30 November 1988 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.

DATE November 30, 1988
                            FROM Financial Industries Division
                              DE M.M. Trotier
                                 957-8957
TO MEMO TO FILE         
A           

                                           FILE 0-0130
SUBJECT:                                DOSSIER 
OBJECT:  $500,000 Exemption Provided         
        Under Certain Treaties (e.g.            
        Canada-U.S. Treaty ("Treaty")          

Non-resident insurers have been requesting that they be entitled to reduce the amount subject to tax under subsections 219(4) and (5.1) of the Income Tax Act ("Act") by the $500,000 exemption referred to in paragraph 6 of Article X of the Treaty.

Paragraph 6 of Article X of the Treaty permits Canada to impose a branch tax on the earnings (as defined in the Treaty) of a U.S. company attributable to a permanent establishment in Canada but restricts the Canadian branch tax to a maximum amount equal to 10% of such earnings. In calculating earnings, for which the starting point is profits, a deduction of $500,000 is provided for. The Treaty does not provide for the $500,000 deduction to be used at the discretion of a taxpayer against amounts calculated for purposes of section 219 of the Act, but rather the deduction is part of the formula which restricts the amount of Canadian branch tax that can be imposed.

It is our view that the non-resident insurer could not argue that the amount computed under subsection 219(4) of the Act represents "earnings" as they are defined under the Treaty. Subsection 219(4) of the Act allows a non-resident insurer who carried on an insurance business in Canada to elect to pay a 25% tax on an amount which is equal to the excess of an amount computed pursuant to paragraph 219(4)(a) of the Act over the insurer's attributed surplus for the year as defined under

Part XXIV of the Income Tax Regulations. To arrive at the amount referred to in paragraph 219(4)(a) of the Act one has to take into account not only "surplus funds derived from operations" as defined in paragraph 138(12)(o) of the Act but also other amounts. Subsection 219(5.1) of the Act requires the non-resident insurer to pay a special tax on an amount equal to the excess of the amount determined under paragraph 219(4)(a) of the Act, referred to above, over the amount in respect of which an election under subsection 219(5.2) of the Act was made. There again such an amount does not refer only to reinvested profits as is specified under the Treaty but is on a broader base.

In summary it is our view that the non-resident insurer is required to compute his earnings in accordance with the Treaty, a component of which is a $500,000 deduction pursuant to paragraph 6(d) of Article X. While not explicit in the Treaty itself the explanatory notes suggest that the calculation of earnings starts with the first year the Convention takes effect. It seems that the parties intended that the first $500,000 of earnings, calculated in accordance with he Treaty, from the first taxation year commencing after January 1, 985 will not be subject to Part XIV tax in Canada. Nevertheless it does not seem to us that amounts subject to tax under 219(4) and 219(5.1) are equivalent to earnings as calculated under the Treaty but before the $500,000 deduction.

Accordingly Canada may levy its branch tax in accordance with Part XIV of the Act but the amount of such tax cannot exceed 10% of earnings calculated in accordance with the Treaty.

While the non-resident insurer will receive the benefit of the $500,000 exemption provided for in Article X of the Treaty this does not entitle him to a $500,000 deduction to be used at their discretion.

F.L. Workman Chief Financial Institutions Section Financial Industries Division Rulings Directorate