30 June 1988 Income Tax Severed Letter 7-2490 - [Canada—United States Income 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.

JUN 30 1988

Mr. J.A. Calderwood Director International Audit Division Attention: Mr. G. Cooper

Canada - United States Income Tax Convention (the "Convention") Specialty Rulings Directorate

This is in reply to your memorandum of January 14, 1988, concerning the application of Part XIII tax and the Convention on excess charges for royalties and management fees paid to related U.S. residents, which were disallowed pursuant to Part I of the Income Tax Act (the "Act"). We apologize for the delay in replying.

Paragraph 7 of Article XII of the Convention clearly indicates that the excess portion of the royalty payment remains taxable according to the laws of each Contracting State with due regard being had to the other provisions of the Convention. Management fees are, on the other hand, usually covered by Article VII of the Convention (Business Profits Article). Article VII would not be applicable, however, where the business profits include items of income which are dealt with separately in other articles of the Convention. It is therefore important to determine for domestic tax purposes the nature of the excess payment in each particular situation and then apply the appropriate article of the Convention.

If unreasonable royalties or management fees are paid by a Canadian corporation to its U.S. parent corporation, the unreasonable portion which is being disallowed would probably be included in the parent's income by virtue of subsection 15(1) of the Act. If the payment has been made to a person other than its parent corporation, it would generally be included in the non-resident income by virtue of either section i5 or subsections 56(2) or 247(1) of the Act. In all such cases, the Act deems such amounts to be a dividend. Subsection 214(3) of the Act states that where section 15 or subsections 56(2) or 247(1) of the Act requires an amount to be included in a non-resident's income, the amount shall be deemed to have been paid to the taxpayer as a dividend from a corporation resident in Canada.

Its is our view that Article X of the Convention will apply to such deemed dividends since paragraph 3 of that Article states that the term dividends includes "income subjected to the same taxation treatment as income from shares by the taxation laws of the State of which the company making the distribution is a resident". Accordingly, the rate of withholding for dividends provided in the Convention will apply on the excess payment of royalties or management fees.

If the payment is brought into income pursuant to subsection 245(2) of the Act, the nature of the payments will determine which article, if any, of the Convention that will apply.

for Director Reorganizations and Non-Resident Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch

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