17 May 1983 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

May 17, 1983

Mr. R. Read, Director General Corporate Rulings, Department of National Revenue, Taxation, 875 Heron Road, Ottawa, Ontario, K1A 0L8

Dear Mr. Read,

At the suggestion of Mr. Keith Harding, Provincial and International Relations Division, we are writing to you seeking an interpretation of Article 13, paragraph 4 of the Canada-United Kingdom Income Tax Convention.

Specifically, we are concerned as to the circumstances under which shares will be considered to derive "their value or the greater part of their value directly or indirectly from immovable property situated in a con- tracting state". We assume that where greater than 50% of the value of the property underlying the shares is attributable to Canadian immovable property, paragraph 4 will be applicable. In making the determination of the relative values of the underlying assets, however, does one look to the gross or net values thereof? The following example will serve to illustrate:

                             UKCO
                                 |
                                 | 100%
                                 |
                           CANCO I
                          /             \
                  100%            100%
                     /                       \
            CANCO II                 USCO

Underlying assets and liabilities:
                                                                                                                 $
CANCO I                  Canadian real property               1,000
                                  Debt                                              (300)              700
                                                                                     --------

CANCO II                Canadian real property                 1,000
                                  Debt                                               (800)             200
                                                                                      --------

USCO                      U.S. real property                          2,500
                                Debt                                             2,000                 500

Value of assets relating to Canadian immovable property:
Gross                     2,000/4,500                         =           44%
Net                         900/1,400                            =           64%

In the above example the determination under paragraph 4(a) will vary depending upon whether the gross or net asset values are considered. We would appreciate your comments as to whether, under the above circumstances, a disposition of the shares of CANCO I by UKCO will be taxable in Canada; assuming the shares of CANCO 1 are taxable Canadian property as defined in paragraph 115(1) (b) of the Income Tax Act.

If net assets are to be used as the test, the question arises as to which liabilities are to be taken into account; all of them or only those secured by the immovable property. If the latter, are all such liabilities con- sidered or only those incurred to acquire the immovable property?

A further question arises if net assets are to be used as the test and there are other assets as well as liabilities. Are the liabilities first applied against the other assets or against the immovable property? This is illustrated as follows.

Assuming the same corporate structure as that noted previously:

CANCO I              Canadian real property              2,000 
                             Other assets                              1,000 
                             Debt                                             (500)

CANCO II             Canadian real property              1,500 
                             Other assets                              1,000 
                             Debt                                             (500)

USCO                 U.S. real property                         2,000 
                           Other assets                                     -
                           Debt                                               (800)

Debt offset first against immovable property:

                         2,500/5,700 = 44% 

Debt offset first against other assets:

                        3,500/5,700 = 61%

In light of the above and given that only assets can give rise to value, we would submit that the only reasonable way to make the determination is to look at gross assets in the parent and any subsidiaries or other companies in which the parent has an interest.

In this regard, it should be noted that the draft U.S.-Canada treaty uses similar, but somewhat clearer wording when dealing with the subject of gains from "real property".

We understand that the U.S. would almost certainly look to gross assets since this is in line with the XXXX approach. We can see no justification for Canada's accepting one approach with respect to the U.K. treaty and a different approach for the draft U.S. treaty.

Should you have questions concerning this request, please contact XXXX of this office.

Yours very truly,

XXXX