Child Support Payments to a Non-Resident Cannot be Made Deductible under the Canada-Switzerland Tax Treaty

In Sruder, 2011 TCC 322, the Tax Court dismissed the taxpayer’s argument that the child support amounts could be deductible under Article 18(2)(d) of the Canada-Switzerland Tax Convention.

In relevant part, Article 18(2)(d) of the Canada-Switzerland Tax Convention reads as follows:

18.2 Notwithstanding anything in this Convention

...

(d)     alimony and other similar payments arising in a Contracting State and paid to a resident of the other Contracting State who is subject to tax therein in respect thereof, shall be taxable only in that other State.

The taxpayer relied on the following excerpt from the Canada Revenue Agency guide to argue that the payments were

Carol and Doug divorced on December 23, 2009. Doug resides in Australia. Carol is a Canadian resident. Under a court order, Doug paid Carol $500 a month in spousal support beginning January 1, 2010.

Under the terms of the Canada-Australia Income Tax Treaty, alimony and other maintenance payments are only taxable in the source country. The payment is taxable only in Australia.

Carol must report $6,000 on line 128 of her tax return and she should also enter this amount on line 156 of her tax return. Carol may also claim $6,000 as a deduction on line 256 of her tax return because of the provisions of the Canada-Australia Income Tax Treaty.

The Tax Court dismissed the analogy used by the taxpayer and pointed that Article 18(2) aims to relief taxation of the recipient. As such, the taxpayer’s argument was flawed because he was payor, and as such the taxation of such payments in his hands was not prescribed by Article 18(2).

As a matter of caution to be excerised by tax advisors, Canadian tax treaties are not consistent in respect of taxability of alimony and other support payments. For example, Canada-Australia Treaty (cited in the example provided in the CRA Guide dealing with Support Payments) provides that such payments may only be taxable in the source State:

Any alimony or other maintenance payment arising in a Contracting State and paid to a resident of the other Contracting State, shall be taxable only in the first mentioned State.

Canadian Foreing Tax Credit and withdrawals from U.S. IRA

Canadian Foreing Tax Credit and withdrawals from U.S. IRA

In a recent tax ruling, the Canada Revenue Agency (“CRA”) allowed a taxpayer to claim as foreign tax credit a 10 percent income tax surcharge levied under the U.S. Internal Revenue Code on the withdrawals from U.S. Individual Retirement Arrangement (“IRA”) accounts.

This view represents a reversal of the previous CRA policies stated in prior interpretations issued by the CRA in 1993 in doc. no. 9330140 and 9304595. The prior position was based on the view that the 10 percent surcharge on the IRA withdrawals is a tax imposed on the taxpayer because he prematurely withdraws funds from the IRA, prior to the legislatively mandated age of 59 y.o.  Further, the CRA noted that, in case of a U.S. citizen or resident, the 10 percnet surcharge would be payable even if the amount of taxable income would be nil. Accordingly, the CRA did not view the 10 percent surcharge as “income tax” for the purposes of the Canadian foreign tax credit rules.

In the ruling, the CRA agreed with the taxpayer’s submission that the 10 percent surcharge imposed under the Internal Revenue Code (“IRC”) is not a penalty but rather an income tax. In particular, the provisions in section 72(5) dealing with the surcharge are found in Chapter 1 -Normal taxes and surtaxes of the IRC, rather than Subtile F - Procedure and Administration of the IRC.

Consequently, the CRA found that the surcharge clearly falls within the scope of Article II(1) of the Canada-U.S. Tax Treaty, which provides that the Treaty applies to taxes on income and on capital imposed on behalf of each Contracting State, irrespective of the manner in which they are levied. In other words, even though the 10 percent surcharge may not be, due to its features, an “income tax” for the purposes of section 126, the negative result should be overturned by the broader provisions in Article II(1) of the Treaty, which makes the particular surcharge to fall within the scope of the relieving provision in the Treaty, including in particular Article XXIV (Foreign Tax Credit), requires that income tax paid or accrued to US on profits, income or gains arising in US be deducted from any Canadian tax payable.

The ruling is relevant for Canadian residents who used to reside in the U.S. and in the course of their employment in the U.S. contributed to a U.S. IRA.  The penalty-like 10 percent surcharge will not be fully creditable in computing the amount of Canadian tax due on the amount of the withdrawal.  As the ruling deals with Canadian residents who are neither U.S. resident or U.S. citizen, such individuals may not be able to obtain benefit outlined in the above ruling. However, theoretically the reasoning adopted by the CRA may be favourably applied to U.S. citizens who are residing in Canada.

Please contact one of our tax lawyers if you need a copy of the ruling (CRA Internal Interpretation no.  2011-0398741I7 (E) Foreign Tax Credit on 10% additional US tax)  or require more information about the application of Canadian foreign tax credit rules or the creditability of income and other foreign taxes in computing Canadian tax liability.

About TaxChambers

TaxChambers is an association of Canadian tax lawyers and advisors.  Our tax lawyers have taught at Canadian law schools and have authored articles published in a wide variety of legal and industry journals and publications, as well as a leading treatise on Canadian International and Cross-border taxation.  Our tax lawyers have also been invited to present at international and domestic tax conferences.

Tax Chambers represents individuals and corporations from Canada and abroad in all areas of Canadian tax law, including and not limited to: corporate and business income taxation, international taxation, individual tax and wealth planning, and commodity taxes (GST/HST).  We have successfully assisted our clients with resolving audits, objections, and appeals before the Tax Court of Canada and the Federal Court of Canada.

Canada starts tax treaty negotiations with Hong Kong

Canada just announced that it will soon commence tax treaty negotiations with Hong Kong.  There is indeed a tax treaty in place with China, which however specifically excludes Hong Kong.  As such, any resident in Hong Kong, including business corporations or individuals, are not entitled to the benefits of the Canada-China Tax Convention.

Notably, the public notice also suggests that certain changes may be brought to the Canada-China Tax Treaty, too. The Canada-China Tax Treaty presently in force was negotiated back in mid-80s and entered in force on December 29, 1986.  It was a different country then! 

Given then increasing role of China as both the capital/goods exporter to and importer from Canada, it will be interesting to see the contents of the new tax treaty (or treaties if both treaties are negotiated at the same time), which has to recognize Canada's role as a bulk purchaser of manufactured goods from China and an investment target for resource-hungry Chinese manufacturing sector.  For example, will Canada extend, as part of its newly found tax vision, a no-withholding tax regime on related party interest payments?

The following is an excerpt from the formal announcement published by the Department of Finance.

TAX TREATY NEGOTIATIONS WITH THE GOVERNMENT OF THE HONG KONG SPECIAL ADMINISTRATIVE REGION OF THE PEOPLE'S REPUBLIC OF CHINA

Negotiations for an income tax treaty between the Government of Canada and the Government of the Hong Kong Special Administrative Region of the People's Republic of China will commence the week of June 27, 2011, in Ottawa.

The purpose of this bulletin is to ensure that persons whose interests are affected have an opportunity to inform the government of any particular issues of double taxation that might be taken into account during the course of negotiations. The government is particularly interested in learning of any difficulties that might be encountered by Canadians under the tax system of the Hong Kong Special Administrative Region of the People's Republic of China. 

About TaxChambers

Vitaly Timokhov is a member of TaxChambers, an association of Canadian tax lawyers and advisors.  Our tax lawyers have taught at Canadian law schools and have authored articles published in a wide variety of legal and industry journals and publications, as well as a leading treatise on Canadian International and Cross-border taxation.  Our tax lawyers have also been invited to present at international and domestic tax conferences.

TaxChambers represents individuals and corporations from Canada and abroad in all areas of Canadian tax law, including and not limited to: corporate and business income taxation, international taxation, individual tax and wealth planning, and commodity taxes (GST/HST).  We have successfully assisted our clients with resolving audits, objections, and appeals before the Tax Court of Canada and the Federal Court of Canada.