CRA rules on a 2-step distribution by a ULC to avoid Art. IV(7)(b) of the Canada-US Convention

CRA provided a ruling on the two-step approach for avoiding the application of the anti-hybrid rule in Art. IV(7)(b) of the Canada-US Income Tax Convention to a dividend deemed to be paid to US Parent by a Canadian subsidiary (“Holdco” - presumably a ULC) that is fiscally transparent for Code purposes.

Under the proposed transactions:

• Opco (a taxable Canadian corporation which is not fiscally transparent for Code purpose) redeems all of its preferred shares held by the US Parent, with the applicable Part XIII tax being remitted.
• Opco then declares and pays a dividend to Holdco out of its safe income.
• Holdco adds a balance to its common share capital account, transferred out of its retained earnings, thereby giving rise to a deemed dividend for Canadian purposes. Crucially, this transaction is disregarded for Code purposes and would be disregarded for Code purposes even if Holdco were not fiscally transparent.
• Holdco then reduces the balance in its common share capital account through a cash distribution equal to the increase in the previous step minus the amount of the Part XIII tax that was applicable to the above deemed dividend.

CRA ruled that Art. IV(7)(b) of the Convention would not apply to treat the deemed dividend as not having been paid to or derived by US Parent, so that withholding tax at the Convention-reduced rate of 5% would apply.

2012-0471921R3 is similar.

Neal Armstrong. Summary of 2025 Ruling 2024-1035241R3 under Treaties – Income Tax Conventions – Art. 4.