18 February 1993 Income Tax Severed Letter 9231095 - Income Flowing Through an Offshore Partnership

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

923109
XXXXXXXXXX K. B. Harding
957-2111

February 18, 1993

Dear Sirs:

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

This is in reply to your letter of October 19, 1992 wherein you requested our opinion on a number of questions concerning the following hypothetical situation.

Y Ltd. ("Y") is a corporation incorporated in and resident of the United States. Y is a limited partner in a limited partnership (the "partnership") established in XXXXXXXXXX The other members of the partnership are residents in countries with which Canada does not have a tax treaty. The partnership's business consists, inter alia, of the ownership and management of various corporations in different parts of the world, engaged in the XXXXXXXXXX. The partnership is the sole shareholder of a Canadian corporation ("Canco") engaged in XXXXXXXXXX business in various parts of Canada. The partnership itself does not carry on business in Canada through a permanent establishment.

In the computation of income of a partnership under subsection 96(1) of the Income Tax Act (the "Act") the partnership is treated as though it were a separate person resident in Canada. The partnership will initially compute its income or loss at the partnership level and the member's share of the income or loss of the partnership from each source will flow through to the individual member in accordance with paragraphs 96(1)(f) and (g) of the Act. Therefore, except for the computation of income, a partnership is treated as a conduit with all income being taxed in the hands of its partners while retaining its characteristics in respect to source and its nature.

We will respond to your questions in the order they were presented in your letter on the basis that all income flows through to the members of the partnership.

• 1. On the disposition of shares of the capital stock of Canco it is necessary to determine whether or not the value of the shares of Canco, for purposes of the Convention, are derived principally from real property situated in Canada. Where the value of the shares is principally derived from real property situated in Canada, the pro rata share of the gain on the disposition of the shares will be taxed in the hands of Y by virtue of paragraph 3(b)(ii) and paragraph 1 of Article XIII of the Convention.
• On the assumption that the partnership is not carrying on business in Canada through a permanent establishment and the sale of shares of Canco does not fall within paragraph 1 of Article XIII of the Convention, the pro rata share of the gain realized by the partnership from the disposition of its shares in Canco which flows through to Y will fall within paragraph 4 of Article XIII of the Convention and will not be taxable in Canada.
• 2. Reasonable management fees which are paid to a resident of a country with which Canada has a tax convention or agreement will generally fall within the business profits article. Otherwise, the management fees are subject to 25% withholding tax.
• To the extent that the pro rata share of reasonable management fees which are paid by Canco to the partnership flow through the partnership to Y, such fees will fall within Article VII of the Convention and will be exempt from tax in Canada provided the partnership is not carrying on business in Canada through a permanent establishment.
• 3. Where Canco pays dividends to the partnership, the pro rata share of such dividends which flow through the partnership to Y, will be subject to a rate of tax equal to 15% of the gross amount of the dividends. The Department's position is that the 10% rate does not apply where dividends are paid to a partnership.
• It should be noted that by virtue paragraph 212(13.1)(b) that Canco would be required to withhold 25% tax on dividend payments made to the partnership. You should contact the appropriate District Taxation Office, where the Canadian corporation files its income tax return, to determine whether or not they are prepared to reduce the withholding rate to that of the treaty rate on the pro rata share of the dividends to be paid to the resident of the U.S.
• 4. In a situation where Canco pays reasonable royalties to the partnership with respect to certain rights that have been licensed to it, the pro rata share of the royalty payments that is flowed out to the U.S. partner will be taxed in Canada at a rate of 10% of the gross amount of the royalty payments in accordance with paragraph 2 of Article XII of the Convention provided such payments fall within the definition of royalties in paragraph 4 of Article XII of the Convention . However, as indicated above, the withholding rate on royalties paid to the partnership would be 25% unless Canco had received prior authority from the Revenue Canada to reduce the withholding rate on the pro rata share of the royalty that flowed to the U.S. partner.

We trust these comments are adequate for your purposes.

Yours truly,

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