28 July 1987 Income Tax Severed Letter

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.

July 28, 1987

Mr. Vance Sider Chief Foreign & Small Business Section Revenue Canada, Taxation 3rd Floor 88 Metcalfe Street Ottawa, Ontario KlA 0L8

Dear Mr. Sider:

Pursuant to your recent telephone conversation with XXXX of our office, we are writing to request the position of Revenue Canada Taxation on the following issues:

Issues

1. Will the federal, state and local governments of the U.S. be considered residents of that State for purposes of The Canada-U.S. Income Tax Convention ("the Convention")?

2. Will a division of the U.S. federal government, or of a state or local government of the U.S., which is constituted and operated exclusively to administer or provide benefits under one or more funds or plans established to provide pension, retirement or other employee benefits, be eligible for the exemption from withholding tax on dividends and interest received from Canadian sources under paragraph 2 of Article 70(1) of the Convention?

Discussion - Issue 1

Interpretation of the Convention

Paragraph 1 of Article IV of the Convention defines a resident of a Contracting State to be "a person who, under the laws of that State, is liable to tax therein by reason of his domicile, residence, place of management, place of incorporation or any other criterion of a similar nature...".

The application of this definition to federal, state and local governments hinges on the meaning to be given to the expression "liable to tax therein". In this regard, it is notable that paragraph 2 of Article XI of the Convention refers to pension trusts and similar organizations which are resident in a Contracting State but exempt from tax in that State, thereby establishing the principal that an entity can be exempt from tax in its State of residence and still be considered resident of that State for purposes of the Convention. Furthermore, it is instructive that Canadian pension trusts enjoy a complete exemption from tax under paragraph 149(o) of the Income Tax Act, whereas U.S. pension trusts enjoy only a partial exemption from tax (i.e. they remain taxable on business income which is unrelated to their exempt function) under sections 501 and 511 of the Internal Revenue Code ("IRC").

As one would expect that the drafters of the Convention considered both U.S. and Canadian pension trusts to be resident of their respective States for purposes of the Convention (otherwise Article XXI, paragraph 2 would only benefit the U.S.), one may conclude that the drafters intended that entities which are liable to tax by reason of their residence but are then partially or completely exempt from tax under an exempting provision would be considered "liable to tax" in their State of residence. Indeed, it would appear that the requirement of liability to tax was intended as an indication of residency when residency is not otherwise clear, in order to deny the benefits of the Convention to persona who do not have sufficient indicia of residence in a Contracting State to trigger liability to tax therein. For example, absent such a requirement, a citizen of a third country who sojourned in the U.S. but was not present in the U.S. for a sufficient period of time to be subject to U.S. tax under U.S. domestic law could attempt to claim the benefits of the Convention with regard to income from Canadian sources.

The U.S. federal government is completely exempt from U.S. tax since it is the taxing body itself. U.S. state and local governments receive complete exemption from U.S. tax under IRC 115, and in addition it has been argued that such governments are exempt from tax under the U.S. Constitution. Clearly, the U.S. federal, state and local governments have sufficient indicia of U.S. residence so that they would be liable to U.S. tax but for the above exempting provisions. Therefore, it is our view that they should be considered residents of the U.S. for purposes of the Convention, and we respectfully request an interpretation to that effect.

Intention of U.S. Congress to Grant Residency Status to Foreign Governments for Tax Treaty Purposes

IRC 892 provides rules under which U.S. source investment income earned by foreign governments is exempt from U.S. federal income tax. Amendments to that section in the Tax Reform Act of 1986 limit its application where income is received from commercial activities. In enacting these amendments, the U.S. Congress indicated its intention to treat foreign governments as residents of their respective countries for tax treaty purposes, unless such governments deny reciprocal treatment to U.S. governmental entities. For your information, we enclose a copy of the Senate Finance Committee Report stating this intention. In this regard, it should be noted that the regulations to IRC 892 include a political subdivision of a foreign country within the definition of a foreign government.

Should you be unable, based upon interpreting the Convention itself, to determine that the U.S. federal, state and local governments are residents of the U.S. for purposes of the Convention, we respectfully request that consideration be given to granting such status as a response to the above-mentioned position of the U.S. government.

Discussion - Issue 2

This issue flows from the first one in that it is dependent upon the relevant government being considered resident of the U.S. for purposes of the Convention. If it is considered so resident, then the remaining question to be resolved is whether a division of that government, the sole function of which is to administer pension plans, would be considered an "organization" within the meaning of paragraph 2 of Article XXI of the Convention. In the spirit of liberal interpretation of income tax conventions which has been established in the jurisprudence, it would appear that the term "organization" is sufficiently broad so as to include a division of a larger entity, particularly when that division is operationally and administratively distinguishable from the larger entity (as would be the case with a division administering pension plans).

The resolution of the above issues is central to a major international transaction, and therefore we would be very appreciative if you could give this matter your earliest possible attention.

Yours very truly,