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: The issues are as follows: (1) what is the correct classification of the gravel extraction payments? (2) what is the correct withholding and reporting of the payments and (3) what are the GST/HST tax implications of the payments?
Position: Canada has the right to tax under Article 6 of the Canada-XXXXXXXXXX tax convention and subparagraph 212(1)(d)(v) of the Act applies. The payments are subject to tax at 25% under Part XIII. Pursuant to subsection 162(2) of the ETA, the supply of the right under the agreement is deemed not to be a supply. Therefore, GST/HST is not exigible on the payments in consideration for the right.
Reasons: The income is considered income from immovable property under the Canada-XXXXXXXXXX tax convention and rents, royalties and similar payments under subparagraph 212(1)(d)(v) of the Act.
MEMORANDUM NOTE DE SERVICE
DATE December 21, 2011
TO Ms. Victoria Faerman FROM K. Podor
À International Audit DE Income Tax Rulings Directorate
Kitchener/Waterloo Tax Services Office International Division
166 Frederick St. International Section III
Kitchener, Ontario N2G 4N1
FILE 2010-038223
DOSSIER
SUBJECT: Taxation of Payments under Aggregate Extraction Agreement - Canada-XXXXXXXXXX
OBJET: Income Tax Convention
Background
We are writing in response to your letter concerning the taxation of income earned by a non-resident individual from the provision of the exclusive right to extract aggregates from a property situated in Canada. You asked our views with respect to the classification of the payments for Canadian tax purposes, the Canadian withholding and reporting requirements and whether the payments are subject to GST/HST.
The facts are as follows:
- Mr. X is a GST/HST registered non-resident person (resident of XXXXXXXXXX) that receives income that is associated with the XXXXXXXXXX that is situated on property that he owns in Canada (the property).
- Mr. X entered into an Aggregate Extraction Agreement (the Agreement) with M Co. that gives M Co. the exclusive right to carry out aggregate activities on the property. The Agreement has a term of XXXXXXXXXX years, with an option to negotiate every XXXXXXXXXX years from the start date of the contract, XXXXXXXXXX .
- M Co. is a GST/HST registered Canadian XXXXXXXXXX company.
- Sections 3(1) and 4 of the Agreement provide that Mr. X supplies to M Co. the exclusive right to enter Mr. X's land for the purpose of XXXXXXXXXX on the land, and XXXXXXXXXX .
- Sections 5(2) and 5(3) of the Agreement state that M Co. shall pay Mr. X for all aggregate materials removed from the property at a rate that is the greater of $XXXXXXXXXX per metric tonne (the Royalty) or a monthly minimum of $XXXXXXXXXX (Minimum Royalty). The annual minimum royalty is $XXXXXXXXXX .
- Section 5(5) of the Agreement states that M Co. pays the monthly amounts net of any applicable taxes (GST/HST, municipal, etc.) and remits these taxes to the respective agencies.
You have sought our opinion regarding the classification of the income earned under the aggregate extraction agreement and whether the income is subject to GST/HST at the request of the taxpayer's representative.
Classification of Income Under the Agreement
Since Canada and XXXXXXXXXX have signed an agreement for the Avoidance of Double Taxation with Respect to Taxes on Income and on Capital (the "Convention"), the Convention must be considered to determine which country has the right to tax.
The provisions for taxing business income are found in Article 7 of the Convention. However, paragraph 7 of Article 7 states that where profits include items of income which are dealt with separately in other Articles, then the provisions of those Articles apply, rather than Article 7. Therefore, even if profits earned are regarded as business income for Canadian tax purposes, there may be other Articles within the Convention which apply and effectively take precedence over Article 7.
Valuable guidance on the interpretation of articles within income tax conventions is provided in the commentary to the OECD Model Tax Convention on Income and Capital (July 2010). Paragraph 2.19 of Article 12 states that variable or fixed payments for the working of mineral deposits, sources and other natural resources are governed under Article 6, Income from Immovable Property.
The definition of "immovable property" is found in paragraph 2 of Article 6 of the Convention. Article 6(2) provides that the domestic definition be used in defining "immovable property". However, paragraph 2 contains certain items that are defined as "immovable property" in addition to the definition for domestic law purposes. These additions to "immovable property" include, inter alia, the right to variable or fixed payments as consideration for the right to work natural resources.
