Canada: U.S. Tax-Exempt Organizations Investing in Canadian Real Estate

Last Updated: March 24 2006

Article by Kenneth Snider, ©2006, Blake, Cassels & Graydon LLP

This article was originally published in Blakes Bulletin on Cross Border-Tax, March 2006

U.S. tax-exempt organizations considering a potential debt or equity investment in respect of Canadian real estate should focus at an early stage on Canadian tax planning.

The investment may take a variety of forms, including 100% equity ownership, participating as a minority or majority joint venture partner, or a mortgage loan. The transaction will fundamentally affect the planning. Structuring the investment to take advantage of Article XXI of the Canada U.S. Tax Convention (the Convention) will be a fundamental objective. A few preliminary points should be borne in mind. A non-resident of Canada is taxable on income from carrying on business in Canada and on capital gains from the disposition of "taxable Canadian property" under Part I of the Income Tax Act (the Act) subject to the application of a tax treaty. Taxable Canadian property is broadly defined and includes real property situated in Canada; a share of the capital stock of a corporation resident in Canada that is not listed on a prescribed stock exchange; a share that is listed on a prescribed stock exchange if certain ownership tests are satisfied, and interests in certain partnerships and trusts that own taxable Canadian property.

Consequently, if rental income earned by a non-resident was considered income from carrying on a business in Canada it would be taxable under Part I. The Convention, like other of Canada’s tax treaties, does not provide any general relief from tax on income and gains from real estate. In contrast to Part I, certain amounts paid or credited to a non-resident including rent (that is considered income from property and not income from business), dividends and interest are subject to withholding tax at the rate of 25%, subject to possible reduction or exemption under the Convention. There is an election that can be made by the non-resident to be taxed on a net basis in respect of rental income at the applicable rate in Part I instead of being subject to a withholding tax on the gross rent.

Article XXI of the Convention

There are two different exemptions from tax under the Act in Article XXI of relevance to U.S. tax-exempt organizations. First, income derived by a religious, scientific, literary, educational or charitable organization shall be exempt from tax in Canada if it is resident in the U.S. for purposes of the Convention but only to the extent that such income is exempt from U.S. tax. Subject to the qualification discussed below, this exemption will apply to taxes payable under Part I and withholding tax under Part XIII of the Act.

Second, subject to the same qualification discussed below, dividends and interest derived by:

  • a trust, company, organization or other arrangement that is a resident of the U.S., generally exempt from U.S. income taxation in a taxable year and operated exclusively to administer or provide pension, retirement or employee benefits; or
  • a trust, company, organization or other arrangement that is a resident of the U.S., generally exempt from U.S. income taxation in a taxable year and operated exclusively to earn income for the benefit of an organization referred to in subparagraph (a);

shall be exempt from tax under the Act in that taxable year.

Because the second exemption only applies to interest and dividends subject to Part XIII withholding tax, a U.S. pension does not qualify for any income tax relief in respect of operating income, or recapture and capital gains. Consequently, "substituting" interest (subject to the possible application of the thin capitalization rules in the Act) and dividends for these types of returns from real estate will be important in order to take advantage of the exemption.

An important qualification is that the two exemptions in Article XXI shall not apply with respect to the income (a) from carrying on a trade or business or (b) from a "related person" that is not also an exempt organization as discussed below.

Look Through Approach for Partnerships

Where the recipient of interest or dividends is a partnership of the U.S. pension funds or other entities otherwise qualified for the benefits of Article XXI, CRA has confirmed that it will look through the partnership to each member and grant or withhold the exemption based on the member’s proportionate interest in the partnership.

Related Persons

The restriction in respect of income from a "related person" is very important to consider. The expression is not defined in the Convention for purposes of Article XXI. CRA has considered the meaning of "related person" and whether it has the same meaning as defined under the Act, and whether a similar look-through mentioned above will be applied in determining a member’s "related person" status under Article XXI of the Convention.

CRA has noted that in accordance with the Canadian Income Tax Conventions Interpretation Act, that term has, except to the extent the context otherwise requires, the meaning it has for purposes of the Act. Where a person is a member of a partnership, the CRA will look through to the members in determining whether a particular member is related to the person from which the income is derived and whether Article XXI of the Convention is applied in respect of that member.

As one would expect, the term "related person" is broadly defined in the Act. In summary, the definition turns on a person having legal control of a corporation or the right to acquire control. For instance, a U.S. exempt organization that owned in excess of 50% of the voting shares of a corporation owning Canadian real estate would generally be related to the corporation and would not be entitled to the benefit of Article XXI. There are special considerations in respect of "related persons" and trusts.

Participating Debt

Participating debt should be considered to deal with reducing taxable income of the entity owning the real estate resulting from increased rents (and decreasing capital cost allowance). The "5/25 exemption" restricts the availability of the withholding tax exemption where interest is linked to a variable participation in the borrower’s profits or cash flow. However, the Article XXI exemption should be available in respect of participating interest provided that the payment falls within the definition of "interest" in the Convention. Article XI(4) of the Convention provides as follows:

"The term ‘interest’ as used in this Article means income from debt-claims of every kind, whether or not secured by mortgage, and whether or not carrying a right to participate in the debtor’s profits ... as well as income assimilated to income from money lent by the taxation laws of the Contracting State in which the income arises ..." [Italics added]

With proper crafting of the participating loan instrument, it is possible to design an instrument whose payments qualify both as deductible interest under the Act (subject to the possible application of the thin capitalization rules in the Act) to the payor and interest eligible for the benefits under Article XXI.

Compliance Considerations

The Act imposes a withholding and remittance obligation on the Canadian resident in respect of certain amounts paid or credited to a non-resident regardless of a treaty exemption. As an administrative matter, the Article XXI exemption cannot override the payor’s withholding obligations under Part XIII of the Act. Information Circular IC 77-16R4 authorizes Canadian payors to rely upon the CRA’s published list of treaty exempt investors under Article XXI. In order for the payor to avoid liability for tax, penalties and interest for failure to withhold and remit tax in respect of payments to an organization described in Article XXI(1) and (2), the payor should withhold unless the organization is listed. Tax exempts would also want to avoid being subject to withholding by not being listed and applying for a refund. Paragraph 78 of Information Circular IC 77-16R4 describes the application process for tax exempts to be listed in CRA’s annual publication of exempt U.S. organizations.

With respect to nominees that hold the security, CRA has stated that in the case of a security held in the name of a nominee (including an approved special nominee) for an organization or trust to which a letter of exemption under Article XXI is issued, the Canadian payor is obliged to withhold tax from any payment on the security unless CRA has provided the payor with written authorization to refrain from doing so for payments on the specific security (i.e., name of issuer, serial number, denomination and date of issue of the share or bond certificate) in question. Reference should be made to Information Circular IC 77-16R4 for instructions regarding obtaining authorization.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Events from this Firm
16 Oct 2018, Seminar, Toronto, Canada

Join Blakes lawyers for our 10th annual overview of recent legal and regulatory developments and practical strategies to navigate the changing regulation of Canada’s payments industry.

26 Oct 2018, Other, Vancouver, Canada

Cybersecurity, including data privacy and security obligations, has become a critical chapter in every company’s risk management playbook.

30 Oct 2018, Other, Toronto, Canada

Please join us for discussions on recent updates and legal developments in pension and employee benefits as well as employment law issues.

 
In association with
Related Topics
 
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions