29 July 1997 External T.I. 9708705 - Distribution by U.S. partnership to a Canadian RESIDENT

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.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues:

Whether the Canada-U.S. Income Tax Convention would apply to restrict the U.S.'s right to impose a withholding of 39.5% on distributions made by a U.S. partnership to a Canadian resident partner.

Position:

No

Reasons:

Not a final tax and the tax applies to business rather than investment income. Consequently, the Business Profits Article of the Convention applies rather than the Dividend or Interest Articles. It appears that the U.S. is taking the same approach as Canada would in considering that the Canadian partner is carrying on a business in the U.S. through a P.E. on the basis that the partnership is carrying on business in the U.S. through a P.E.

970870
XXXXXXXXXX David R. Senécal

Attention: XXXXXXXXXX

July 29, 1997

Dear Sirs:

Re: U.S. Withholding Rates - Distributions from U.S. Limited Partnerships

This is in reply to your letter of April 2, 1997, wherein you enquire as to whether the provisions of the Canada-U.S. Income Tax Convention (the "Convention") would apply to restrict the U.S.'s right to impose a withholding tax of 39.6% on distributions made by U.S. limited partnerships to foreign partners including those who are residents of Canada.

We wish begin by stating that our department is not in a position to interpret the provisions of the U.S. Internal Revenue Code (the "Code") and, in this regard, we would suggest that you communicate with the U.S. Internal Revenue Service regarding the appropriateness of imposing the withholding in the situation you describe.

Having said this, it is our understanding that pursuant to Code Section 1446, where a partnership which has effectively connected taxable income and a portion of such income is allocatable to a foreign partner, the partnership must withhold tax at the applicable percentage from the said income which is allocatable to each foreign partner. We understand that "effectively connected taxable income" means the taxable income of the partnership which is effectively connected with the conduct of a trade or business in the U.S. We also understand each foreign partner is allowed a credit for such partner's share of the withholding tax paid by the partnership and, consequently, the tax does not represent a final tax.

As it seems from our limited knowledge that the withholding tax in question is only applicable with respect to a foreign partner's share of income "from a trade or business" in the U.S. rather than to the foreign partner's share of any U.S. source dividend or interest income earned by the partnership, it would appear that the Dividend or Interest Articles of the Convention would not be applicable to possibly restrict the rate of tax which the U.S. could impose as alluded to in your letter.

For Canadian tax purposes, it is our position that, where a partnership carries on business in Canada through a permanent establishment, each partner is considered to be carrying on business in Canada through a permanent establishment. Consequently, if a non-resident partner is resident in a country with which Canada has an income tax convention, the Business Profits Article (Article VII in the case of the Convention) would not apply to prevent Canada from taxing that partner's share of the partnership's income at full Part I rates as the Business Profits Article would only deny Canada's right to tax the income if it was determined that the partnership (and, consequently, the non-resident partner) did not have a permanent establishment in Canada. It would seem from the above that the U.S. rules operate in the same manner. If such is indeed the case, we are of the view that the provisions of the Convention would not prevent the U.S. from taxing in the manner described, although it should be kept in mind that the withholding tax may differ from a foreign partner's actual U.S. tax liability after filing a U.S. income tax return. For foreign tax credit purposes, Canada would only grant a credit based on the Canadian resident partner's actual tax liability to the U.S.

We trust that our comments will be of assistance.

Yours truly,

for Director
Reorganizations and International Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch