2010 Ruling 2010-0359981R3 - License and Service Fee Payments

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: 1) Whether a subsection 84(1) deemed dividend is a dividend for the purposes of Article X of the Treaty; 2) Whether Article IV(7)(b) of the Treaty applies to treat a subsection 84(1) deemed dividend as not being paid to or derived by a resident of the United States; 3) Whether Article IV(7)(b) of the Treaty applies to treat certain royalty and service fee payments as not being paid to or derived by a resident of the United States.

Position: 1) The definition of "dividends" in Article X(3) of the Treaty is broad enough to include a subsection 84(1) deemed dividend; 2) Article IV(7)(b) does not apply because the deemed dividend is subject to the same treatment under the taxation laws of the United States as it would be if the dividend payer were not fiscally transparent; 3) Article IV(7)(b) does not apply because the royalties and service fees are subject to the same treatment under the taxation laws of the United States as they would be if the payer of the fees was not fiscally transparent.

XXXXXXXXXX 							2010-035998

XXXXXXXXXX , 2010

Dear Sir:

Re: XXXXXXXXXX
Advance Income Tax Ruling Request

We are writing in response to your letter of XXXXXXXXXX , in which you requested an advance income tax ruling on behalf of the above-noted taxpayers. We also acknowledge the information provided in subsequent e-mail correspondence, and in the course of various telephone conversations. You have advised us that, to the best of your knowledge and that of the taxpayers involved, none of the issues involved in this ruling request are:

(i) in an earlier return of the taxpayers or persons related to the taxpayers;
(ii) being considered by a tax services office or taxation centre in connection with a previously filed tax return of the taxpayers or persons related to the taxpayers;
(iii) under objection by the taxpayers or persons related to the taxpayers;
(iv) before the courts; or
(v) the subject of a ruling previously issued by the Income Tax Rulings Directorate.

Unless otherwise noted, all statutory references herein are to the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.), as amended (hereinafter referred to as the "Act"). Unless otherwise noted, all references to currency are to Canadian dollars.

DEFINITIONS

(a) "adjusted cost base" has the meaning assigned by section 54;

(b) "arm's length" has the meaning ascribed in subsection 251(1);

(c) "Canco" means XXXXXXXXXX ;

(d) "Convention" means the Convention Between Canada and the United States of America With Respect to Taxes on Income and Capital Signed on September 26, 1980 as Amended by Protocols Signed on March 28, 1984, March 17, 1995,
July 29, 1997 and September 21, 2007;

(e) "CRA" means the Canada Revenue Agency;

(f) "License Fee" has the meaning ascribed in Paragraph 10;

(g) "Company Legislation" XXXXXXXXXX ;

(h) "paid-up capital", unless otherwise specified, has the meaning ascribed in the Company Legislation;

(i) "Paragraph" means a numbered paragraph in this letter;

(j) "Pubco" means XXXXXXXXXX , a corporation incorporated under the laws of XXXXXXXXXX ;

(k) "related persons" has the meaning assigned by subsection 251(2);

(l) "Service Fee" has the meaning ascribed in Paragraph 11;

(m) "taxable Canadian corporation" has the meaning assigned by subsection 89(1);

(n) "United States" means the United States of America;

(o) "US Holdco" means XXXXXXXXXX , a corporation incorporated under the laws of XXXXXXXXXX ;

FACTS

1. Pubco and all of the companies in the Pubco group have XXXXXXXXXX year-end for Canadian and United States federal income tax purposes.

2. Pubco is a XXXXXXXXXX products and services XXXXXXXXXX . For the tax year ended XXXXXXXXXX , Pubco generated gross revenues of approximately US$XXXXXXXXXX.

3. Pubco's issued and outstanding share capital consists of XXXXXXXXXX , Class XXXXXXXXXX common shares, and Class XXXXXXXXXX common shares. The rights, privileges, conditions and restrictions attached to the Class XXXXXXXXXX common shares and Class XXXXXXXXXX common shares are identical, except that the Class XXXXXXXXXX common shares entitle the holder to one vote per share whereas the Class XXXXXXXXXX common shares entitle the holder to XXXXXXXXXX votes per share. XXXXXXXXXX .

4. Pubco is not a disregarded entity for United States tax purposes and is therefore not fiscally transparent under the taxation laws of the United States for the purposes of the Convention. Pubco is a resident of the United States for the purposes of the Convention.

5. US Holdco is not a disregarded entity for United States tax purposes and is therefore not fiscally transparent under the taxation laws of the United States for the purposes of the Convention. US Holdco is a resident of the United States for the purposes of the Convention.

6. Pubco and US Holdco are part of a group of corporations that is permitted to file a consolidated income tax return as contemplated by section 1501 of the Internal Revenue Code.

7. US Holdco owns all of the issued and outstanding shares of Canco. Canco carries on the Pubco group's XXXXXXXXXX business in Canada. For the tax year ended XXXXXXXXXX , Canco generated gross revenues of approximately $XXXXXXXXXX .

8. Canco is a taxable Canadian corporation incorporated as an unlimited liability company under the Company Legislation. Canco's address is XXXXXXXXXX . Its files its corporate tax returns with the XXXXXXXXXX Tax Centre and its Canadian federal income tax affairs are administered by the XXXXXXXXXX Tax Services Office.

9. Canco is treated as a disregarded entity for United States income tax purposes and is therefore fiscally transparent under the taxation laws of the United States for the purposes of the Convention. Canco is a resident of Canada for the purposes of the Convention.

10. Pursuant to a License Agreement dated XXXXXXXXXX , Pubco has licensed to Canco XXXXXXXXXX for use in Canco's Canadian business operations. As consideration, Canco pays Pubco a license fee (the "License Fee"). For the taxation year of Canco ended XXXXXXXXXX , the amount of the License Fee payable by Canco to Pubco was approximately $XXXXXXXXXX .

11. Pursuant to a XXXXXXXXXX Services Agreement dated XXXXXXXXXX , Pubco provides XXXXXXXXXX services to Canco in connection with Canco's Canadian business operations. As consideration for the services provided, Canco pays Pubco a service fee (the "Service Fee"). For the taxation year of Canco ended XXXXXXXXXX , the amount of the Service Fee payable by Canco was approximately $XXXXXXXXXX .

12. Pubco and US Holdco do not carry on business through a "permanent establishment" located in Canada, as that term is described in Article V of the Convention. Similarly, Canco does not have a "permanent establishment" in the United States, as that term is described in Article V of the Convention.

PROPOSED TRANSACTIONS

13. On or after XXXXXXXXXX , Canco will make License Fee and Service Fee payments to Pubco pursuant to the terms of the License Agreement and the XXXXXXXXXX Services Agreement, respectively, as those agreements may be amended from time to time.

14. On or after XXXXXXXXXX , in lieu of paying and declaring a cash dividend (or a dividend to be paid through a set-off of an intercompany balance owing by Canco), Canco will:

(a) increase, in accordance with the provisions of the Company Legislation, the paid-up capital in respect of its shares by an amount equal to the amount it wishes to distribute to its shareholders;

(b) reduce, as soon as practicable after the increase referred to in Paragraph 14(a), the paid-up capital in respect of its shares in accordance with the provisions of the Company Legislation by an amount equal to the amount of the increase described in Paragraph 14(a); and

(c) distribute to US Holdco, as a return of capital on its shares, an amount of cash equal to the reduction referred to in Paragraph 14(b) (or set-off an amount owing by Canco in respect of an intercompany balance equal to the amount of that reduction).

PURPOSES OF THE PROPOSED TRANSACTIONS

15. The purpose of the proposed transaction described in Paragraph 13 is to continue to comply with the terms of the License Agreement and the XXXXXXXXXX Services Agreement, as those agreements may be amended from time to time.

16. The purpose of the proposed transactions described in Paragraph 14 is to distribute cash generated from Canco's business operations, as described in Paragraph 7, to US Holdco in a manner that avoids the application of Article IV(7)(b) of the Convention.

ADDITIONAL INFORMATION

17. For the purposes of Article XXIX-A(3) of the Convention, the income derived by Pubco and US Holdco in respect of the Licence Fee, the Service Fee, and in respect of dividend income received or deemed to be received on the shares of Canco is derived in connection with the active trade or business carried on in the United States by Pubco and its related subsidiaries, and the active business activities carried on by Pubco and its related subsidiaries in the United States is substantial in relation to Canco's Canadian business activities.

18. Notwithstanding that the proposed transaction described in Paragraph 14(a) will result in a deemed dividend on the shares of Canco owned by US Holdco under subsection 84(1), no income, profit or gain will arise or will be recognized under the taxation laws of the United States as a result of the transactions described in Paragraphs 14(a) and 14(b). Similarly, no amount of income, profit or gain would arise or be recognized under the taxation laws of the United States as a result of those transactions if Canco were not fiscally transparent under the taxation laws of the United States.

