25 September 1979 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.

XXXX

September 25th, 1979

REVENUE CANADA TAXATION Non-Corporate Rulings Division 5th Floor, Metcalfe Building 875 Heron Road OTTAWA, Ontario K1A 0L8

Attention: Mr. Kai Yee

Re: Disposition by XXXX of an income interest in a trust;

Gentlemen:

Further to our brief telephone conversation of yesterday, I am writing you in order to provide you with a summary of certain of the matters of discussion which were raised during our meeting of last Thursday relating to the ques- tion of the application of Article 12(3) of the Canada- U.K. Tax Agreement in the instant case, which Article reads as follows:

12(3) Gains from the alienation of any property other than those mentioned in paragraphs (1) and (2) shall be taxable only in the territory of which the alienator is a resident.

In order to determine the applicability of Article 12(3) of the Agreement, we believe that there are three elements to be established, these elements being (i) gains, (ii) alienation and (iii) property. The other elements men- tioned in Article 12(3) are not to be disputed inasmuch as it is conceded that our client is a resident of the United Kingdom. If it can be established that these three elements are present in the instant transaction the con- sequence is that only the United Kingdom authorities have the jurisdiction to tax the proceeds resulting from the disposition by XXXX.

Dealing first with the elements of alienation and prop- erty, we respectfully submit as follows.

1. In the situation at hand, XXXX a resident of the United Kingdom, has disposed of her income inter- est in a trust. It seems clear that the disposition by XXXX of her right during her lifetime to receive interest from the relevant trust fund must be considered as being an alienation. The term "aliena- tion" is defined in Websters Third New International Dictionary as meaning "a transfer of ownership of title" or "a conveyance of property to another".

Furthermore, it is our contention that the right to receive interest which has been alienated must fall within the ambit of "any property" contained in Article 12(3). That the right to receive income is property cannot be disputed. Classifying this right in terms of the traditional legal classifications XXXX interest must be considered as being personal property and as being a chose in action. It is also to be regarded as being moveable property. It is to be noted that the term "any property" contained in paragraph (3) of Article 12 is all encompassing and includes all kinds of properties excepting only the exclusions contained in paragraph (1) and para- graph (2). Inasmuch as the right in question cannot be considered as being immoveable property, the right to income disposed of by XXXX is clearly moveable property not falling within the classes of moveable property described in paragraph (2) and must therefore fall within the ambit of the term "prop- erty" as used in paragraph (3).

2. In determining the applicability of paragraph (3) of Article 12 of the Agreement the only remaining ele- ment to be discussed is the ambit of the word "gains" as used in that paragraph. It is our contention, as mentioned in previous correspondence and during our recent meeting, that "gains" must be accorded a broad interpretation such that it refers to both income and capital receipts. In support of a broad interpreta- tion, we would make the following comments:

(a) the term used in the Agreement is the term "gains" and not "capital gains". Giving this tern its normal meaning in English usage it seems clear that Article 12(3) should apply to the transaction at hand. In the same diction- ary as has been referred to above, the term "gain" is defined as being "an increase in or addition to what is a profit, advantage, or benefit". We submit that a profit advantage or benefit accrued to XXXX upon the disposition of her income interest and that this profit, advantage or benefit is taxable only in the United Kingdom.

(b) The Canada-U.K. Tax Agreement contains no defi- nition of the term "gains" which is the rele- vant term in Article 12(3). However, Article 2(2) of the Agreement provides that any term not otherwise defined shall have the meaning which it has under the laws of that government relating to the taxes which are the subject of the Agreement.

We are, therefore, directed to look to the local legislation for the definition of the term "gain". The term "gain" is utilized in Sections 39 and 40 of the Income Tax Act (Canada) and it is utilized in such fashion as to clearly indicate that the term refers to both income and capital elements. Pursuant to Section 40, all gains from the disposition of all properties are calculated in accordance with the formula set out in that section. However, pursuant to Section 39, a capital gain is defined as being restricted to certain kinds of gains. According to this Section, capital gains are defined as only those gains not otherwise included in income. Therefore, gains which have already been included in income are to be disregarded for the purposes of calcu- lating capital gains.

