Article 10 - Dividends

A partnership whose partners are resident in the U.S. and in other countries with which Canada does and does not have a treaty owns a French entity (that is fiscally transparent for U.S., but not Canadian or French purposes) that earns dividends and interest from a Canadian company. Can the Canadian payor of the dividends determine its withholding tax obligations in accordance with the relevant articles under either the Canada-France, or Canada-US, Treaty?

CRA noted that the first option is that, if IV(6) of the Canada-US Treaty applies, and some of the dividend paid by the Canadian company to the French company is deemed to be derived by the US partners, US Treaty benefits can be claimed to reduce the withholding rate on the portion of the dividend attributable to those partners, under Art. IV(6).

The second option is that, from a Canadian perspective, there is a single dividend payment from a Canadian entity to a French entity, so that the French Treaty is applicable to the entire amount of the dividend.

CRA indicated that the two options are mutually exclusive and exhaustive – either the French Treaty applies to the full amount of the dividend, or the US Treaty applies pro-rata to the US partners.

Parentco, a U.S.-resident, is the only member of Parentco LLC, which is the only member of Sisterco LLC, and also wholly-owns Canco. Canco resides in Canada for purposes of the Canada-US Income Tax Treaty (the “Treaty”).

CRA proposed an inclusion in Canco’s income under s. 247(2) of the difference between an arm’s length price for goods sold by Canco to Sisterco LLC and the consideration paid, and also proposed a secondary adjustment under s. 247(12) on the basis that a resulting benefit conferred on Sisterco LLC was deemed to be a dividend that was paid by Canco that was subject to a Pt. XIII remittance obligation.

The Directorate found that the s. 247(12) amount (which was a deemed dividend under ITA s. 2121(2)) was also a dividend for Treaty purposes, stating:

Although Sisterco LLC is not a shareholder of Canco, the transfer pricing income adjustment made under subsection 247(2) results from the fact that they are not dealing at arm’s length (or to paraphrase paragraph 29 of the OECD Commentary, that “the persons receiving such benefits are closely connected with a shareholder; this is the case, for example, where the recipient is a relative of the shareholder or is a company belonging to the same group as the company owning the shares”).

Two U.S. corporations that were “qualifying persons” for purposes of the Canada-U.S. Treaty (USCo1 and USCo2) held 58% and 42%, respectively, of LLC1 which held LLC2 which, in turn, held LLC3. LLC3 operated a Canadian branch business.

Headquarters stated:

[T]he fact that there may be more than one fiscally transparent entity in the corporate chain does not alter the fact that the condition of there being an entity that is fiscally transparent and through which a U.S. resident person derives income is already met.

Accordingly, if all the LLCs were fiscally transparent for U.S. income tax purposes (so that LLC1 was a partnership for U.S. purposes), USCo1 and USCo2 would be considered to be deriving income through LLC3 that met the same tax treatment condition in Art. IV(6) – and, similarly, LLC1 Itself would be considered to be deriving such income as a qualifying person if it had chosen to be treated as a corporation. Thus, in both scenarios, such income would be entitled to the branch profits rate reduction in Art. X(6).

A UK corporation (“GP Co”) is the general partner (with a 1% interest) of a UK limited partnership which is fiscally transparent for UK purposes and a partnership for ITA purposes (“UK LP” – all of whose partners are non-residents), and the Limited Partners include LP1 and LP3, which provide benefits under a “recognized pension plan” (as defined in Art. 10, para. 4 of the Canada-UK Treaty) and own 7% and 11% partnership interests, and LP2, a UK corporation owning a 19% partnership interest. In addition to being unrelated, the partners factually deal with every other at arm’s length. UK LP wholly owns Holdco, which wholly owns Canco, also a taxable Canadian corporation. UK LP used the subscription proceeds from the issuance of its partnership interests to make a loan to Canco (the “UK LP Loan”), the interest on which is not a “participating debt interest.”

Issue 1

Would LP2 and LP3 be considered to have “indirect control” over the voting power of Holdco, the shares of which are held by UK LP, for purposes of Art. 10, subpara. 2(a)?