19. The proposed transactions described in Paragraphs 14(a) and 14(b) will not affect the tax treatment in the United States of any subsequent distribution on the Canco shares owned by US Holdco, including the return of paid-up capital referred to in Paragraph 14(c).

20. Pursuant to a pending joint venture proposal with a Canadian-resident corporation that deals at arm's length with Pubco and its subsidiaries, including Canco, it is proposed that the Canadian-resident corporation will transfer certain of its business assets to Canco in exchange for shares of Canco that will provide the corporation with a non-controlling equity interest in Canco. If the joint venture proposal is consummated, Canco will be treated as a partnership for United States income tax purposes and will no longer be considered a disregarded entity for United States income tax purposes, but would continue to be fiscally transparent under the taxation laws of the United States for the purposes of the Convention.

21. The United States income tax treatment described in Paragraphs 18 and 19 will be the same if the proposed joint venture described in Paragraph 20 is consummated and Canco is treated as a partnership for United States tax purposes.

22. If the proposed joint venture transaction described in Paragraph 20 is not consummated, Pubco will include the License Fee and Service Fee in computing its separate taxable income for United States income tax purposes. US Holdco will deduct the License Fee and Service Fee in computing its separate taxable income for United States tax purposes. In computing the consolidated taxable income of the group of corporations referred to in Paragraph 6, the License Fee and Service Fee income included in the computation of Pubco's separate taxable income will be reduced by the amount of License Fee and Service Fee expense deducted by US Holdco.

23. If the proposed joint venture transaction described in Paragraph 20 is consummated, Pubco will include the License Fee and Service Fee in computing its separate taxable income for United States tax purposes. US Holdco will deduct a portion of the License Fee and Service Fee in computing its separate taxable income for United States tax purposes based on its proportionate equity interest in Canco. In computing the consolidated taxable income of the group of corporations referred to in Paragraph 6, the License Fee and Service Fee income included in the computation of Pubco's separate taxable income will be reduced by the amount of License Fee and Service Fee expense deducted by US Holdco.

RULINGS

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, the preliminary transactions, the proposed transactions and the purposes of the proposed transactions, and provided further that the proposed transactions are completed in the manner described above, we rule as follows:

A. Article IV(7)(b) of the Convention will not apply to the License Fee or Service Fee paid by Canco to Pubco.

B. To the extent that Canco is deemed to have paid, and US Holdco is deemed to have received, a dividend pursuant to subsection 84(1) as described in Paragraph 14(a), that dividend will be a taxable dividend as described in paragraph 212(2)(a).

C. For the purposes of applying Article X of the Convention, the amount of the dividend referred to in Ruling B will be considered to be income as described in the definition of "dividends" in Article X(3) of the Convention.

D. Article IV(7)(b) of the Convention will not apply to treat the dividend referred to in Ruling B as not having been paid to US Holdco.

E. Subsection 245(2) will not apply to re-determine the tax consequences confirmed in the rulings given above.

The above-noted rulings are based on the Act and the Convention in their present form and do not take into account any proposed amendments to the Act or the Convention which, if enacted, could have an effect on the rulings provided herein.

CAVEAT

Nothing in this letter should be construed as implying that the CRA has agreed to or reviewed:

(a) the determination of the adjusted cost base, the paid-up capital, as defined in subsection 89(1), or the fair market value of any shares or other property referred to herein;

(b) the amount of any dividend that will be deemed to be paid by Canco as a consequence of a transaction described in Paragraph 14(a);

(c) whether Canco is fiscally transparent under the taxation laws of the United States for the purposes of the Convention;

(d) whether the dividend that will be deemed to be paid by Canco as a consequence of the proposed transaction referred to in Paragraph 14(a) is disregarded under the taxation laws of the United States or would be disregarded if Canco were not fiscally transparent under the taxation laws of the United States for the purposes of the Convention;

(e) whether the License Fee and Service Fee are taxable only in the United States pursuant to the Convention; and

(f) the deductibility of the License Fee and the Service Fee in computing Canco's income under the Act and the application of subsection 247(2) in respect of the License Fee and the Service Fee;

(g) any tax consequences relating to the facts and proposed transactions described herein other than those described in the rulings given above.

This ruling is based solely on the facts, the proposed transactions and additional information described above and is subject to the limitations and qualifications set forth in Information Circular 70-6R5 issued on May 17, 2002. This ruling is binding on the CRA provided that the proposed transactions are completed on or before XXXXXXXXXX .

Yours truly,

for Director
International and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch