14 July 1986 Income Tax Severed Letter S-1880 - [860714]

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.

Revenue Canada, Taxation Corporate Rulings Directorate 875 Heron Road Ottawa, Ontario K1A 0L8

Dear Sirs:

We are writing to request your views as to the appropriate application of paragraph 2(b) of Article XXIV of the Canada-U.S. Income Tax Convention (1980), as amended, in relation to paragraph 113(1)(a) and subsection 258(3) of the Income Tax Act, Canada ("the Act").

Paragraph 113(1)(a) provides a deduction in computing income in respect of dividends received from a foreign affiliate of a corporation resident in Canada to the extent that the dividends are considered to have been paid out of the exempt surplus of the foreign affiliate.

Subsection 258(3) provides, inter alia, that for the purposes of section 113, a dividend received on a share as contemplated by paragraph (a) or paragraph (b) of subsection 258(3) shall be deemed to be interest and not a dividend.

As a result, where subsection 258(3) is applicable, any dividend received by a corporation resident in Canada from a foreign affiliate of the corporation will be included in income pursuant to paragraph 12(1)(c) of the Act and no deduction may be taken in respect thereof under paragraph 113(1)(a), notwithstanding that the dividend is in fact a dividend out of the exempt surplus out of the foreign affiliate.

Paragraph 2(b) of Article XXIV of the Canada-U.S. Income Tax Convention provides, subject only to the provisions of the law of Canada regarding the determination of the exempt surplus of a foreign affiliate, that a company which is a resident of Canada shall be allowed to deduct in computing its taxable income any dividend received by it out of the exempt surplus of a foreign affiliate which is a resident of the United States. The term "dividend" is not defined for purposes of paragraph 2(b) of Article XXIV. Consequently, pursuant to paragraph 2 of Article III of the Treaty, the term dividend would have the meaning which it has under the law of Canada. We understand that under the proposed Income Tax Conventions Interpretation Act, paragraph 2 of Article III would be interpreted as referring to the laws of Canada as amended from time to time.

It appears to us that where a dividend out of exempt surplus is in fact paid by a foreign affiliate resident in the United States to a corporation resident in Canada, paragraph 2(b) of Article XXIV should apply such that an amount equal to the amount of the dividend received will be deductible by the recipient corporation in computing income for tax purposes, notwithstanding that subsection 258(3) might otherwise apply to deny the deduction. This is based on the view that such a dividend would be considered a dividend for Canadian tax purposes generally, and that the dividend is only considered to be interest for the purposes of the specific provisions set out in subsection 258(3).

It appears to us that in these circumstances, paragraph 2(b) of the Article XXIV of the Canada-U.S. Income Tax Convention has the effect of either:

(a) overriding the application of subsection 258(3), or

(b) providing a deduction, separate and apart from any provision of the Income Tax Act, in respect of any dividends the deduction of which pursuant to paragraph 113(1)(a) would be prohibited by virtue of the application of subsection 258(3).

We would appreciate confirmation that you concur with this interpretation of the application of paragraph 2(b) of Article XXIV of the Canada-U.S. Income Tax Convention, or alternatively your views as to the appropriate application of that paragraph in the context described.

Yours very truly,