Canada: Long Awaited Canada-US Treaty Protocol Includes Some Twists

Last Updated: October 22 2007

On September 21, 2007, Canadian Finance Minister, Jim Flaherty, and U.S Treasury Secretary, Henry M. Paulson, Jr., signed the Fifth Protocol to the 1980 Canada-U.S. Tax Treaty (the "Treaty"), concluding nearly 10 years of negotiations.  

The Protocol will enter into force once Canada and the U.S. exchange ratification documents, which is not expected to occur before later on in 2008, and not earlier than January 1, 2008. Generally, the Protocol is effective for taxable years that begin after the calendar year in which ratification documents are exchanged (i.e. as early as 2008), but several provisions have other effective dates, as described below.

The principal elements of the Protocol were widely anticipated as their content was announced as part of Canada's controversial March 19, 2007 Budget; however, other changes to the Treaty come as a surprise. The key implications of the Protocol may be briefly summarized as follows.

  • The most significant change to the Treaty is the elimination of the current 10% withholding tax on payments of interest between residents of Canada and the U.S.
    This provision is effective for interest paid on or after the first day of the second month that begins after the date of the Protocol's entry into force (i.e. as early as March 1, 2008). However, with respect to cross-border group financings and - other related party loans, the exemption from withholding tax on interest will be phased in: the current 10% rate will drop to 7% for the first calendar year ending after the date of entry into force of the Protocol (i.e. as early as 2008), then to 4% in the calendar year that follows and, finally, to 0% thereafter. The March 19, 2007 Budget announced that once the exemption from withholding tax on both arm's length and non-arm's length interest is implemented under the Canada-U.S. Tax Treaty, Canada will unilaterally eliminate its domestic withholding tax on all arm's length interest regardless of the country of residence of the lender.
    The elimination of withholding tax on interest will eliminate the need for Canadian borrowers to comply with Canada's domestic "5/25 exemption" (exemption from withholding tax on interest where the borrower may not be obliged to repay more than 25% of the principal within 5 years). The Protocol will also eliminate withholding on interest paid by U.S. borrowers to Canadian banks or other lenders which are not eligible for the U.S. domestic "portfolio interest exemption".
    The new withholding tax exemption on interest will not apply to contingent or participating interest; rather, the 15% withholding tax rate on dividends will apply. This limitation corresponds to the limitations that currently apply to Canada's 5/25 "exemption" and the U.S. "portfolio interest exemption".
  • Unfortunately for multinational groups, the substantial representations made to the Canadian government have not resulted in the two countries adopting the current U.S. treaty policy of exempting cross-border subsidiary-to-parent dividends from withholding tax.
    One notable change to the "Dividends" article of the Treaty clarifies that where a company derives dividends through a fiscally transparent entity, such as a partnership, for the purposes of the 5% rate on dividends, it is considered to own voting stock of the payer in proportion to the company’s ownership in the fiscally transparent entity.
    Also, the Protocol extends the benefit of the 15% dividend withholding rate to certain distributions from U.S. REITs that previously were not eligible for such treatment. Specifically, the 15% rate will continue to be available to individuals holding 10% or less of a U.S. REIT; and will become available to any shareholder holding 5% or less of any class of a publicly traded U.S. REIT or any person holding l0% or less of a diversified U.S. REIT.
  • Unfortunately, the 10% withholding tax on cross-border trade-name and trade-mark royalties has been maintained.
  • Multinationals in both countries, with operating subsidiaries in the other, will be delighted with the adoption of a taxpayer right to binding arbitration to resolve ubiquitous and contentious inter-company transfer pricing issues.
  • A major issue under the current Treaty for U.S. investors or multinationals with interests in Canada, which have been structured through, or use a form of U.S. hybrid entity – a limited liability company ("LLC") – which is treated as a corporation from a Canadian standpoint, but, by default, is considered a flow-through for U.S. tax purposes, is addressed by the Protocol. U.S. resident investors in or owners of LLCs should no longer be denied the treaty benefit of a reduction of or an exemption from Canadian tax otherwise available on Canadian source income derived by them through LLCs. While this appears to be the clear intent of the Treaty negotiators, the Protocol falls short of spelling out exactly how all the conditions for Treaty relief are met. Specifically, the Protocol does not contain a clear rule that members of an LLC are the beneficial owners of income derived through the LLC, which is regarded as a separate taxpayer for Canadian tax purposes. We understand that these concerns may be addressed by a technical explanation to the Protocol to be jointly released by Canada and the U.S.  Also, because of the limited scope of the changes, investors in or owners of U.S. LLCs who are resident in third countries will continue to be denied treaty benefits under the Treaty while not eligible for treaty benefits under a treaty between a third country and Canada.
