5th Protocol to the Canada-US Tax Convention – Limitation on Benefits
Question 1
Does the CRA agree that, in applying subparagraph XXIX A(2)(e) of the treaty, indirect ownership is not tested through a publicly traded company that is a qualifying person (that is, a company described in subparagraph XXIX A(2)(c))?
Response 1
In applying the indirect ownership test in subparagraph XXIX A(2)(e), the CRA will not look through to the ownership of the shares in a publicly traded company. In this respect, the CRA will be guided by the following comments to article XXIX A in the technical explanation to the fifth protocol:
“It is understood by the Contracting States that in determining whether a company satisfies the ownership test described in subparagraph 2(e)(i), a company, 50 percent or more of the aggregate vote and value of the shares of which and 50 percent or more of the vote and value of each disproportionate class of shares (in neither case including debt substitute shares) of which is owned, directly or indirectly, by a company described in subparagraph 2(c) will satisfy the ownership test of subparagraph 2(e)(i). In such case, no further analysis of the ownership of the company described in subparagraph 2(c) is required.” 34 (underlining added)
Question 2
Would a tested company be regarded as a qualifying person pursuant to subparagraph XXIX A(2)(e) if 50% of its relevant shares are owned directly by a qualifying person described in subparagraph XXIX A2(c) and the other 50% of its relevant shares are owned directly by an individual who is not resident in the United States?
Response 2
A tested company would be regarded as a qualifying person if 50% of its relevant shares are owned directly by a qualifying person described in subparagraph XXIX A2(c). Our views in this respect are consistent with the comments to article XXIX A in the technical explanation to the fifth protocol cited in the response to the preceding question.
Question 3
In applying clause XXIX A(2)(e)(i) of the treaty, will the CRA take into consideration both the direct and indirect relevant shareholdings in a tested company to determine whether 50% or more of the relevant shares of the tested company are not owned, directly or indirectly, by persons other than qualifying persons?
Response 3
Yes.
Question 4
In applying the “active trade or business” test in paragraph XXIX A(3) of the treaty, will the CRA consider dividends received by a US resident on the shares of the capital stock of a Canadian-resident corporation and capital gains realized by a US resident from the disposition of the shares of a Canadian-resident corporation to be “income” that may, depending on the circumstances, be derived “in connection with” a relevant US trade or business?
Response 4
Paragraph XXIX A(3) extends the benefits of the treaty to a resident of a contracting state (other than a qualifying person) with respect to items of income derived from the other state in connection with, or incidental to, the active conduct of a trade or business (other than certain investment businesses) in the resident state. This paragraph applies to income derived directly or indirectly by a resident of a contracting state through one or more persons who are resident in the other contracting state. However, paragraph XXIX A(3) does not apply to income derived in connection with a trade or business in the resident state unless that trade or business is substantial in relation to the activity carried on in the other state.
Meaning of “income”
The term “income” is not defined in the treaty. Paragraph III(2) of the treaty provides that where a term is not defined in the treaty, the term shall, unless the context otherwise requires, have the meaning it has under the law of the state concerning the taxes to which the treaty applies. In addition, paragraph 1 of annex B to the treaty states:
“1. Meaning of undefined terms
For purposes of paragraph 2 of Article III (General Definitions) of the Convention, it is understood that, as regards the application at any time of the Convention, and any protocols thereto by a Contracting State, any term not defined therein shall, unless the context otherwise requires or the competent authorities otherwise agree to a common meaning pursuant to Article XXVI (Mutual Agreement Procedure), have the meaning which it has at that time under the law of that State for the purposes of the taxes to which the Convention, and any protocols thereto apply, any meaning under the applicable tax laws of that State prevailing over a meaning given to the term under other laws of that State.”
In our view, the context of paragraph XXIX A(3) does not require the term “income” to have a narrower meaning than it has under the Income Tax Act. Accordingly, both dividends and taxable capital gains would be considered to be income within the meaning of paragraph XXIX A(3).
Meaning of “in connection with”
In determining whether Canadian-source income has been derived by a US resident in connection with an active trade or business in the United States, the CRA will be guided by the commentary set out in the technical explanation to the fifth protocol and the 2006 US model technical explanation. 35
In general terms, we would consider Canadian-source income to be derived “in connection with” a trade or business in the United States if the income is derived from an activity in Canada that is a part of, or is complementary to, the trade or business in the United States.
An activity in Canada will be considered to be part of a trade or business in the United States if the trade or business in the United States is upstream, downstream or parallel to the activity in Canada. Business activities will generally be considered to be upstream, downstream or parallel to each other if they relate to the production of the same types of products or the provision of the same or similar services. Business activities will generally be considered to be complementary if they are part of the same industry and the activities are interdependent (that is, success or failure of one activity will tend to result in success or failure of the other).
Example
The following example is intended to illustrate a situation in which Canadian-source dividends and taxable capital gains would be considered to be derived in connection with an active trade or business carried on in the United States by a US-resident corporation (USco).
Assume that USco carries on an active business in the United States (other than an investment business). USco owns all of the shares of Canco, a corporation resident in Canada, which carries on an active business in Canada that is parallel to USco’s active business. The active business carried on by USco in the United States is substantial in relation to the active business carried on by Canco.
1) Canco distributes a portion of its after-tax income from its active business to USco in the form of dividends on its shares.
Since USco and Canco carry on parallel business activities and the dividends are paid out of the after-tax earnings from Canco’s business, we would consider the dividends received by USco to be derived in connection with USco’s active business.
2) USco sells the shares of Canco and realizes a taxable capital gain.
Since the value of the Canco shares (and thus the taxable capital gain) is derived from an active business in Canada that is parallel to the active business carried on by USco in the United States, we would consider the taxable capital gain on the disposition of the shares of Canco to be derived in connection with USco’s active business.
Question 5
In the context of a competent authority determination made under paragraph XXIX A(6), does the CRA agreethat such a determination can be made in advance of any adverse determination having been made that the tested company is not otherwise a qualifying person or entitled to the relevant treaty benefits?
Response 5
Yes.
Link to Source: https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/itnews-41/archived-income-tax-technical-news-no-41.html#P16