8 October 1992 Income Tax Severed Letter 9213585 - Flow Through Rules from U.S. Trust Re Tax Credits

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.

File No 921358
24(1) 957-2125
D. Patrick

Attention: 19(1)

October 8, 1992

Dear Sirs:

RE: Canada - U.S. Tax Convention
Paragraph 5(a) of Article XXIV of the Convention

This is in reply to your letter of April 23, 1992 wherein you requested our interpretation of how Article XXIV, paragraph 5(a) applies to determine the extent to which Canada and the United States may tax a certain type of royalty income. We are advised that the facts are as follows:

• 1. The taxpayer, is a U.S. citizen who is a Canadian resident, who has only U.S. source interest, dividend or royalty income
• 2. We are asked to assume, that the taxpayer's only income is $100,000 U.S. of U.S. source royalty income and that his U.S. income tax on that

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• amount, (before any credit for income taxes paid to Canada in respect of that amount) is $25,000 U.S. We also are advised that this $25,000 U.S. is the Federal income tax that taxpayer must pay to the U.S. on that income if he were resident in the U.S. in the particular year.

You have asked us to confirm that under paragraph 5(a) of Article XXIV of the Convention, Canada is obliged to allow the taxpayer a deduction under sub section 20(11) of the Income Tax Act of $10,000 U.S. and a sub section 126(1) non- business foreign tax credit of $15,000. U.S. We agree that with respect to any U.S. sourced royalty income Canada will provide the taxpayer with a foreign tax credit up to a maximum of 15% of the gross amounts received from such income (expressed in Canadian dollars) emanating from the United States. In addition, the taxpayer will be permitted to claim a subsection 20(11) deduction for any U.S. taxes that would have been paid in excess of 15% of the gross amounts of such royalty income (expressed in Canadian dollars) received before the application of tax credits for Canadian taxes paid as set out in paragraph 5(c) of Article XXIV of the Convention. We agree that in accordance with paragraph 5(c) of Article XXIV of the Convention, the United States may allow a credit against U.S. tax on any income tax paid or accrued to Canada after Canada has permitted the foreign tax credit pursuant to Section 126.

In the penultimate paragraph of your inquiry, you asked whether paragraph 5(a) of Article XXIV of the Convention would only apply to U.S. source interest, dividend and royalty income. In this regard you indicated that you wanted to have our interpretation of the situation, where the taxpayer receives income from a U.S. resident trust, and whether Revenue Canada would "look through" the distribution from the trust to its source in the trust. You gave the example, of where the trust's income consists of only interest income, and you inquired whether Canada would regard a trust distribution of such income to a U.S. citizen who is a Canadian resident, as being an account of interest, so as to permit the application of paragraph 5(a) of Article XXIV of the Convention to the trust income.

In essence your inquiry raises the question of whether the flow through rules with respect to income emanating from U.S. resident trusts, under paragraph 2 of Article XXII of the Convention will apply for the purposes of Article XXIV of the Convention concerning the elimination of Double Taxation.

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As you are aware in Canada, a distribution by a Canadian resident trust results in a separate type of trust income, which is taxable in the beneficiaries hands. However, in the United States, pursuant to Code sections 667(e) and 662(b), distributions from most American trusts have the same character in the hands of the non-resident beneficiary as they did in the hands of the trust. According to the Commentary on paragraph 2 of Article XXII of the Convention, "The taxation of such a distribution in the United States is governed by the distribution's character, the provisions of the Code and the provisions of the Convention other than the provision in paragraph 2 limiting the tax at source to 15%."

In our opinion therefore, the "interest" income which arose from the U.S. trust, which is payable to a U.S. citizen who is a Canadian resident would be covered by the provisions of Paragraph 5 of Article XXIV of the Convention on double taxation, assuming of course, that the United States has in fact the right to tax this "interest" income pursuant to Article XI of the Convention. Yours truly,

for Director
Reorganizations and Foreign Division
Rulings Directorate
Legislative and Intergovernmental
Affairs Branch

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