5 September 1989 Income Tax Severed Letter AC74083 - Capital Gains under Canada-U.S. Income Tax Convention

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.

SEP 5 1989

International Audits Division           Specialty Rulings
                                          Directorate
                                        K.B. Harding
                                        957-2129
Mr. R.E. Campbell

                                        7-4083

Paragraph 3 and 4 of Article XIII of the Canada-U.S. Income Tax Convention (the "Convention")

This is in reply to your memorandum of June 27, 1989 wherein you requested our opinion concerning the treatment of capital gains arising from the disposition of real property under Article XIII of the Convention.

Subparagraph (b)(i) of paragraph 3 of Article XIII of the Convention states that real property means "(r)eal property referred to in Article VI... situated in Canada". Paragraph 2 of Article VI of the Convention clearly defines the term real property to include "... rights to explore for or to exploit mineral deposits, sources and other natural resources and rights to amounts computed by reference to the amount or value of production from such resources (overriding royalties). In addition, paragraph 1 of Article VI of the Convention indicates it was the intention of the negotiators to include resource properties in that article when they added the word "or other natural resources" to the wording of the OECD Model.

Accordingly, it is our view that Canada has maintained its right under Article VI of the Convention to tax income from resource property whether the non-resident has a permanent establishment or not in Canada to the extent that such amounts are included in the income of the non-resident by virtue of section 115 of the Income Tax Act (the "Act").

In our opinion paragraph 3 of Article XIII of the Convention was intended to tax capital gains on the disposition of shares of the capital stock of a company, the value of which is derived principally from real property as that term is defined in the Convention (i.e. including not only real property as defined in Article VI of the Convention but also shares of the capital stock of other corporations or an interest in a partnership, trust or estate which is real property as defined in subparagraph 3(b) of Article XIII of the Convention).

We are attaching a copy of correspondence we have had with the Department of Finance and taxpayers concerning the valuation of assets when applying subparagraph (b)(ii) of paragraph 3 of Article XIII of the Convention. It should be noted that taxpayers have been advised that the Department may not be prepared to accept the net asset basis in circumstances where there is evidence of manipulation in the contemplation of a share sale such as by increases of the debt on the real property in the company or by increasing the non-real property in the company so as to fall within the 50 per cent test. In applying the 50 per cent test, the Department would use the fair market value of all assets of the company as of the date of disposition of the shares. We have no further guidelines since our experience on this topic has been limited.

We trust the comments will be suitable for your purposes.

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