15 January 1993 Income Tax Severed Letter 9234212 F - Partnership & "Business Income" (HAA 4093-U5 Art 21)

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.

923421 XXXXXXXXXX 

Attention:  XXXXXXXXXX

Dear Sirs:

RE:  Article XXI and XXII of the Canada-U.S. Income Tax Convention (the "Convention")

This is in reply to your letter of November 13, 1992. You requested clarification of the following paragraph in our letter issued to you on October 19, 1992:

     "Where the investment activities of the limited partnership constitute carrying on business, the charitable organization's share of business income therefrom would not be subject to paragraph 1 of Article XXI by virtue of paragraph 3 of that Article. Such income would be subject to Article VII of the Convention and Canada's right to tax that income would depend on whether the partnership was considered to have carried on business in Canada through a permanent establishment situated therein."

You indicated that the first sentence in the above paragraph appears to be inconsistent with a technical interpretation issued on March 25, 1991 which is referred to in Window on Canadian Tax, at paragraph 1169. In this regard, the letter of March 25th was in respect of an inquiry concerning the provision of refunds of tax withheld under Part XIII of the Income Tax Act (the "Act") on interest paid to a partnership where such tax would not have been exigible or would have been exigible at a lesser rate had there not been a partnership and had the debt been owed and the interest been paid to the partners directly. This inquiry not only dealt with Part XIII tax exemptions by virtue of an income tax convention but also by virtue of provisions of the Act or by virtue of the fact the partner is a resident of Canada and thus not subject to tax under Part XIII. The issues in that letter were not centred around paragraphs 1 and 3 of Article XXI of the Convention. Any general comments made therein regarding exemptions from Part XIII tax were clearly on the assumption the income flowing through to the partners for purposes of Article XXI were income from property.

As stated in our October 19th letter, it is a question of fact whether the activities carried out by a partnership constitute carrying on business and the Department does not rule out the possibility that a partnership can earn income from property for purposes of the Act.

In respect to the second sentence in the above mentioned paragraph, business income would be subject to Article VII of the Convention unless the provisions of that Article state that business profits are to be dealt with separately in another Article in the Convention . In this regard we are in agreement with you that pursuant to the Convention there would appear to be three possible treatments applicable to a charitable organization's share of dividends received by a U.S. partnership from Canadian resident corporations where the charitable organization is resident in the United States:

1.     If the U.S. partnership carries on business in Canada through a permanent establishment and the holding of shares is effectively connected with such permanent establishment, then paragraph 1 of Article VII would apply and Canada's ability to tax the charitable organization's share of the business profits (i.e. dividends) would not be restricted (i.e. paragraph 4 of Article X would apply and such dividends would be subject to Article VII).

2.     If the investment activities of the partnership constitute the carrying on of a business, but not through a permanent establishment situated in Canada, paragraph 6 of Article VII and paragraph 2 of Article X would apply to the charitable organization's share of dividends. It should be noted that the rate of withholding tax would be 15% regardless of the percentage ownership by the partnership of shares of the payer.

3.     Paragraph 1 of Article XXI would generally apply to the charitable organization's share of the dividends in other situations so long as the dividends are not paid by a related person other than a person referred to in paragraph 1 or 2 of that Article.

As a final matter, you requested our comments with respect to the application of Articles VII and XXII of the Convention where a U.S. partnership acquires an interest in a trust that is a resident of Canada. The trust makes an annual distribution of its income to its beneficiaries, including the partnership. The partners are all residents of the United States for the purposes of the Convention.

Subject to Article XXI of the Convention, in our opinion, regardless of whether or not the partnership is considered to be carrying on a business in respect of its investment in the trust, income distributions, including taxable capital gains (see paragraph 17 of Interpretation Bulletin IT-465R), from the trust are considered to be dealt with under Article XXII of the Convention. In this regard reference should be made to the following sentence in the Technical Explanation to paragraph 2 of Article XXII of the Convention:

     "Thus, in a case where the law of Canada treats a distribution made by a trust resident in Canada as a separate type of income arising in Canada, Canadian tax is limited by paragraph 2 to 15 percent of the gross amount distributed to a U.S. resident beneficiary."

Regardless of whether the partnership is considered to be carrying on a business in respect of its investment in the trust, income of a trust is generally considered a separate source of income for purposes of Part I and Part XIII of the Act by virtue of paragraph 108(5)(a) and subsection 212(9) of the Act, respectively, and would fall within Article XXII of the Convention.

Article XXII would reduce the Part XIII withholding tax (i.e. where paragraph 212(1)(c) of the Act is applicable) to either 15% or 0%, depending on whether the income earned by the trust arises inside or outside Canada. However, where an organization described in paragraph 1 of Article XXI of the Convention is a member of a partnership that is not considered to be carrying on a business in respect to its investment in the trust, such an organization would be exempt from Canadian tax on its share of trust income pursuant to that paragraph.

Where the trust has "designated income" as defined in subsection 210.2(2) of the Act (e.g. income from a business carried on in Canada), the trust may be subject to tax under subsection 210.2(1) of the Act. The Convention will not affect Canada's right to tax under that provision.

We trust you will find this to your satisfaction.

Yours truly,

for DirectorReorganizations and Foreign DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch