was whether a payment made to a newly hired executive was capital in nature for privileges lost under the former employment or whether it was on account of income. The Supreme Court dictated that “its true nature must be found in the terms of the two agreements and the surrounding circumstances.”

In light of the fact that the appellant in Khabibulin was not entitled to receive further instalments should he refuse to perform any services, the Court concluded that the amount was not a signing bonus:

“It is true that the Appellant, in the unlikely event that he accepted the July 1994 payment and then refused to perform any services, would be entitled to keep the amount that had been paid to him. He would not, however, be entitled to receive the July 1995 payment, and that fact alone demonstrates that the character of the amount is something other than simply a signing bonus.”

Characterization of the Bonus

The issue that is the object of this letter is whether the Bonus paid to the Taxpayer is an amount on account of an “inducement to sign an agreement” such that Article XVI(4) of the Treaty is applicable, or whether it is on account of remuneration for the performance of employment services.

Consistent with the finding of the Court in the Khabibulin decision and for the reasons stated below, the surrounding circumstances support the view that the Bonus is remuneration for the performance of employment services and not an “inducement to sign an agreement” as described in Article XVI(4) of the Treaty.

The Contract requires the Taxpayer to give services and play in all games of the Team, to report to training camp, to keep in good physical condition, and to play only for the Team. In accordance with the Contract, if during a XXXXXXXXXX Sport Year the Taxpayer breached the Contract, voluntarily retired, withheld XXXXXXXXXX services (including a refusal to report, practice or play) or left the Team without its consent, the Taxpayer would only be entitled to a pro rata portion of the Bonus, computed by reference to the number of days that the Taxpayer performed employment services.

Although the Agreement defines the Bonus as meaning compensation for signing the contract, the contractual requirement for the payment of the Bonus links the amount of the Bonus to which the Taxpayer is entitled to the performance of employment services.

Conclusion

While other surrounding circumstances, such as the magnitude of the amount of the Bonus compared to the amount described as salary under the Contract, provide additional support for our conclusion, the reasons outlined above substantiate that Article XVI(4) of the Treaty is not applicable to the amount of the Bonus.

We trust our comments are of assistance.

Unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency’s electronic library. After a 90-day waiting period, a severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. You may request an extension of this 90-day period. The severing process removes all content that is not subject to disclosure, including information that could reveal the identity of the taxpayer. The taxpayer may ask for a version that has been severed using the Privacy Act criteria, which does not remove taxpayer identity. You can request this by e-mailing us at: ITRACCESSG@cra-arc.gc.ca. A copy will be sent to you for delivery to the taxpayer.

Yours truly,

Nicolas Bilodeau
Section Manager
for Division Director
International Division
Income Tax Rulings Directorate
Legislation Policy and Regulatory Affairs Branch