Treaty Interpretation and the Meaning of “Liable to Tax”
In order to qualify for the benefits under Canada’s tax treaties, a person must be considered a resident of a contracting state. To be a resident of a contracting state for treaty purposes, a person must be “liable to tax” in that state by virtue of a criterion referred to in the treaty. Treaty residence is also a prerequisite for certain deductions under Canada’s domestic foreign affiliate rules and regulations.
The question arises as to what level of taxation the jurisdiction must levy on that person’s income before the person could be considered “liable to tax” under an income tax treaty. If a person is “liable to tax” under the criteria in the particular treaty, such person is entitled to the benefits of the treaty and, in the case of a foreign affiliate of a Canadian corporation, to exempt surplus treatment of certain dividends paid to the Canadian corporation.
Question 1
What is the CRA’s current position on “liable to tax”?
Response 1
Based on our interpretation of the Supreme Court of Canada decision The Queen v. Crown Forest Industries Ltd et al[Footnote 18] the CRA’s current position is that to be considered “liable to tax” a person must be subject to the most comprehensive form of taxation that exists in the relevant country. For Canada, this generally means full tax liability on worldwide income.
Most entities residing in countries with which Canada has a tax treaty are subject to tax under the countries’ general tax system on worldwide income at a rate comparable to Canadian rates, but particular entities are, according to special regimes, either specifically exempted from such taxation or taxed at very low rates that are capped at a maximum amount. The CRA currently considers that certain entities benefiting from such special regimes may not be subject to the most comprehensive form of taxation and, therefore, would not be “liable to tax”.
Tax professionals have pointed out that the same rationale should apply to charities and pensions, but we nonetheless consider such persons as “residents” under our treaties and give them treaty benefits. In light of this apparent inconsistency, tax professionals requested that we revisit our position.
Question 2
Is the CRA reviewing its current position?
Response 2
Yes, we are undertaking a review, which includes consulting with the Department of Justice and with the Department of Finance. Hopefully, by the end of this year we will be able to make an announcement with respect to our position.