To stress this point, therefore, it appears that under Section 40 of the Act, all gains from the disposition of all properties are cal- culated in accordance with the formula stated therein. Then Section 39 directs us to dis- regard those gains which are otherwise included in income. The taxpayer's capital gains con- sist only of those gains which would not other- wise be included in income ("... to the extent of the amount thereof that would not ... be included in computing his income..."). And, finally, Section 38 of the Act provides that the taxpayer's taxable capital gain shall be one half of his capital gains for the year from the disposition of property.

In summary therefore, the term "gains" is the operative term and this term must be given the same meaning in the Agreement as it has in the Income Tax Act (Canada). The meaning of the term "gains" in the Act clearly encompasses both income and capital receipts. The separate and distinct term "capital gain" has very clearly a separate and distinct and much more restrictive meaning and it is consequently illogical and contrary to the rules of inter- pretation of statutes to ascribe to the term "gain" the meaning of the very different term "capital gain".

(c) Judicially, the term "gain" has been defined in Canada by Osler J.A. as "'that which is acquired or comes as a benefit, profit, or advantage', and it may be derived indirectly as well as directly". R. v. James (1903), 6 O.L.R. 35 at p.38.

(d) What appears to be a conclusive argument in favour of the broad interpretation of the term "gains" under the Article 12(3) arises upon considering the unreasonable results which ne- cessarily flow from the Agreement in the event the more restrictive interpretation is applied. Specifically, let us take the case of a resi- dent of the United Kingdom who is not engaged in business and who disposes of an immoveable property situated in Canada. There is no question, even applying the more restrictive interpretation of the term "gains", that the transaction is taxable by the Canadian authori- ties pursuant to Article 12(1) of the Agree- ment. However, let us assume the same U.K. resident has a score of Canadian immoveable properties and is engaged in the active trading of such. Assuming for the purposes of this ar- gument that the person has no permanent estab- lishment in Canada, it appears that if the U.K. resident were to carry on the economic activity of disposing of and purchasing real estate in Canada such that he would be clearly considered to be carrying on business in Canada, the Canadian authorities would not be entitled to tax the relevant transactions if the restriction interpretation is applied. Where the Canadian authorities would be empow- ered to tax a U.K. resident in the event he were to dispose of a recreational property in Canada, the same authorities would be powerless to tax the same U.K. resident in the event that he were to clearly carry on business dealing with a large number of identical properties, because pursuant to the Agreement only capital gains and not income would be subject to assessment in respect the disposition of im- moveable property located in Canada. This is clearly an absurd conclusion and necessarily results if the term "gains" as used in Article 12(1) is to be accorded the narrow definition of referring to capital gains. The term "gains" in Article 12(1) must refer therefore to both income and capital receipts thereby permitting the domestic law to determine how in fact the receipts are to be taxed. Similarly, the term "gains" in Article 12(3) is to be accorded the same interpretation.

(e) At one point during our discussion, it was sug- gested that to interpret the term "gains" as contained in Article 12 as referring to both income and capital receipts would result in a contradiction with Article 6 of the Agreement. Again, taking the example of a United Kingdom enterprise with no permanent establishment in Canada and which enterprise is involved in the business of trading in Canadian real estate, it might appear that the profits realized from the business are taxable in Canada pursuant to Art- icle 12(1) of the Agreement but are not taxable in Canada on the basis of Article 6(1) of the Agreement. This is correct but there is no contradiction involved. The same "contradic- tion" occurs between Article 6(1) and Article 5(1) of the Agreement. Looking at the applica- tion of Article 5(1) of the Agreement, let us continue to examine the case of a United Kingdom enterprise having no permanent estab- lishment in Canada which, however, owns prop- erty in Canada and which derives income in the form of rent therefrom. According to Article 5(1) of the Agreement such income would clearly be taxable in Canada although Article 6(1) of the Agreement would not provide Canadian au- thorities with the power to tax such profits. Clearly, therefore, Articles 5(1) and 6(1) are not to be read as being mutually exclusive.

