23 October 1998 9827211 - ARTICLE XIII(5) OF THE CANADA-U.S. TAX TREATY

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.

Question

Mom and Dad jointly own an Ontario farm. Mom is a Canadian citizen and resident, and Dad is a U.S. citizen, but has been a Canadian resident for 55 years. Dad is retired and receives a U.S. R.R. pension and social security. The farm is presently being rented out, because of the fathers age and health. The Son is a U.S. citizen and resident and will retire in the next few years. Mom and Dad are considering gifting the Ontario farm to their Son. What are the tax implications? With the revised US/Canadian Tax Treaty, what is the U.S. withholding tax rate for Canadian residents receiving U.S. social security and U.S. R.R. pensions? Does this withheld tax qualify as a foreign tax credit? What can be claimed as a deduction?

Answer

Subsection 73(3) of the Act provides a rollover of farm property from a parent to a child on a tax free basis when certain conditions have been met. In order for the provisions of subsection 73(3) to apply, the child must be a resident of Canada immediately before the transfer. In the above example, the Son is not a Canadian resident, consequently the provisions of subsection 73(3) would not provide for a tax free rollover for Mom and Dad.

In a situation, where Mom and Dad gift property to their son and the provisions of subsection 73(3) do not apply, Mom and Dad will be deemed to have received proceeds of disposition equal to the fair market value of the property pursuant to paragraph 69(1)(b) of the Act. The son would acquire the property at the amount equal to his parents’ deemed proceeds of disposition pursuant to paragraph 69(1)(c) of the Act. In such a situation, the parents could claim the capital gains deduction pursuant to subsection 110.6(2) of the Act if all of the requirements in the definition of qualified farm property in subsection 110.6(1) of the Act have, in fact, been met.

In the event that there is any net taxable capital gain realized by Dad in Canada as a result of the gifting of the farm property to his son, under the Income Tax Act (the “Act”) Canada would impose tax on such taxable capital gain and would not provide foreign tax credits for U.S. income taxes, if any, paid by Dad as a result of the gifting of the farm property. The Canada-United States Income Tax Convention (the “Convention”) has no impact on such taxation by Canada.

With respect to the U.S. social security benefits (including tier 1 railroad retirement benefits), pursuant to Article XVIII of the Convention, Canada has the right to tax such benefits but would allow a deduction of 15% of such benefits in computing Dad’s taxable income. (Note that 100% of the benefits has to be included in computing income and 15% thereof is allowed as a deduction in computing taxable income under paragraph 110(1)(f) of the Act.) Pursuant to the Convention, Canada is not obliged to, and will not, grant a foreign tax credit for regular U.S. taxes paid on such benefits. In this case, if the U.S. imposes alternative minimum tax (“AMT”) in respect of such benefits, Canada will provide a foreign tax credit for that portion of the AMT.

It is our understanding that the U.S. would normally not withhold tax on such benefits paid to a U.S. citizen. Dad, being a U.S. citizen, is required to file a U.S. income tax return reporting, among other things, such benefits according to the U.S. tax law, and the U.S. is obliged to provide a credit for Canadian taxes paid on such benefits pursuant to paragraph 4 of Article XXIV of the Convention. After the credit, in general, there should not be any U.S. regular tax on such income.