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: Whether the particular partners of a UK LP (a) have indirect control over the voting power of Holdco held by the UK LP; (b) considered to indirectly own more that 10% of the shares and capital of Holdco; and (c) considered to be dealing at arm's length with Canco, a subsidiary of Holdco.
Position: (a) Only the general partner would be considered to control directly or indirectly at least 10% of the voting power in Holdco; (b) LP3 would be considered to indirectly own more than 10% of the capital of Holdco while LP1 would not exceed this threshold; (c) Likely yes, but it is a question of fact.
Reasons: (a) Consistent with prior views. (b) "directly or indirectly" modifies the ownership test. (c) It's a question of fact.
XXXXXXXXXX 2014-056378
John Meek
(416) 954-6038
September 7, 2016
Dear XXXXXXXXXX,
RE: Application of the Canada-UK Tax Treaty to Dividends and Interest Paid to a UK Limited Partnership.
This is in response to your letter, wherein you asked for our views regarding the application of the Canada-UK Income Tax Convention (the “Treaty” (footnote 1)) to dividends and interest paid in the hypothetical fact pattern described below by a corporation resident in Canada to a limited partnership established under United Kingdom (“UK”) law (“UK LP”). We apologize for the delay in responding to your request.
This technical interpretation provides general comments about the provisions of the Income Tax Act (the “Act”) and related legislation (where referenced). It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R7 “Advance Income Tax Rulings and Technical Interpretations”. However, we offer the following general comments, which may be of assistance to you.
Facts and Assumptions
1. UK LP is a limited partnership established under the laws of the UK and is treated as fiscally transparent for UK tax purposes. UK LP is a partnership for purposes of the Act. Under the partnership agreement governing UK LP, the interests of UK LP are divided into general partnership interests and limited partnership interests and the income or loss of UK LP is generally allocated among its partners in proportion to the respective capital contributed by each partner.
2. The general partner (“GP Co”) is a UK corporation and is a non-resident of Canada for purposes of the Act. GP Co is the sole general partner of UK LP and holds a general partnership interest representing 1% of the interests in UK LP. Under the terms of UK LP’s partnership agreement, GP Co has sole authority to manage and control the management activities and affairs of UK LP, and implicit in that authority, the ability to vote on any shares of corporations held by UK LP. GP Co has the ability to delegate the day-to-day management of UK LP to a third party (that is a non-resident of Canada for purposes of the Act); however, in any such case, GP Co is not relieved of its obligations as the general partner of UK LP.
3. The limited partners of UK LP (collectively, the “Limited Partners”) are non-residents of Canada for purposes of the Act. The Limited Partners collectively hold limited partnership interests representing 99% of the interests in UK LP; however, no Limited Partner (alone or together with persons with whom the Limited Partner is not dealing at arm’s length for purposes of the Act) owns 25% or more of the limited partnership interests in UK LP.
4. The Limited Partners of UK LP include LP1, LP2 and LP3 as follows:
a. LP1 and LP3 are each an organization that is constituted and operates in the UK exclusively to administer and/or provide benefits under a “recognized pension plan” (as defined in paragraph 4 of Article 10 of the Treaty) that provides benefits primarily to UK-resident individuals. Each of LP1 and LP3 is generally exempt from tax under the tax laws of the UK. Among the various investments held by LP1 and LP3, LP1 owns a 7% limited partnership interest in UK LP and LP3 owns an 11% limited partnership interest in UK LP.
b. LP2 is a corporation that is subject to tax on its worldwide income under the tax laws of the UK and is a resident of the UK for the purposes of the Treaty. LP2 owns a 19% limited partnership interest in UK LP.
5. No Limited Partner is related to another Limited Partner or GP Co for the purposes of the Act and each Limited Partner factually deals with every other Limited Partner and GP Co at arm’s length for the purposes of the Act.
6. UK LP holds 100% of all of the issued and outstanding shares in Holdco, a taxable Canadian corporation for the purposes of the Act. Holdco only has one class of shares issued and outstanding.
7. Holdco holds 100% of all of the issued and outstanding shares in Canco, a taxable Canadian corporation for the purposes of the Act.