Article 5(1) does not prevent income from im- moveable property when derived from a permanent establishment from being treated as income of an enterprise but secures that income from im- moveable property will be taxed in the juris- diction in which the property is situated also in the case where such property is not part of a permanent establishment situated in such jurisdiction. A jurisdiction is granted the taxing power provided the income derived from the immoveable property can be attributed to either a permanent establishment in the juris- diction or to the situs of the property in the jurisdiction in question. The same situation exists in respect of Article 6 and Article 12 of the Agreement. Failing the existence of a permanent establishment in Canada, a U.K. enterprise pursuing the business of trading in real estate in Canada may be taxed by the Canadian authorities because of the situs of the relevant immoveable properties in accord- ance with Article 12(1) of the Agreement.

In this connection it is to be noted that Arti- cle 5(1) of the Agreement would not allow the Canadian authorities to tax the proceeds of disposition in the event of such trading be- cause the income deriving therefrom must be regarded as being business income and not income from the property; this is the basic distinction made in the Income Tax Act (Canada) between business and property income. Accord- ingly, the term "gains" used in Article 12(1) must refer to both capital and income receipts; there is no contradiction involved here and to rule otherwise is tantamount to stating that a U.K. resident carrying on the business of trading in real estate in Canada is not subject to taxation by Canadian authorities.

3. Notwithstanding the above-mentioned arguments, it is our contention that s. 106(2)(b) of the Income Tax Act (Canada) provides an additional conclusive argu- ment in favour of the position that the proceeds realized by XXXX are not taxable in Canada. As you are aware, the relevant sub-subsection states that any taxable capital gain or allowable capital loss of the taxpayer resulting from the disposition of an income interest in a trust is deemed to be nil. Therefore, even if in applying Article 12(3) of the Agreement we ascribe to the term "gains" the more restrictive (and unwarranted) meaning of "capital gains", it is clear that s. 106(2)(b) of the Act recognizes the characterization of the relevant asset as being one which is capital in nature. The Depart- ment has in the past suggested that this particular provision was inserted in the Act "for greater cer- tainty" but this appears to be an untenable position precisely because the phrase "for greater certainty" appears in the two provisions immediately following the sub-subsection in question, i.e. in s. 106(2)(c) and s. 106(3). Far from being a statement inserted "for greater certainty", the provision in question drastically modifies the statements of common law referred to in earlier correspondence. The Act clearly, as a result of this provision, alters the tax treatment to be accorded to the proceeds of dis- position but does not change the characterization of the asset as capital. Once the capital nature of the asset has been determined, then it follows that pursuant to Article 12(3) of the Agreement only the United Kingdom is entitled to levy tax in respect of the disposition of such capital asset. The common law characterization of the income interest as a capital asset having been recognized in the Act, it is not open to the Canadian authorities to seek to tax such proceeds by treating the receipts as income.

4. During our meeting, reference was made G. Evans v. M.N.R. (1960) S.C.R. 391 and the statement made therein by Justice Cartwright to the effect that the right to income should not be considered as being a capital asset. It is our contention that these statements are to be regarded as being obiter dicta and this matter is more fully dealt with in our letter of April 18, 1978, addressed to the attention of Mr. A. Joswiak.

We wish to thank you for making yourselves available for our discussion of last Thursday and trust you will find the present comments to be of some assistance as only informal notes were taken during our meeting. We appre- ciate your cooperation and anticipate hearing your deci- sion in the near future.

Yours truly,

W:87 c.c. A. Butler L. Raphael