Copyright 2008, Blake, Cassels & Graydon LLP
Originally published in Blakes Bulletin on Tax, July 2008
The Fifth Protocol (the Protocol) to the Canada-United States Income Tax Convention (the Treaty) modifies the Treaty with respect to contributions and benefits under pension plans (or certain other qualifying retire¬ment plans) by and on behalf of individuals residing in one Contracting State and working in the other (Commuters), as well as individuals who move from one Contracting State to the other on short-term (up to five years) work assignments, and continue to contribute to a plan in the first country (Transferees). The Technical Explanation (TE) emphasizes that, in general, the amount of contributions that may be deducted or benefits that may be tax-sheltered will be subject to the limits under the tax laws of the country of employment in the case of Commuters, and the country of original residence in the case of Transferees. In addition, certain rules will be applied to prevent "double dipping" so that individuals may not accrue benefits under plans in both countries in respect of the same services or time period.
For U.S. citizens living and working in Canada, the TE makes it clear that deductible contributions or tax-sheltered benefits in respect of a qualifying Canadian retirement plan must not exceed the lower of the limits on such contributions or benefits under the law of the U.S. and the law of Canada, notwithstanding the more general rule that deduction of contributions and tax-sheltering of benefits is governed by the laws of the country of residence where an individual is not a Commuter.
The Protocol also amends the Treaty to clarify that tax-exempt trusts, companies, organizations and other arrangements that are investment vehicles for charitable and similar organizations and/or tax-exempt trusts, companies, organizations and arrangements operated exclusively to administer or provide pension, retirement or employee benefits (collectively, Employee Plans) will now be exempt from tax on interest and dividend income pursuant to Article XXI of the Treaty. The exemption under Article XXI is available to an invest¬ment vehicle that is a "resident of" a contracting state. In addition, Article XXIX, "A Limitation on Benefits" extends the benefits of the Treaty to charitable and pension investment vehicles that are "exempt organiza¬tions" under Article XXI provided the investment vehicle is a "resident of a contracting state". "
Unlike Articles XXI and XXIX, Article IV of the Treaty, which is concerned with who is to be a resident of a contracting state, does not expressly address trusts that are investment vehicles for Employee Plans and conse¬quently there is a technical question as to the residence for Treaty purposes of certain tax-exempt trusts, such as pension master trusts under the Act. We understand that the Canadian and U.S. tax authorities have gener¬ally been willing to treat such trusts as residents of the contracting state in which they are constituted. However, on its face, Article IV does not specifically deal with such tax-exempt trusts and the general rule is that trusts are residents of a Contracting State only to the extent that they are liable to tax on their income in that state, either directly at the trust level or in the hands of a beneficiary. In the case of a pension master trust, both the master trust and the registered pension plan trusts that are beneficiaries of the master trust are exempt from tax under the Act.
Under the Protocol, new paragraph 6 of Article IV provides that income will be considered to have been derived by a person who is a resident of a Contracting State where the person is considered to have derived the income from a "fiscally transparent" entity. We had originally anticipated that this new provision could be applied to tax-exempt trusts that were investment vehicles for Employee Plans, but the TE suggests that this will not be the case as it indicates that, in the Canadian context, only "bare" trusts will be considered fiscally transparent. From a Canadian perspective, the new provisions in Articles XXI and XXIX that expressly extend Treaty benefits to investment vehicles (including trusts) for Employee Plans would be of limited utility if they did not apply to elected master trusts under the Act, and we see no reason for the Canadian and U.S. tax authorities to deny Treaty benefits to elected master trusts and similar trust arrangements. However, it would have been helpful if the TE could have addressed this issue explicitly.
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