26 January 2004 External T.I. 2003-0039051E5 - Application of treaty rates to Alberta partnership

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues: 1. Does the treaty rate on interest flow through to the US partners of an Alberta limited partnership? 2. Does the use of a Canadian bank account to receive interest payments and re-loan money mean that the partnership is carrying on business in Canada through a PE in Canada?

Position: 1. Yes, but position under review as contrary to OECD Commentary on partnerships. 2. Probably not.

Reasons: 1. Previous positions taken in NRO wind-up rulings. 2. Use of bank account in Canada will not in and by itself constitute carrying on business in Canada through a PE. Question of fact.

XXXXXXXXXX 							2003-003905
								Eliza Erskine
January 26, 2004

Dear XXXXXXXXXX:

Re: Taxation of Interest Paid to Partnership

This is in reply to your letter of September 12, 2003, asking us to confirm that the partnership described in your letter would not be considered to be carrying on business in Canada through a permanent establishment. In your letter, you refer to a number of rulings we have issued with respect to interest received by partnerships in situations similar to the one outlined in your letter (the "Partnership Rulings").

Facts

The situation you describe in your letter involves a taxable Canadian corporation ("Canco") and a limited partnership governed by the laws of the province of Alberta (the "Partnership") whose partners are two U.S. corporations (the "Partners"). The Partners are both residents of the United States for purposes of the Canada-United States Income Tax Convention (the "Convention"). The Partners are both related to Canco. The Partnership has elected under the United States Internal Revenue Code (the "Code") to be treated as a foreign corporation for purposes of the Code. Neither of the Partners has a permanent establishment ("PE") in Canada for purposes of the Convention. The Partnership has loaned money to Canco and Canco will make Canadian dollar interest payments to the Partnership with respect to that loan.

"Part I" and "Part I tax" and "Part XIII" and "Part XIII tax", as those terms are used below, refer to Part I and Part XIII of the Income Tax Act (the "Act") and the tax imposed under those Parts.

Issues

1. Will the interest paid to the Partnership be subject to Part XIII tax at the treaty rate of 10% on the basis that the Partnership is a flow-through entity for Canadian tax purposes and each of the Partners is resident in the United States for purposes of the Convention?

2. If the Partnership has a Canadian bank account and receives the payments of interest and capital from Canco in that bank account and, furthermore, re-lends funds to Canco through that bank account, will that bank account, in and by itself cause the interest paid by Canco to the Partnership to be regarded as attributable to a business carried on in Canada by the Partnership through a PE in Canada such that full Part I tax would apply to the interest? It is assumed that apart from receiving payments of capital and interest in Canada and the re-lending of such funds to Canco through the Canadian bank account, all other activities of the Partnership are conducted outside Canada, all books and records of the Partnership are kept outside Canada, and all management and investment decisions of the Partnership will be made outside Canada.

Our Comments

The circumstances outlined in your letter appear to relate to a specific fact situation. We note that written confirmation of the tax implications arising out of a specific fact situation are given by this Directorate only where the circumstances or events are the subject matter of an advance income tax ruling request. We refer you to Information Circular 70-6R5, Advance Tax Rulings, for detailed information on the scope of the services we provide. This Information Circular can be obtained from the Canada Customs and Revenue Agency ("CCRA") website at www.ccra-adrc.gc.ca. We can offer the following general comments, however, which may be helpful to you.

Issue 1: If Part XIII tax applies, is it limited to the rate set under the Convention?