Issue 2

Would LP1 and LP3 be considered to own indirectly shares of Holdco for purposes of Art. 10, para. 3?

CRA responded:

Issue 1…

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.” …

[O]nly 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…that LP3 would meet the definition of a “company” in Article 3….

Issue 2...

Paragraph 3 of Article 10… 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.

…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…fractional ownership under the partnership law would generally prevent partners from owning a particular percentage of the partnership’s property…the words “directly or indirectly” enable to attribute a particular percentage of ownership of partnership property to a partner….

Consequently, the requirements of subparagraph 3(b) would be satisfied in respect of LP1 but not in respect of LP3.

A corporation resident in Switzerland ("Swissco") wholly-owns "Holdco," which wholly-owns "Canco"). S. 214(3)(a) deems Canco to pay a dividend to Swissco. The rate of withholding tax would be 15% under the English version of the Swiss Treaty but 5% under the French version. How would Art. 10(2)(a) of the Swiss Treaty apply? CRA responded:

[T]axpayers should, in these circumstances, apply the version of the Swiss Treaty that gives them the most favourable result. We would normally expect that this would be the French version… .

What is CRA's position on the application of the GAAR to treaty shopping arrangements? CRA stated:

The…comments on treaty shopping… made in the February 2014 Budget as well as in the August 2014 Finance news release [do not] preclude[e] the application of the GAAR to treaty shopping arrangements.

The CRA continues to contemplate the application of the GAAR to transactions undertaken primarily to secure a tax benefit afforded by a tax treaty and, in fact, the GAAR Committee has recently approved the application of the GAAR to certain treaty shopping arrangements.

An IRA account of Mr. X (who is a citizen and a resident of the US) receives a distribution on units held in a REIT as defined in s. 122.1(1). Before concluding that the REIT distributions would not be eligible for 0% withholding under Art. XXI, para. 2 of the Canada-U.S. Treaty as the REIT was not a SIFT trust, CRA stated:

[A] distribution of income from a SIFT Trust is deemed to be a dividend pursuant to subsection 104(16)… and is similarly treated as a dividend for the purposes of the Treaty pursuant to the 2007 Protocol Annex B in regards to paragraph 3 of article X.

A Canadian-resident corporation (CanCo1) and its wholly-owned Canadian-resident subsidiary (CanCo2) are the 99% limited partner and 1% general partner, respectively, of CanLP. CanLP lends $1 million to the immediate Netherlands-resident parent of CanCo1 (Foreign Parent) or, alternatively ("situation 2"), lends $1 million to the Netherlands parent of Foreign Parent (Foreign Grandparent). In either situation, the loan is not repaid on a timely basis, so that in the absence of Treaty relief, Foreign Parent or Foreign Grandparent is deemed under s. 214(3)(a) to receive a dividend which is subject to Part XIII withholding tax of 25%. Subpara. 2(a) of Art. 10 of the Canada-Netherlands Treaty provides that if the recipient of the dividend (i.e., Foreign Parent or Foreign Grandparent, as applicable) owns at least 25 per cent of the capital of, or controls directly or indirectly at least 10 per cent of the voting power in, the company paying the dividend, a 5 per cent withholding tax rate would apply.

In finding that the 5% Treaty-reduced rate applied to either deemed dividend, CRA stated:

In the context of applying the provisions of Article 10 of the Treaty, subsection 96(1) of the Act does not apply and CanLP is not considered a separate person. As CanLP is not a separate person, each of the partners thereof would be viewed as having made their pro rata share of the loan described in hypothetical situations 1 and 2 above. It follows, in our view, that each of CanCo1 and CanCo2 would be considered, for the purposes of Article 10 of the Treaty, to have paid their pro rata share of the dividend deemed to have been paid pursuant to paragraph 214(3)(a)….

Furthermore, the above structure would satisfy the indirect voting control test in para. 2(a) so that, for example, it would be considered that Foreign Grandparent "satisfies the controlling threshold of controlling directly or indirectly at least 10 per cent of the voting power in each of CanCo1 and CanCo2."