    The change designed to provide U.S. investors in or owners of LLCs with benefits under the Treaty is accompanied by two anti-avoidance provisions dealing with hybrid entities. Under the first provision, U.S.-based multinationals with Canadian operating subsidiaries will no longer be able to minimize overall (Canadian and U.S.) group taxes by financing those subsidiaries through Canadian-formed partnerships which elect to be treated for U.S. tax purposes as separate corporations, but that are seen as fiscally transparent in Canada. The Protocol will deny any reduction in Canada's 25% withholding tax on interest paid by such subsidiaries to such hybrid entities. This rule effectively reflects the thrust of IRC section 894(c). Surprisingly, under the second anti-avoidance rule, treaty benefits would seemingly be denied to U.S. residents deriving income from a Canadian unlimited liability company ("ULC"), organized under the laws of either Alberta, British Columbia or Nova Scotia, that is treated as fiscally transparent in the U.S. Therefore, it appears that dividends paid by a ULC will not qualify for the reduced withholding tax under the Treaty and will thus be subject to Canada's statutory withholding rate of 25%. This result is clearly unwarranted as under the Protocol the overall Canadian tax on amounts derived by a U.S. resident through a ULC would be significantly higher than the tax levied where the U.S. resident either derives the amounts directly or through an interposed regular corporation that is not fiscally transparent under the law of either Canada or the U.S. Accordingly, this outcome may not have been intended by the treaty negotiators.  These anti-avoidance provisions will likely affect a wide range of other investments as well and take effect as of the first day of the third calendar year that ends after the entry into force of the Protocol (i.e. no earlier than January 1, 2010).
  • For individuals, a major issue under the current Treaty for Canadians is that, upon emigration, the Canadian departure tax which deems emigrants to have disposed of and re-acquired their assets at fair market value, may not be reflected in an increased cost basis for U.S. tax purposes, thus potentially resulting in double taxation. Effective September 17, 2000, the Protocol will amend the Treaty to provide that the emigrant can choose to be treated in the new home country as likewise having disposed of and reacquired the property at the time of changing residence, thus correspondingly increasing the individual's tax cost in the property in the new home country.
  • Finally, the "Limitation on Benefits" provision of the Treaty, which currently applies only with respect to the application of the Treaty by the U.S., will apply bilaterally and has been updated to reflect the most recent U.S. Model Tax Convention. This is a significant departure from Canada's position that it could rely on its domestic general anti-avoidance rule (the "GAAR") to police abuses of Canada's tax treaties and, because of the complex and arbitrary nature of these rules, will inevitably increase the cost of cross-border transactions, rather than facilitate them.

Other notable changes to the Treaty introduced by the Protocol are as follows:

  • The tax treatment of pension contributions is harmonized;
  • Canada and the U.S. have agreed on common interpretation of the Treaty to prevent double taxation on stock option benefits.
  • The tax effects of corporate continuance have been clarified, as previously announced by the Canadian Department of Finance on September 18, 2000. Specifically, absent agreement between the competent authorities, treaty benefits will be denied to corporations that continue from one state to the other but do not discontinue in the state of origin.

The Protocol, together with the related Backgrounder and Annexes, is available on the Department of Finance's web site at

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 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
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). 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 & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd 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 or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.