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. 

 

Information Exchange Agreements - OECD Report

The OECD reported that three more states, Dominica, Grenada and Saint Lucia have been moved into the category of jurisdictions considered by the OECD to have substantially implemented the standard on transparency and exchange of information. Each of these States has now signed at least 12 exchange of information agreements conforming to the standard.

According to the OECD, there are now 28 jurisdictions that have moved into this category since April 2009. T


For more information, see the OECD website.

US LLC is entitled to treaty relief under the Canada-US Tax Treaty

In TD Securities (USA) LLC v. Her Majesty The Queen, the Tax Court of Canada held that a single member US LLC was a US resident for the purposes of the Canada-US Tax Treaty.  The decision was issued by Patrick Boyle, T.C.J., on April 8, 2010. The decision overrides the long-standing position adopted by the Canada-Revenue Agency that a US LLC is not resident in the U.S. for the purposes of the Canada-US tax treaty, because its income is not subject to the most comprehensive form of taxation in the U.S. at the entity level.

The issue before the court was whether a US LLC owned by another US corporation was entitled to branch tax relief in Article X (Dividends) in the Canada-US Tax Treaty.

Given that this result is consistent with Article IV(4) of the Canada-US Tax Treaty (that provides relief to the income derived by a U.S. resident through a US LLC), it is not clear if the CRA would appeal the decision. 

Read the decision here: US LLC is entitled to relief under the Canada-US Tax Treaty, provided that its income is subject to US tax in the hands of its sole member.

Australia classifies US LP as a partnership, not a corporation

The Australian Taxation Office has issued an interpretative decision dealing with the classification of US Limited Partnerships (LP).   In Interpretative Decision ATO ID 2010/81 , ATO found that a US LP established under state law of Delaware should not be treated as a "company" for the purposes of Art. 10 of Australia-US Tax Treaty but is treated as a partnership.

It is notbable that even if it were a "body corporate", it still would not be entitled to treaty relief under the principles laid out by the Canadian Supreme Court in the Crown Forest case.


Notably, a US partnership is still a "body of persons" and, therefore, a person itself for the purposes of an OECD-based tax treaty.

The following is the text of the decision published by ATO, including the facts and ratio.


Issue
 Is a United States (US) limited partnership (US LP), which is treated as a partnership for US federal tax purposes, a company for the purposes of Article 10 of the Convention between Australia and the US contained in Schedules 2 and 2A to the International Tax Agreements Act 1953 (the US Convention)?
Decision
No. A US LP which is treated as a partnership for US federal tax purposes is not a company for the purposes of Article 10 of the US Convention.
For the purpose of the US Convention, US LP is neither a 'body corporate' nor 'an entity which is treated as a company or body corporate for tax purposes'. Consequently it is not a company for the purposes of Article 10 of the US Convention, and does not qualify for either of the reduced rates for certain cross-border inter-corporate dividends flowing between Australia and the US.
Facts

US LP is a limited partnership established under US (Delaware) state law (the Delaware Revised Uniform Limited Partnership Act (DRULPA)).
A limited partnership under the DRULPA is formed upon the execution and filing of a certificate of limited partnership under section 17-201 of the DRULPA.
As a limited partnership formed under the DRULPA, US LP is an unincorporated hybrid business entity having features commonly associated with both a business carried on by partners as partners and with a company.
The DRULPA does not incorporate a limited partnership, nor does it provide that a limited partnership is a body corporate.
US LP is a separate legal entity, and exists as such until cancellation of the certificate of limited partnership under paragraph 17-201(b) of the DRULPA. Section 15-201 of the DRULPA also provides that US LP has separate legal personality distinct from its partners.
US LP is 'for all purposes a partnership', per section 15-202 of the DRULPA.
US LP is treated as a partnership (and so is fiscally transparent) for US federal tax purposes and not as a taxable unit.
All income derived by US LP is subject to US tax in the hands of its US resident partners. All partners are US resident corporations.
US LP is a 'person' under Article 3(1)(a) of the US Convention.
US LP is a 'resident' of the US for tax treaty purposes within the meaning of Article 4(1)(b)(iii) of the US Convention, because Article 4(1)(b)(iii) treats a US partnership as a US resident for tax treaty purposes to the extent that the income it receives is subject to US income tax either in its hands or in the hands of a partner.
US LP is not treated as a company by the US for tax treaty purposes because it is treated as a partnership for US federal tax purposes.
US LP owns all the shares in an Australian resident company. During the income year the Australian resident company paid an unfranked dividend (not assessable income and not exempt income) to US LP, which was legally and beneficially entitled to that dividend.
US LP would be taxed as a company under Australian domestic law (Division 5A of the Income Tax Assessment Act 1936 , ITAA 1936) if it derived Australian source assessable income. US LP is not a resident of Australia under section 94T of Division 5A of the ITAA 1936.
US LP is not a 'foreign hybrid limited partnership' under section 830-10 of the Income Tax Assessment Act 1997 (ITAA 1997) as it is not a CFC (per paragraph 830-10(1)(e)) of the ITAA 1997.

Limitation on Benefits: Webinar on Article XXIXA of the Canada-US Tax Treaty

Webinar: The Limitation on Benefits provisions contained in Article XXIXA of the Canada - US Tax Treaty

Date: Wednesday, March 31, 2010

Time: 12:pm-1:30pm EST

This 90 minute webinar will analyze the legal framework and application of the Limitation on Benefits provisions in Article XXIXA of the Canada-US Tax Treaty. Limitations on Benefits provisions of the Canada-US Tax Treaty in the Fifth Protocol have been implemented to combat treaty shopping and prevent third country residents from obtaining benefits under the Canada-US Tax Treaty by routing Canadian-source income through US-based entities.

The webinar will discuss various scenarios based on the 2008 Technical Explanations and recent CRA pronouncements illustrating the definition of qualifying person, as well as the application of active trade and business test and derivate benefits tests, as these provisions apply to the income paid to individuals, corporations, and fiscally transparent entities.

Who Should Attend

The webinar is an LOB-101 presentation designed for Canadian tax advisors with foreign clients doing business in Canada and clients carrying on business in the U.S. or abroad.

For more information on the webinar, please click here or contact me at:

Vitaly Timokhov

(E) vitaly.timokhov@taxchambers.ca

(T) 416 847 7300

(W) http://www.taxchambers.ca