8. UK LP used the subscription proceeds from the issuance of its partnership interests to make an interest-bearing loan to Canco (the “UK LP Loan”). Canco used the proceeds of the UK LP Loan in the course of its active Canadian business operations. The interest on the UK LP Loan is not a “participating debt interest” and is not “fully exempt interest”, as those terms are defined in subsection 212(3) of the Act. The terms and conditions of the UK LP Loan (including the interest rate) are generally comparable to the terms and conditions of borrowings that Canco would otherwise be able to obtain from arm’s-length third parties.
9. Canco periodically declares and pays cash dividends to Holdco and Holdco periodically declares and pays cash dividends to UK LP.
10. Each of LP1, LP2 and LP3 is the beneficial owner of its partnership interest in UK LP.
11. UK LP is the beneficial owner of all of the shares of Holdco and of any dividends received from Holdco.
You have asked for our views on two issues with respect the application of Article 10 of the Treaty:
- Whether each of LP2 and LP3 is considered to have “indirect control” over the voting power of Holdco, the shares of which are held by UK LP, for purposes of subparagraph 2(a) of Article 10? (“Issue 1”); and
- Whether LP1 and LP3 are considered to own indirectly shares of Holdco for purposes of paragraph 3 of Article 10? (“Issue 2”)
With respect the application of Article 11 of the Treaty, you have asked for our views on the following issue:
- Whether LP1, LP2 and LP3 are considered to be dealing at arm’s length with Canco for purposes of subparagraph 3(c) of Article 11? (“Issue 3”)
Our Comments
The Treaty may reduce the rate of the Canadian withholding tax that would otherwise be imposed on the dividends and/or interest paid to a recipient of such dividends/interest, but only if that recipient is a resident of the UK for purposes of the Treaty and is the beneficial owner of such dividends/interest.
The CRA would look through UK LP to determine if the partners are entitled to the Treaty benefits in respect of the income of the partnership. In addition, the “look-through” approach is specifically provided for in the Interpretative Protocol for 2014 Protocol in respect of fiscally transparent UK limited liability partnerships to the extent that the income or gains derived by or through a limited liability partnership are treated for UK tax purposes as the income or gains of a resident of the UK.
For purposes of the following discussion we assume that each LP1, LP2 and LP3 is a resident of the UK as that term is defined in Article 4 of the Treaty and is the beneficial owner of the dividends and interest.
Issue 1 - Whether each LP2 and LP3 is considered to “control directly or indirectly” at least 10% of the voting power of Holdco for purposes of subparagraph 2(a) of Article 10
The 5% withholding rate under subparagraph (2)(a) of Article 10 of the Treaty applies if the beneficial owner of the dividend “is a company which controls, directly or indirectly, at least 10 per cent of the voting power in the company paying the dividends.”
We interpreted the meaning of the expression “controls directly or indirectly” as used in paragraph 2 of Article 10 of the Canada-Luxembourg Treaty in the context of dividend payments to a partnership with the majority partner resident in Luxembourg (see 2007-022954). In that document we concluded that the Luxembourg resident partner (Luxco) controlled directly or indirectly more than 10% of the voting power in the company paying the dividends that was held by the partnership. Pursuant to the terms of the partnership agreement, Luxco had the power to elect or appoint the majority members of the Partnership Board, which was established to provide oversight activities directly related to the administration and stewardship of investments held by the partnership. In addition, Luxco controlled the general partner and could cause it to vote in accordance with Luxco’s desire in respect of dismissing and appointing the Board members.
However, in the fact pattern you describe, it is our view that only GP Co would be considered to control directly or indirectly at least 10% of the voting power in Holdco unless the partnership agreement specifically provided the limited partners with the ability to vote on the shares of Holdco. Therefore, LP2 and LP3 would not qualify for the 5% withholding rate under subparagraph 2(a) of Article 10. In addition, it is unclear, on the facts provided, that LP3 would meet the definition of a “company” in Article 3, such that it would meet the other requirement in subparagraph 2(a).
Issue 2 - Whether LP1 and LP3 are considered to own indirectly shares of Holdco for purposes of paragraph 3 of Article 10?