Assuming that Part XIII, rather than Part I, applies to the interest payments, it is our current position that on the facts set out above, the rate of withholding tax on the payments received by the Partnership would be limited to the reduced rate on interest set out in the Convention (currently 10%). This position is currently under review, as it conflicts with the OECD Commentary relating to Article 1 of the OECD Model Convention (the "Article 1 Commentary"). See the Article 1 Commentary under the heading "Application of the Convention to partnerships", found in paragraphs 2 et seq. of that commentary. In particular, paragraph 6.2 of the Article 1 Commentary states as follows:

Another issue is that of the effect of the provisions of the Convention on a Contacting State's right to tax income arising on its territory where the entitlement to the benefits of one, or more than one, Conventions is different for the partners and the partnership. Where, for instance, the State of source treats a domestic partnership as fiscally transparent and therefore taxes the partners on their share of the income of the partnership, a partner that is resident of a State that taxes partnerships as companies would not be able to claim the benefits of the Convention between the two States with respect to the share of the partnership's income that the State of source taxes in his hands since that income, though allocated to the person claiming the benefits of the Convention under the laws of the State of source, is not similarly allocated for purposes of determining the liability to tax on that item of income in the State of residence of that person. [Emphasis added.]

The CCRA generally supports giving significant weight to the OECD Commentary for purposes of tax treaty interpretation except where Canada has specifically entered an observation. Canadian courts are increasingly of the same view, building on the decision of the Supreme Court of Canada in The Queen v. Crown Forest Industries, 95 DTC 5389, [1995] 2 CTC 64. See, for example: Pacific Network Services Ltd. v. MNR, 2002 DTC 7585, [2003] 1 CTC 333 (FCTD); Edwards v. The Queen, 2002 DTC 1856, [2002] 4 CTC 2202 (TCC), aff'd in 2003 FCA 378 (October 14, 2003); McFadyen v. The Queen, 2000 DTC 2473, [2000] 4 CTC 2573 (TCC), aff'd in [2003] 2 CTC 28, 2003 DTC 5015 (FCA); The Queen v. Dudney, 2000 DTC 6169, [2000] 2 CTC 56 (FCA); Sumner v. The Queen, 2000 DTC 1667, [2000] 2 CTC 2359 (TCC); Cudd Pressure Control Inc. v. The Queen, 98 DTC 6630, [1999] 1 CTC 1 (FCA).

We note that Canada has not entered an observation for the Article 1 Commentary dealing with partnerships. The results of our review of this issue will be released in a future Income Tax Technical News. In the meantime, the CCRA intends to maintain its long-standing position of allowing the reduced withholding rate (i.e., 10%) on interest payments made by Canco to the Partnership in the circumstances described in your letter.

Issue 2: Carrying on business in Canada through a PE in Canada

It is not clear, on the facts set out above, that the Partnership is carrying on business in Canada. Despite the fact that carrying on business is fundamental to the definition of "partnership" for purposes of the various provincial statutes, the level of activity required for purposes of determining whether two or more persons are carrying on business for purposes of the definition of "partnership" in such statutes is not necessarily the same as the level of activity required under the Act in order to distinguish business income from property income. On the other hand, income tax related jurisprudence indicates that the threshold for carrying on business is quite low in the case of corporations and this view would seem to apply to partnerships as well.

In any event, in our view, if a business is being carried on in Canada on the facts set out above, it is unlikely that the business is being carried on in Canada through a PE in Canada for purposes of a tax treaty. In particular, the use of the Canadian bank account by the Partnership as described above would not, in and by itself, be sufficient for the Partnership to be considered to be carrying on business through a PE in Canada for purposes of the Convention such that the interest income would be taxable in Canada at full Part I tax rates.

Both the determination of whether a partnership is carrying on business in Canada and the determination of whether a partnership is carrying on business in Canada through a PE in Canada are questions of fact to be determined on a case by case basis taking into account all of the circumstances of the particular situation. Consequently, our comments immediately above are strictly general in nature. As explained above, we will only confirm the tax consequences flowing from a particular transaction or situation in an advance income tax ruling.

We trust that our comments will be of assistance to you. If you have questions regarding the content of this letter please contact the officer noted above at (613) 952-1361.

Yours truly,

Jim Wilson, Manager
International Section I
for Director
International and Trusts Division
Income Tax Rulings Directorate