A US LLC, which has two US-resident members (either two corporations or an individual and a corporation) who qualify for Treaty benefits, carries on business in Canada through a permanent establishment. CRA indicated:

To facilitate the computation of the relevant Article X(6) earnings that may be eligible for a reduced 5% branch tax, the earnings are computed by the LLC as if it were the company referred to in Article X(6). Once the LLC has computed its earnings attributable to permanent establishments in Canada, they are then allocated to the LLC's members by applying Article IV(6). Accordingly, the LLC can generally pay the reduced rate of branch tax in Article X(6) in respect of the share of branch profits that are considered to be derived by its corporate members.

After indicating that the LLC may not claim the reduction under Art. X(6) in respect of the portion of its "branch profits that are considered, by virtue of Article IV(6), to be derived by individual members," CRA stated:

It is the CRA's view that a LLC has only one $500,000 cumulative exemption. It must be shared by associated companies with respect to the same or similar business and reduced by any portion which has previously been deducted.

The two partners of a partnership which has elected to be a domestic corporation for Code purposes are: a corporation which is resident in the U.S. for purposes of the Canada- U.S. Income Tax Convention; and a corporation resident in a non-Treaty country.

CRA indicated that a member of the partnership can access benefits under Article X(6) of the US Treaty ("partnership-level benefits") to the extent that the partnership could have claimed such benefits had the partnership been the entity subject to Canadian branch tax. Although the partnership would not so qualify as a "qualifying person" as defined in Art. XXIX A(2) of the US Treaty due to the absence of share capital for the partnership, "partnership-level benefits" under Art. X(6) may apply to business profits earned by a US-resident partnership through a Canadian permanent establishment in accordance with the "active trade or business" test under Art. XXIX A(3), or, if treaty benefits are granted by the Canadian competent authority, under Article XXIX A(6).

Additionally, a member of the partnership that is itself eligible to claim treaty benefits under Article X(6) may still apply the reduced branch tax rate to its share of the partnership's profits earned through a Canadian permanent establishment.

In the first "partnership-level benefits" situation, partnership profits will not be reduced by partner-level expenses or Canadian income tax liabilities. "Consequently, the member of the partnership may find that its share of the partnership's Article X(6) earnings amount exceeds the amount upon which Part XIV tax is otherwise payable under subsection 219(1)."

Holdco, which had been a listed U.S. company, was taken private by L5, which was a fund whose members are not known. Holdco and its subsidiary, USCo (neither of which carry on a business of making or managing investments) filed a Chapter 11 Plan (following their filing of a petition in bankruptcy), and a Plan Administrator was appointed. Although a Canadian subsidiary of Holdco (Canco) ceased to sell assets to securitization trusts when the group financial difficulties became severe, it continues to earn income from obligations to it of those trusts, including the receipt of deferred purchase price. Canco will pay three cash dividends to Holdco, its sole shareholder. "Through the Plan Administrator under the Plan of Liquidation, Holdco will have full discretion and control over the Dividends throughout the period during which the Dividends are paid."

Ruling that the rate of withholding under Art. X will be 5%.

All of the Class A shares of two taxable Canadian corporations ("OpCo2" and "Salesco") are owned by a corporation ("USSalesco1") which is not fiscally transparent and is resident in the U.S. for purposes of the Canada- U.S. Treaty, and all their commons shares (with essentially identical attributes to the Class A shares) are owned by a taxable Canadian corporation ("OpCo1") which is a direct wholly-owned subsidiary of USSalesco1. OpCo2 and Salesco are not fiscally transparent for U.S. purposes.

Salesco and OpCo2 purchase for cancellation all the issued and outstanding Class A shares (held by USSalesco1) for cash or promissory note consideration equal to the shares' fair market value.

Rulings that provided that USSalesco1 is the beneficial owner of dividends paid on the Opco2 and Salesco Class A shares pursuant to Article XXIX-A(3) and Article X(2)(a) of the Treaty, the benefits of the Treaty will apply to USSalesco1 with respect to the s. 84(3) deemed dividend resulting from the redemptions.