Paragraph 3 of Article 10 of the Treaty provides an exemption from withholding tax on dividends beneficially owned by a “recognized pension plan” if, among other conditions, such an organisation “does not own directly or indirectly” more than 10% of the capital or 10% of the voting power of the company paying the dividends.
For the purposes of subparagraph 3(b) of Article 10, we are of the view that LP1 and LP3 will be considered to own indirectly the shares of Holdco and accordingly Holdco’s capital in proportion to their partnership interests in UK LP. While we are of the view that fractional ownership under the partnership law would generally prevent partners from owning a particular percentage of the partnership’s property and meeting the ownership test, in our view, the words “directly or indirectly” enable to attribute a particular percentage of ownership of partnership property to a partner in this case.
Pursuant to this reasoning, LP3 would be considered to indirectly own more than 10% of the shares and capital of Holdco while LP1 would not exceed this threshold. Consequently, the requirements of subparagraph 3(b) would be satisfied in respect of LP1 but not in respect of LP3.
Issue 3 - Whether LP1, LP2 and LP3 are considered to be dealing at arm’s length with Canco for purposes of subparagraph 3(c) of Article 11?
Absent the Treaty, interest paid by Canco to UK LP will be subject to a 25% withholding tax under paragraph 212(1)(b) of the Act because paragraph 212(13.1)(b) will deem the UK LP to be a non-resident person for Part XIII withholding tax purposes and since UK LP and Canco would be considered to be related persons under subsection 251(2), subsection 251(1) will deem the UK LP not to deal at arm’s length with Canco for the purposes of applying paragraph 212(1)(b).
Under subparagraph 3(c) of Article 11 of the Treaty, interest arising in Canada and paid to a resident of the UK shall be exempt from Canadian withholding if the beneficial owner of the interest is a resident of the UK and is dealing at arm's length with the payer.
Pursuant to the Interpretative Protocol, whether persons are considered to be dealing at arm's length with each other or not is determined by subsection 251(1) of the Act. Under subsection 251(1), related persons are deemed not to deal with each other at arm’s length; and it is a question of fact whether persons not related to each other are, at a particular time, dealing with each other at arm’s length. Related persons, or persons related to each other are defined in subsection 251(2) of the Act.
In the fact pattern you described, we will consider GP Co to control Holdco and Canco. Since no Limited Partner is related to another Limited Partner or GP Co, each of LP1, LP2 and LP3 should not be considered to be related to Canco under the “related persons” definition in subsection 251(2) of the Act. As such, LP1, LP2 and LP3 will not be deemed not to deal at arm’s length with Canco. However, as mentioned above, it is a question of fact as to whether unrelated persons are dealing at arm’s length. You referred to our comments in Folio S1-F5-C1:
1.43 Where one partner is in a position to control a partnership, that partner is not considered to be dealing at arm's length with the partnership. For example, a partner can be in a position to control a partnership through ownership of a controlling interest or through a mandate vested in that partner by the other partners. However, when a partner is not in a position to control a partnership and that partner has little or no say in directing the operations of the partnership, it is generally recognized that the partner is dealing at arm's length with the partnership.
Where a related group of partners owns a controlling interest in a partnership, each member of that related group will not be considered to deal at arm's length with the partnership.
By analogy, you reason that a partner who is considered to be dealing at arm’s length with a partnership should also be considered to be dealing at arm’s length with the corporation controlled by the partnership. We generally agree with your reasoning, however as we mentioned earlier, a determination of whether unrelated persons are dealing with each other at arm’s length can only be made after the consideration of all the relevant facts and circumstances.
Provided that each LP1, LP2 or LP3 is factually dealing at arm’s length with Canco, LP1, LP2 and LP3’s respective share of the interest paid by Canco to UK LP will be exempt from Canadian withholding tax by virtue of subparagraph 3(c) of Article 11 of the Treaty.
We trust our comments are of assistance.
Yours truly,
Julia Belova
Manager
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
FOOTNOTES
Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:
1 Convention Between the Government of Canada and the Government of the United Kingdom of Great Britain and Northern Ireland for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion With Respect to Taxes on Income and Capital Gains, as Amended by the Protocols Signed on April 15, 1980, October 16, 1985, May 7, 2003 and July 21, 2014.
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