22 July 2011 Internal T.I. 2011-0397191I7 - Article 13 of Canada-Germany 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.

Principal Issues: An individual resident in Germany disposed of shares of Holdco, a corporation resident in XXXXXXXXXX . Holdco owns two Canadian resident corporations, Canco1 and Canco2. Holdco's shares derive their value principally from immovable property situated in Canada. Is the gain on the disposition of the Holdco shares taxable in Canada by virtue of Article 13(1)?

Position: No. The gain on the disposition of the Holdco shares is taxable only in Germany pursuant to Article 13(6) of the Canada-Germany Tax Convention.

Reasons: Article 13(1) refers to the term "immovable property" as defined in Article 6(2) and that definition does not include shares. In the case of a share disposition, only Article 13(4)(a) can be considered. As Holdco is not resident in Canada, the gains are taxable only in the country of residence of the alienator, pursuant to Article 13(6).

									July 22, 2011

	XXXXXXXXXX 							K. Podor
	XXXXXXXXXX  TSO
	XXXXXXXXXX
									2011-039719

Gain on Disposition of Shares - Canada-Germany Income Tax Convention

Background

We are writing in response to your February 16, 2011 e-mail concerning the application of paragraph 1 of Article 13 of the Canada-Germany Income Tax Convention (the "Convention") to a disposition of shares. Specifically, you asked for our views with respect to whether Canada is entitled to tax the gains on the disposal of shares of a non-resident corporation on the basis that the shares of the company derive their value principally from immovable property situated in Canada.

The facts are as follows:

• A non-resident individual (Mr. X) is a resident of Germany. Mr. X owns 100% of the shares of a corporation (Holdco) resident in XXXXXXXXXX .
• Holdco owns two corporations, Canco1 and Canco2, which are resident in Canada and own rental properties situated in Canada.
• Canco1 and Canco2 earn rental income and a small amount of interest income.
• Mr. X has disposed of his shares in Holdco to his XXXXXXXXXX .

You have suggested that the gains on the disposition of Holdco's shares are taxable in Canada under Article 13(1) of the Convention because that provision can be applied independently of Article 13(4).

The taxpayer contends that the gains are exempt from Canadian tax pursuant to Article 13(6) of the Convention.

Our Comments

The general provision for taxing capital gains is found in paragraph 1 of Article 13 of the Convention. Paragraph 1 refers to gains derived by a resident of a Contracting State (in this case, Germany) from the alienation of immovable property referred to in Article 6 and situated in the other Contracting State (Canada). Where the Holdco shares meet the definition of "immovable property" pursuant to Article 6(2), the gains on such shares will be taxable in Canada.

Paragraph 2 of Article 6 of the Convention provides that the domestic definition be used in defining "immovable property". The term "immovable property" is not defined in the Income Tax Act ("the Act") and there does not appear to be any commentary on how this term would be defined in a purely domestic context. As such, we would generally rely on the common law and/or civil law definition of "immovable property" which may be modified by provincial statute. Under common law, "real property" is generally considered to be comprised of interests in real property (i.e. land and interests in land).

The Income Tax Conventions Interpretations Act (ITCIA) expands the definitions of "immovable property" and "real property", for the purposes of interpreting income tax conventions. Section 5 of the ITCIA provides that "immovable property" and "real property" include rights to explore or exploit natural resources in Canada and certain rights to payments involving such rights to explore or exploit natural resources in Canada.

It is our view that the domestic definition of the terms "immovable property" or "real property" does not include shares. As a result, shares in a company holding immovable property do not fall within the meaning of "immovable property" as referred to in Articles 13(1) and 6(2) of the Convention. This conclusion is consistent with the OECD Commentary which makes reference to the fact that Article 13(4) must be considered in the case of gains from a disposition of shares in a company holding immovable property.

In the case of a share disposition, paragraph 4(a) of Article 13 of the Convention must be considered in determining which country has the right to tax the gains. Paragraph 4(a) states that Canada has the right to tax gains derived by a resident of Germany from the disposition of shares (other than shares listed on an approved stock exchange in Canada) if the shares form part of a substantial interest in the capital stock of a company which is resident in Canada and the shares derive their value principally from immovable property situated in Canada.

Based on the facts provided, we understand that the Holdco shares derive their value principally from immovable property situated in Canada. However, the shares do not form part of a substantial interest in the capital stock of a company that is resident in Canada. As a result, the gains from the disposition of the Holdco shares are subject to tax only in Germany by virtue of paragraph 6 of Article 13.

Under certain circumstances that do not seem to arise in your particular situation, the Canada Revenue Agency will consider the application of the general anti-avoidance rule in section 245 of the Act if it is evident that in contemplation of a sale of the shares of a particular Canadian company a structure was put in place in an attempt to obtain tax relief from an income tax convention.

We trust these comments are helpful.

Steve Fron, CA
Acting Manager
International and Trust Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch