Canada: New Protocol Proposes Major Changes To The Canada-US Income Tax Treaty

Last Updated: October 1 2007
Article by Fasken Martineau's Taxation Practice

On September 21, 2007, representatives of Canada and the US signed the Fifth Protocol to the Canada-United States Income Tax Convention ("Protocol"). The Protocol will enter into force after ratification by both countries, which is not expected to occur before the end of 2007.

Taxpayers should consider how the Protocol affects them, particularly in the case of:

    1. Taxpayers resident in Canada or the US making interest payments to residents of the other country;
    2. Taxpayers that have cross-border structures involving hybrid entities;
    3. Employers, employees and service providers working in a cross-border context;
    4. Persons who could become subject to the limitation on benefits article in the Canada-US Income Tax Treaty.
Elimination of Withholding Tax on Interest Payments and Guarantee Fees

The Protocol eliminates withholding tax on interest payments and guarantee fees made by a resident of Canada or the US to a resident of the other country. The elimination of withholding tax on interest means that US lenders will be able to provide revolving facilities and other facilities to Canadian borrowers without having to comply with the so-called 5/25 debt rule.

Avoidance rules have been introduced in the Protocol to ensure that inappropriate interest payments cannot benefit from the elimination of the withholding tax. Pursuant to these rules, withholding at a rate of 15% will be applied in the following situations:

    1. Interest arising in the US that is contingent interest of a type that does not qualify as portfolio interest for US tax purposes;
    2. Interest arising in Canada that is determined with reference to receipts, sales, income, profits or other cash flow of the debtor or a related person or to any change in the value of any property of the debtor or a related person or to any dividend, partnership distribution or similar payment.

For interest payments between unrelated parties, the elimination of the withholding tax on interest will apply as of the second month beginning after the Protocol enters into force.

However, withholding on interest payments made between related parties will be eliminated progressively over a three-year period. For the first and second years, withholding on interest payments between related parties will be at rates of 7% and 4% respectively.

The Department of Finance (Canada) has stated in a recent comfort letter that it is their intent to modify Canadian tax law so that debts that require repayment of more than 25% of their principal amount within 5 years can qualify for the existing 5/25 withholding tax exemption so long as the obligation to repay the principal amount can arise only if a change to the Income Tax Act or the Canada-US Income Tax Treaty has the effect of relieving the non-resident lender from liability for withholding tax in respect of interest in such circumstances. Furthermore, the 2007 Canadian federal budget proposed to eliminate withholding tax on interest paid to all arm’s length non-residents, regardless of their country of residence once the exemption is implemented in the Canada-US Income Tax Treaty.

Modifications dealing with Limited Liability Companies, Partnerships and Hybrid Entities

Extension of Treaty Benefits to Limited Liability Companies ("LLC")

Under the Protocol, income that a US resident earns through a LLC will be treated as having been earned directly by the US resident for the purposes of the Canada-US Income Tax Treaty. The effective date for this measure depends on the type of income to which it applies.

Withholding Rate on Dividends where Shares are held through a Partnership

A company that owns shares of another corporation via a partnership will be considered to own the shares held by the partnership in proportion to the company’s interest in the partnership. This ensures that companies owning at least 10% of the shares of a corporation, either directly or indirectly via a partnership, will be able to benefit from the 5% withholding tax rate on dividends.

Elimination of Treaty Protection for Hybrid Entities

The benefits of the Canada-US Income Tax Treaty will no longer be available in respect of payments made to and by certain hybrid entities. Hybrid entities generally refer to entities that are treated differently for Canadian and US tax purposes. For example, Canadian unlimited liability companies constitute hybrid entities because they are treated as corporations for Canadian income tax purposes and as flow-through entities for US income tax purposes. Hybrid entities are often used in cross-border financing structures, both for investments by US residents into Canada and by Canadian residents investing into the US. Structures that include hybrid entities will have to be reviewed. This measure will enter into force on the first day of the third calendar year that ends after the Protocol comes into force.

Expansion of the Permanent Establishment Concept with regard to Service Providers

The concept of permanent establishment has been broadened with regard to Canadian or US resident enterprises that provide services in the other country. These measures have the effect of reversing recent case law that held that service providers were not taxable in jurisdictions in which they were rendering services where they did not have sufficient connections to be considered to have a permanent establishment in the other jurisdiction.

An enterprise residing in one country will be considered to have a permanent establishment in the other country if services are performed in that other country for the enterprise by an individual and:

    1. The individual is present in the other country for 183 days or more in any 12 month period; and
    2. More than 50% of the gross active business revenues of the enterprise consists of income derived from the services performed by that individual in that other country.

The scope of the permanent establishment concept has also been expanded to include any services of an enterprise provided in the other country for a period of 183 days or more in any 12 month period with respect to the same or a connected project for customers who are either residents of the other country or who have a permanent establishment in the other country in respect of which the services are provided.

This measure will enter into force as of the third taxable year that ends after the Protocol comes into force. Days of presence, services rendered and gross active business revenues occurring or arising prior to January 1, 2010 will not be taken into account for the purposes of determining whether an enterprise has a permanent establishment due to this new article.

Withholding Tax Rate on Dividends paid by US Real Estate Investment Trusts ("US REIT")

For a Canadian resident to be able to benefit from a withholding rate of 15% on dividends received from a US REIT, one of the following conditions must be fulfilled:

    1. The beneficial owner of the dividends is an individual holding not more than 10% of the REIT;
    2. The dividends are paid with respect to a publicly traded class of stock and the owner of the stock does not own more than 5% of any class of stock of the REIT; or
    3. The beneficial owner of the dividends owns not more than 10% of the REIT and the REIT is diversified.

If none of these conditions is fulfilled, the US domestic law withholding tax rate will apply.

This measure will apply upon the later of (i) the second month that begins after the Protocol enters into force and (ii) January 1, 2008.

Adjustments for Departure Tax on Emigration

For Canadian income tax purposes, Canadian residents that cease to reside in Canada are deemed to have disposed of many types of property upon emigration from Canada. This can create double taxation where the other country does not recognize the deemed disposition. The Protocol allows an individual to choose to be considered as having disposed of and reacquired the property on a change in the country of residence. This measure will apply to deemed dispositions occurring after September 17, 2000.

Changes regarding Pensions and Annuities

The Protocol contains detailed rules concerning the deductibility of contributions as well as for the accrual of benefits in relation to qualifying retirement plans. Cross-border commuters will be able to deduct in their home countries contributions made to retirement plans or arrangements in the country where they work. Also, taxpayers who move from Canada to the US (or vice versa) for work will be able to deduct contributions made to a plan or arrangement in the US (or Canada, as the case may be) for up to five years. If ratification of the Protocol is completed in 2007, which is considered to be unlikely, these rules will apply in 2008. Otherwise, they will enter into effect for taxation years beginning after the calendar year in which the Protocol enters into force.

Mixing Funds invested on behalf of Exempt Entities

Under the Protocol, dividends and interest earned by a non-taxable entity operating exclusively on behalf of one or more exempt organizations described in Article XXI of the Canada-US Income Tax Treaty will be exempt from tax in both Canada and the US. Previously, the mixing of funds between multiple exempt organizations was not possible.

Attribution of Benefits arising on Employee Stock Options

The "Diplomatic Notes: Annex B to the Convention" provide guidance on how to apportion taxing rights between Canada and the US in respect of the employment benefit arising on the exercise or the disposition of an employee stock option. Where an employee is granted an employee stock option while employed in Canada or the US and then works for the same or a related employer in the other country, the employment benefit arising on the exercise or disposition of the employee stock option will generally be calculated based on the proportion of the days between the grant of the option and the exercise or disposition of such option that the employee was situated in either Canada or the US. This principle of proportionate attribution of income will not be applied where the competent authorities agree that the granting of the option is more appropriately treated as a transfer of ownership. This exception could apply, for instance, where the options granted are in the money or if the options have a short vesting period.

Ability to compel Mandatory Arbitration

Taxpayers will be able to compel Canadian and US tax authorities to refer a double taxation dispute to binding arbitration where the competent authorities have endeavoured but are unable to reach a complete agreement in a case. This measure will apply to disputes that are already under consideration under the mutual agreement procedure when the Protocol enters into force.

Extension of the Scope of the Limitation on Benefits Article

Under the Protocol, the limitation on benefits article has been extended so that it can be applied by Canada as well as the US.

Please click here to read about Fasken Martineau's Taxation Practice Group.

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

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

In association with
Related Topics
Related Articles
Related Video
Up-coming Events Search
Font Size:
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
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
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 (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

To Use 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.


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.


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