17 July 1990 Ministerial Letter 59618 F - Canada-U.K. Income Tax Convention on Capital Gains

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.

Attention: 19(1)

July 17, 1990

Dear Sirs:

Re:  Paragraph 48(1)(c) and Subsection 48(2) of the Income Tax Act (the "Act") and the Canada-U.K. Tax Convention (1978)

We refer to your letter of February 15, 1990 in which you described the following hypothetical situation involving the application of the above noted provisions of the Act and Article XXI and Article XXI of the Canada-U.K. Tax Convention (1978) (the "Convention").

An individual (the "taxpayer"), formerly resident in Canada owned real estate property (the "real property") located in the United Kingdom (the "UK").  At the time the taxpayer ceased to be a resident of Canada and became a resident of the U.K., he elected in prescribed manner and in prescribed time pursuant to paragraph 48(1)(c) of the Act with respect to the real property with the result that the disposition thereof would be deferred until the earlier of the times referred to in subsection 46(2) of the Act.  Security acceptable to the Minister of National Revenue was furnished at the time of the election.  In consequence of the election, the real property was deemed to be taxable Canadian property for the purposes of subparagraph 115(1)(b)(ix) of the Act.

You have requested our views on the income tax consequences arising in Canada if the real property is sold while the taxpayer is resident in the U.K. and is not resident in Canada. Specifically, you would like to know if Canada would grant relief (presumably, pursuant to the Convention) in respect of taxes payable in the U.K. on the gain arising on the disposition.

Opinions

Before arriving at a conclusion of the income tax consequences arising in Canada as a result of the disposition of the real property in the U.K., it is necessary to first consider the relevant paragraphs of Article XIII (Capital gains) of the Convention.  On the assumption that the real property is capital property within the meaning assigned by paragraph 54(b) of the Act, and is also immovable property as referred to in paragraph 2 of Article VI of the Convention, these would be paragraphs 1, 8 and 9 of Article XIII. It is further assumed that the taxpayer was a resident of Canada for 15 years or more prior to the alienation of the real property, and was also a resident of Canada for some time within five years from the date of such alienation.

Paragraph 1 of Article XIII

Paragraph 1 provides that gains derived by a resident of a Contracting State from the alienation of immovable property situated in the other Contracting State may be taxed in that other State.

Analysis

In the situation referred to above, the taxpayer is resident in the U.K., the Contracting State in which the gain would be derived.  Since paragraph 1 clearly contemplates that the alienator be resident in the "other" Contracting State (i.e. Canada), this paragraph has no application to the situation referred to above.

Paragraph 8 of Article XIII

Paragraph 8 states that gains from the alienation of any property, other than that referred to in paragraphs 1, 2, 3, 4 and 5, shall be taxable only in the Contracting State of which the alienator is a resident.

Analysis

The words "other than that referred to in paragraph(s) 1" are meant to exclude gains derived by a resident of a Contracting State (i.e. the "U.K.") from the alienation of immovable property situated in the other Contracting State (i.e. Canada).  Since paragraph 1 has no application to the above situation, then but for paragraph 9 of Article XIII of the Convention, the U.K. would have the sole right to tax the gain on the real property.

Paragraph 9 of Article XIII

Paragraph 9 permits a Contracting State to tax gains derived by an individual who is a resident of the other Contracting State from the alienation of any property if the individual were a national or resident of the first-mentioned State for 15 or more years prior to the alienation and had resided in that State at any time during the five years immediately preceding such alienation.

Analysis

On the assumption referred to above, Canada has the right to tax the gain, since the taxpayer had resided in the first-mentioned State (i.e. Canada) for the required periods.

Conclusion

The above discussion leads to the initial conclusion that both Canada and the U.K. may tax the gain on the real property. Consequently, it is necessary to now review the guidelines set out in Article XXI (Elimination of double taxation).

Paragraph 1(a) of Article XXI

Paragraph 1(a) requires that Canada grant a deduction from any Canadian tax payable on gains arising in the U.K. in respect of tax payable in the U.K. on such gains.

Paragraph 2(a) and Paragraph 3 of Article XXI

Paragraph 2(a) requires that the U.K. allow a credit against any U.K. tax on chargeable gains from sources within Canada in respect of tax payable under the laws of Canada on such gains.

Paragraph 3, which applies for the purposes of paragraphs 1 and 2, then states that capital gains owned by a resident of a Contracting State which are taxed in the other Contracting State in accordance with the Convention shall be deemed to arise from sources in that other Contracting State.

Analysis

The underlined words in paragraph 2(a) and paragraph 3 are, in our view, key to the proper interpretation of Article XXI.  To put these words in the context of the situation described above, since paragraph 9 of Article XXI permits Canada to tax the gain on the real property, "it is a gain that is taxed in the "other Contracting state" (i.e. Canada), in accordance with the Convention".  By virtue of paragraphs 2(a) and 3, this gain is deemed to arise from sources within Canada.

Final Conclusions

In our opinion, the effect of Article XXI is that the U.K. must allow a credit against U.K. tax on the gain arising on the alienation of the real property to the extent of any Canadian tax payable thereon.  Thus, if the Canadian tax is equal to or greater than the U.K. tax, the U.K. must forego its taxing privilege. If, on the other hand, the U.K. tax is greater than the Canadian tax, then the taxpayer is subject to tax in the U.K. on the difference.  This situation would appear to give rise to an anomaly, in that subsection 126(2.2) of the Act, which allows a foreign tax credit to a taxpayer who disposed of property that was deemed by subsection 48(2) of the Act to be taxable Canadian property of the taxpayer, seems to create a circularity problem vis-à-vis Canada's priority right to tax the gain under the Convention.  This type of problem may have to be resolved through the competent authority procedures set out in Article VIII of the Convention.

Yours truly,

for DirectorReorganizations and Non-Resident DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch