10 January 1990 Administrative Letter 74446 F - Taxation of Gains under 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.

Re:  Article XlII of the Canada-U.S. Income Tax Convention (the "Convention")

This is in reply to your memorandum of October 19, 1989 concerning what is meant by the term "gain which is liable to tax in that other State" in paragraph 9 of Article XIII of the Convention.

You are concerned whether the use of the word "gain in the Convention has the same meaning as set out in paragraph 40(1)(a) of the Income Tax Act (the "Act") or whether it refers to the excess of proceeds of disposition over the adjusted cost base of the property.

Article III of the Convention provides a definition of many terms used in the Convention, however, the article does not define the term "gain" for purposes of the Convention.  Other terms, such as permanent establishment, real property etc. are defined in the applicable article of the Convention.

Article XIII of the Convention provides for the taxation of gains derived by a resident of a Contracting State from the disposition of a particular asset. Since that article does not define the term "gain" for purposes of the Convention, it is necessary to follow the provisions of paragraph 2 of Article III which states that "... any term not defined therein shall, unless the context otherwise requires and subject to the provisions of Article XXVI (Mutual Agreement Procedure), have the meaning which it has under the law of that State concerning taxes to which the Convention applies".  Since the Competent Authority of Canada has not agreed to the meaning of any term under subparagraph (d) of paragraph 3 of Article XXVI of the Convention and the term gain is not defined in the Convention, paragraph 2 of Article III of the Convention will apply.

Since the term gain is not defined in the Convention, it is our opinion that the definition of gain set in paragraph 40(1) (a) of the Act will apply for purposes.of paragraph 9 of Article XIII of the Convention.  In addition, since a contracting state must first have authority under its income tax legislation to tax any income, the words "the gain liable to tax in the other State" must mean the gain liable to tax in this case under the Canadian Income Tax Act after the deduction of any outlays and expenses incurred to make the disposition as set out in paragraph 40(l) (a) of the Act.  As such a gain can only accrue after December 31, 1971, the portion of gain attributable on a monthly basis to the period ending December 31, 1984 must be the portion of gain attributable to the period between December 31, 1971 and December 31, 1984.  Since the primary purpose of the rule set out in paragraph 9 of Article XIII of the Convention is to exempt any capital gain that arose in Canada prior to December 31, 1984, it is our position that it is reasonable to prorate only that portion of the gain that had arisen between December 31, 1971 and the date of disposition. Therefore, as set out in the attached Appendix "A", the number of months owned prior to 1972 will be ignored in the calculation of the exempt portion of the gain that arose prior to December 31, 1984 and the computation of the gain will include the deduction for any outlays and expenses as provided in paragraph 40(1)(a) of the Act. 

We trust this is adequate for your purposes.

for DirectorReorganizations and Non-Resident DivisionSpecialty Rulings DirectorateLegislative and Intergovernmental Affairs Branch

APPENDIX A

Proceeds (April 30, 1989)                $150,000

Cost                $ 50,000

V-Day Value                $ 80,000

Outlays and Expenses                $ 10,000

# of months property owned after December 31, 1971                208

# of months property owned between December 31, 1971 and December 31, 1984           156

Proceeds of disposition                $150,000

Less:  ACB      $80,000           Outlays and Expenses       $10,000                   90,000

Gain liable to tax                $ 60,000

Taxable Capital Gain (115(1)(b)) $60,000 X 2/3          $ 40,000

Exempt Portion of Gain (Article XIII(9))     $60,000 X 156/208                $ 45,000

Deduction from Income (115(1)(d) and 110(1)(f))    $45,000 X 2/3                $ 30,000