10 March 1983 Income Tax Severed Letter B-4156 - [Paragraph 4 of Article XXVII of the Canada-U.K. 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.

MEMORANDUM

March 10, 1983

TO Provincial and International Relations Division Mr. P. Pinkus Director

ATTENTION Mr. K. Harding

FROM Non-Corporate Rulings Division G.D. Middleton 995-2455

RE: Paragraph 4 of Article XXVII of The Canada-U.K. Income Tax Convention (1978) (the "Treaty")

We enclose the letter dated December 20, 1982 from XXXX concerning the above-mentioned Treaty and its application to a repurchase of shares by a U.K. corporation from an individual shareholder who is resident in Canada or from a corporate shareholder which is resident in Canada and owns less than 10% of the voting power of the U.K. corporation. As you requested, we have reviewed the situation to determine the Canadian income tax consequences for such Canadian shareholders.

We have assumed that the U.K. income tax law has changed in the manner described by XXXX and that paragraph 3(b) of Article 10 of the Treaty does, in fact, apply to such a repurchase of shares. In addition, any amounts which we refer to are those amounts which XXXX sets out in his illustration.

Our comments are as follows:

Paragraph 30(2) of the Act to implement the Treaty (Chapter 44 of the 1980 Statutes of Canada) makes it clear that in the event of any inconsistency between the provisions of the Treaty and the provisions of the Income Tax Act (the "ITA"), the provisions of the Treaty prevail to the extent of the inconsistency. Given the facts in the particular situation, there is an inconsistency between the provisions of the ITA and the provisions of the Treaty. On the one hand, the ITA requires a Canadian shareholder to treat the entire amount received on the repurchase of shares as proceeds for the disposition of property, whereas, paragraph 4 of Article 27 of the Treaty requires the Canadian shareholder to treat certain amounts received on the repurchase of shares as a dividend for Canadian income tax purposes. As a result of this inconsistency, it is our view that, technically, the provisions of the Treaty prevail so that certain amounts received by a Canadian shareholder on the repurchase of shares are treated as a dividend rather than proceeds for the disposition of property. Appendix I attached to XXXX letter summarizes the tax implications for a Canadian shareholder if this view is followed.

Notwithstanding the technical interpretation, we recommend that the Department adopt the following administrative position:

To regard the total amounts received by a Canadian shareholder on the repurchase of shares (i.e. the amount of the proceeds from the U.K. corporation - $1,500 and the amount of the U.K. tax credit - $600) as proceeds of disposition for the Canadian shareholder's shares. Appendix II attached to XXXX letter summarizes the tax implications for a Canadian shareholder if this position is adopted.

The rationale and arguments to support this position are:

- Paragraph 4 of Article 27 of the Treaty should be interpreted in light of the general purpose it was intended to serve with respect to the tax law that existed at the time the Treaty was entered into. The general purpose of this paragraph was to provide more favourable income tax treatment to Canadian shareholders who received dividends from U.K. corporations and will normally achieve that end. However, the anomaly is caused by the new U.K. tax law, which appears to be similar to subsection 84(3) of the ITA and which was not in place at the time the Treaty was entered into. Therefore, it is arguable that paragraph 4 of Article 27 was not intended to apply to situations where there is a repurchase of shares (i.e. deemed dividends) such as to create a more onerous tax burden on Canadian shareholders of U.K. corporations than would otherwise be the case.

- Given a situation where a Canadian shareholder's original cost of a share in a U.K. corporation exceeds the aggregate of the repurchase price and the U.K. tax credit - which produces a capital loss instead of a capital gain - the administrative position still allows the shareholder more favourable and equitable tax treatment than the technical view. This is so even though the shareholder may not be able to claim any foreign tax credit for the $300 U.K. tax paid because the capital loss was his only source of income in the U.K.

The foregoing comments are directed at shareholders who treat their shares as capital property or as inventory, since the tax effect under the technical view (i.e. as dividends) is more onerous in either case.

for Director Non-Corporate Rulings Division