Ruling that provided that USSalesco1 is the beneficial owner of dividends paid on the Opco2 and Salesco Class A shares, pursuant to Article XXIX-A(3) and Article X(2)(a) of the Treaty, the benefits of the Treaty will apply to USSalesco1 with respect to the subsection 84(3) deemed dividend resulting from the redemptions.

In response to a query as to whether the branch tax reduction in Art. X(6) of the Canada-US Tax Convention is available to a fiscally transparent LLC that is wholly-owned by US-resident individuals, CRA stated that such Treaty benefits may be claimed by an LLC on behalf of its members with respect to an amount of profit attributable to a Canadian branch only if the amount is considered to be derived, pursuant to Art. IV(6), by a US-resident company that is a "qualifying person" (or entitled, with respect to the amount, under Art. XXIX A(3)) – so that no such benefits would be available here as the earnings of the LLC are derived by individuals.

Where a US corporation that is a qualifying person is a 99.99% limited partner of a Delaware limited partnership which, in turn, is a 99.99% limited partner of a second Delaware limited partnership which owns all the shares of Canco, the US corporation will be considered to have an "ownership interest" in Canco, so that it will be entitled to the 5% rate on dividends paid by Canco.

In the Prévost Car case, "the Court implied that where an intermediary acts as a mere conduit or funnel in respect of an item of income, the intermediary would not have sufficient economic entitlement to the income to be considered the 'beneficial owner'. The CRA will examine future back-to-back dividend, interest and royalty cases that have encounters with a view to whether an intermediary could, on the facts, be considered a mere conduit or funnel".

a dividend deemed to be received by significant Japanese corporate shareholder of a Canadian corporation under s. 84(3) on the purchase for cancellation y the Canadian corporation of shares held by the shareholder was eligible for the treaty-reduced rate of 5% under the Canada-Japan Convention.

Although a partner is not considered to own a specified percentage of the shares of a corporation held by a partnership, a favourable ruling was granted where a corporation issued sufficient voting preferred shares directly to each partner in order to comply with the formal requirements, of the Canada-U.S. Convention, Article X, para. 2(a), that the beneficial owner of the dividend must own at least 10% of the voting stock of the corporation paying the dividend.

Following the repeal of U.K. ACT in 1999, paragraph 3 of the Canada-U.K. Convention continues to apply since individuals in the United Kingdom are still entitled to a tax credit in respect of dividends paid by a U.K. company. However, the U.K. Competent Authority has informed CCRA that non-resident individuals should no longer be eligible for any net refund from the U.K. because the tax credit available under paragraph 3(b) is now less than the tax allowed by paragraph 3(a)(ii).

A deemed dividend under s. 219(5.3) of the Act will be treated as a dividend governed by Article X, paragraph 2 of the Canada-U.S. Convention, rather than paragraph 6, notwithstanding that such deemed dividend could be attributed to the decision not to pay branch tax pursuant to s. 219(5.1) at the time the non-resident insurance company incorporates the Canadian branch.

Because the purpose of the "source country deemed dividend rule" in the definition of "dividend" in paragraph 3 of Article X of the Canada-U.S. Convention is only "to ensure that the source country's right to tax an amount that would not otherwise meet the definition of a 'dividend', but is treated as such in the source country, will be governed by paragraph 2 of Article X", that rule does not trammel the ability of Canada to tax as a dividend a distribution received by Canadian-resident shareholders of a Delaware corporation that might not be treated like a dividend under the U.S. Internal Revenue Code.

Where a Canadian subsidiary issues a demand note to its U.S. parent, the deemed dividend arising under s. 214(3)(a) will be eligible for the reduced rate of withholding tax under Article X, paragraph 2(a) of the Canada-U.S. Convention.

The word dividend in the Canada U.S.-Convention includes deemed dividends arising under s. 214(3)(a) of the Act.

Where s. 214(3)(a) imputes a shareholder benefit to U.S. resident shareholders of a U.S. corporation which allows them to use a Canadian vacation property free of rent, Article X(5) of the Canada-U.S. Convention will not grant relief to them because s. 214(3)(a) deems the dividend to have been paid by a corporation resident in Canada rather than by a U.S. corporation.