It is our view that the non-resident individual's right to variable or fixed payments under the aggregate extraction agreement falls within the meaning of "immovable property" as defined in Article 6(2) of the Convention. As a result, the income is classified as income from immovable property for the purposes of the Convention. As the income is taxed under Article 6 of the Convention, Canada retains its right to tax the income, including any business income from immovable property situated in Canada, whether or not the resident of XXXXXXXXXX carries on the business through a permanent establishment in Canada.
Canadian Withholding and Reporting Requirements
The Canadian tax implications to a non-resident person who receives amounts from real property in Canada depends on whether the non-resident is carrying on business in Canada in respect of the property or simply receiving passive income (income from property). It is our view that amounts received by Mr. X in consideration for the granting of a right or licence to extract aggregates from his property represent income from property. Mr. X is not directly carrying on the gravel extraction business on the property. Mr. X has leased all his rights, title and interest in the property to M Co who is carrying on the business of gravel extraction in Canada.
Paragraph 212(1)(d) of the Income Tax Act (the "Act") requires a non-resident to pay Part XIII tax of 25% on gross income from rents, royalties and similar payments derived from within Canada. Subparagraph 212(1)(d)(v) of the Act includes payments dependent on the use of or production from property in Canada. It is our view that the payments made under the aggregate extraction agreement fall within the provisions of subparagraph 212(1)(d)(v) of the Act.
Based on the information provided, Mr. X appears to be filing his income tax return and paying tax under Part I of the Act. It is our view that the payments based on $XXXXXXXXXX per metric tonne of aggregates removed from the property, pursuant to the aggregate extraction agreement, fall within the meaning of "royalties" rather than the term "rent". As these payments are not "rent", the taxpayer cannot file a subsection 216(1) election or file an income tax return and pay tax under Part I on that income.
Although the income falls within the meaning of a "royalty" in the general sense of the term for purposes of subparagraph 212(1)(d)(v) of the Act, this meaning differs from the definition of the term "royalties" as specifically defined under paragraph 4 of Article 12 of the Convention. Under the Convention, the income earned pursuant to the aggregate extraction agreement falls under Article 6, not Article 12. Article 6 does not provide for a reduced withholding tax rate. Therefore, the income is taxed at 25% under paragraph 212(1)(d) of the Act without the benefit of a reduction in the withholding tax rate under the Convention.
Guidance on the term "rent" is provided in several court cases. In The Queen v Saint John Shipbuilding & Dry Dock Co. Ltd. [80 DTC 6272], the judge commented:
"A rental can, of course, be paid in a lump sum but in my opinion the word is inseparable from the connotation of a payment for a term, whether fixed in time or determinable on the happening of an event or in a manner provided for, after which the right of the grantee to the property and to its use reverts to the grantor. Royalties, though a broad term, when used in the sense of a payment for the use of property, connotes a payment calculated by reference to the use or to the production or revenue or profits from the use of the rights granted. [emphasis added]
In addition, IT-303, paragraph 7, provides the following guidance:
7. The Department considers that the words "rent" and "royalty" are used in a broad sense...In general, a rent or royalty represents a payment made to the owner of property for the right to use such property for a given period of time. In most circumstances where a rent or royalty is paid, the owner of the property used by the person paying the rent or royalty retains ownership. However, where property in Canada is sold and payment is dependent upon the use of or production from the property, this payment will be subject to tax under subparagraph 212(1)(d)(v), unless the property is agricultural land.
In conclusion, the payments based on $XXXXXXXXXX per metric tonne are akin to payments calculated with reference to the use of the right to extract aggregates under the agreement.
Each payment made pursuant to the aggregate extraction agreement is considered to be a fee or royalty charged or reserved in respect of that right for the purposes of section 162 of the Excise Tax Act (ETA). Pursuant to subsection 162(2) of the ETA, the supply of the right is deemed not to be a supply and the consideration paid in respect of that right is deemed not to be consideration for the right. Therefore, GST/HST is not exigible on the payments made under the aggregate extraction agreement.
Conclusion
Based on the facts provided, the income earned under the aggregate extraction agreement is considered income from property and falls within Article 6 of the Convention. For Canadian tax reporting purposes, tax must be withheld at 25% pursuant to subparagraph 212(1)(d)(v) of the Act. The payments made under the aggregate agreement are not subject to GST/HST.
We trust these comments are helpful.
Lita Krantz, CA
Assistant Director
International Division/ Division des opérations internationales
International Section III
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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