Copyright 2009, Blake, Cassels & Graydon LLP
Originally published in Blakes Bulletin on Tax, September 2009
The Fifth Protocol (the Protocol) to the Canada–U.S. Income Tax Convention (the Treaty) introduced bilateral limitation on benefits (LOB) provisions. Under the LOB rules, effective for taxation years beginning after 2008, the benefits of the Treaty (from the Canadian perspective) are restricted to only certain U.S. residents. A resident of the U.S. that is not otherwise entitled to the benefits of the Treaty under any of the other LOB provisions may apply to the Canadian competent authority (the Canada Revenue Agency or CRA) to determine whether Treaty benefits should be granted to such person in the circumstances.
Art. XXIX-A(6) of the Treaty states that the competent authority shall, upon a person's request, determine on the basis of all factors including the history, structure, ownership and operations of such person whether (a) its creation and existence did not have as a principal purpose the obtaining of benefits under the Treaty that would otherwise not have been available; or (b) it would not be appropriate, having regard to the purpose of this Article, to deny the benefits of the Treaty to that person. Art. XXIX-A(6) also provides that where the competent authority determines that either of the two above conditions are met, it shall grant Treaty benefits to such person.
Given the uncertainty surrounding the interpretation of some of the LOB provisions, and their apparent narrow scope of application in certain respects, it has been anticipated that the competent authority relief provisions in the Treaty might become an important mechanism for U.S. residents to gain access to Treaty benefits. However, neither the Protocol nor the Technical Explanation to the Protocol released on July 10, 2008 (the Technical Exploration) provided many details about the procedures to apply for a determination by the competent authority, or the criteria that the CRA viewed as relevant to the making of such a determination. Taxpayers were left wondering how viable a solution competent authority relief would be to their Treaty benefits issues.
To help clarify the CRA's position, the CRA recently released guidelines for U.S. residents seeking to apply to the CRA for such a determination (the Guidelines) (see: http://www.cra-arc.gc.ca/tx/nnrsdnts/rtcl29-eng.html ). However, as discussed below, there remain a few issues and uncertainties which leave in doubt whether, and at what time relative to a particular transaction, U.S. residents will view seeking a competent authority determination of their entitlement to Treaty benefits as a practical step.
Making a Request
The Guidelines state that a request should only be made to the competent authority if a U.S. resident is not a qualifying person for purposes of the LOB rules, and neither the "connected trade or business" test in Art. XXIX-A(3) nor the "derivative benefits" rule under Art. XXIX-A(4) of the Treaty extends Treaty benefits to the particular item of income in respect of which Treaty benefits are sought. The Guidelines state that taxpayers will be expected to explain why benefits are not otherwise available in respect of the relevant item of income. This requirement limits the practicality of the competent authority determination provision to taxpayers, as many taxpayers that are uncertain of their status under the LOB rules may not want to take the position that Treaty benefits are not otherwise available before receiving a positive determination from the competent authority. The Guidelines encourage taxpayers who are uncertain about their entitlement to Treaty benefits under the "objective" tests in Art. XXIX-A to seek the advice of the CRA Rulings Directorate; however, the time required to receive an advance tax ruling means that this option is not available in many circumstances.
Interestingly, the Guidelines state that "it is expected that U.S. resident individuals and virtually all other U.S. residents will not need to make a request since they will meet one of the objective tests...". It is unclear why the CRA believes that "virtually all" U.S. residents will qualify for benefits of the Treaty. In many cases, particularly those involving private companies or trusts, it is very difficult to determine whether the tests to be met for full Treaty benefits are satisfied for each year. Also, U.S. residents ultimately controlled by a foreign shareholder that is not a U.S. or Canadian resident cannot quality for full Treaty benefits and may be eligible only for a narrow set of "derivative benefits". While it remains to be seen how the CRA will apply the "active conduct of a trade or business" test in Art. XXIX-A(3), the CRA's statement could suggest that it intends to interpret that provision broadly.
Requests can be made at any time, and can – but need not – follow a determination by the CRA that Treaty benefits are not otherwise available. It is clear from the Technical Explanation, and confirmed in the Guidelines, that upon a determination being made under Art. XXIX-A(6) that Treaty benefits are available, such benefits should be extended retroactively to the later of the coming into force of the relevant provision of the Treaty (i.e., January 1, 2009 for calendar-year taxpayers) or the establishment of the relevant structure in respect of which the determination is sought.
While no prescribed forms have been issued for purposes of making requests, Appendix I to the Guidelines sets out a long list of very detailed information that should accompany any requests to the competent authority. The CRA will require detailed information about the taxpayer, its ownership structure, business activities, liability to tax in the U.S., any other related entities participating in the relevant transactions, and the taxpayer's financial statements, among other things. It is not yet known whether the CRA's practice will be to relax some of these detailed informational requirements in situations where very compelling arguments can be made that the creation and existence of a particular U.S. resident did not have, as a principal purpose, the obtaining of benefits under the Treaty – e.g., in the case of a long-established U.S. resident that, but for a recent change in ultimate ownership, would have been entitled to Treaty benefits.
According to the Guidelines, the CRA will not consider a request under Art. XXIX-A(6) of the Treaty until it is "complete", i.e., until all of the information required under Appendix I to the Guidelines has been provided. Taxpayers are also expected to co-operate with the CRA in the course of its consideration of any request, and to provide any requested information and assistance on a timely basis. The Guidelines note that the CRA may consult with the U.S. or other competent authorities, or provide information to them, about the proposed grant of Treaty benefits.
The Guidelines provide that the CRA will undertake to use "best efforts" to issue a determination letter within six months of receiving a complete request from a taxpayer. This timeline may make seeking a determination in advance of a particular transaction difficult. The Guidelines are unclear as to whether the CRA views Art. XXIX-A(6) of the Treaty as mandatory, such that if the competent authority concludes that either of the two conditions set out in that article are met, then Treaty benefits must be granted, even though the wording of Art. XXIX-A(6) does use mandatory language.
If the CRA does determine that Treaty benefits should be granted, it will issue a determination letter setting out the scope of such benefits. Such letters will expire at the time that is the earlier of three years from the original date of issue, or immediately before the occurrence of a "material change" in the relevant facts and circumstances. The Guidelines do not fully define a "material change", other than as a change that potentially would have been relevant to the competent authority's decision to grant Treaty benefits had such change occurred prior to the grant of benefits. The Guidelines state that a material change could include (but is not limited to) changes related to direct or indirect ownership, residency for purposes of the relevant tax treaty, business activities carried on, or business restructurings. Taxpayers are encouraged to consult with the CRA for its view as to whether any particular event constitutes a material change.
The Guidelines state that the grant of Treaty benefits by the competent authority does not preclude the CRA from taking action to deny benefits, and refers to Art. XXIX-A(7) in support of this position. This paragraph of the LOB provisions in the Treaty states that Art. XXIX-A of the Treaty shall not be construed as restricting the rights of either contracting state to deny Treaty benefits where it can reasonably be concluded that to do otherwise would result in an abuse of the provisions of the Treaty. It is understood that Art. XXIX-A(7) was intended (from the Canadian perspective) to clarify that, notwithstanding the inclusion of comprehensive LOB provisions in the Treaty, the Canadian authorities would not be precluded from applying the general anti-avoidance rule (GAAR) in section 245 of the Income Tax Act (Canada) in situations where it was deemed appropriate to do so. However, this provision applies to the LOB article as a whole. It is unclear what circumstances, if any, could ever justify the CRA applying the GAAR to deny Treaty benefits where the CRA itself had determined pursuant to Art. XXIX-A(6) that such benefits should be granted.
According to the Guidelines, a determination letter is binding on the CRA, subject to the limitations discussed above (including expiry and material changes). This is consistent with the apparent intended effect of Art. XXIX-A(6). What is unclear in the Guidelines are the circumstances in which a payer may rely upon a determination letter as conclusive evidence of a U.S. resident's entitlement to the benefits of the Treaty, including a reduced rate of withholding tax on certain payments. From a practical perspective, Art. XXIX-A(6) would be of very limited benefit if payers could not rely on determination letters, or alternatively some form of certification process. The Guidelines require that applications for a competent authority determination be accompanied by an undertaking by the U.S. resident to notify both the competent authority and all persons reasonably believing that such U.S. resident is entitled to Treaty benefits of the termination of such benefits. This suggests that it is intended that payers be able to rely on determination letters. However, additional guidance to payers in this respect would be helpful.
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