5 September 2003 External T.I. 2003-0029675 - Article XIII(3)(b)(ii) U.S. Treaty

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: Should the gross asset valuation method be used generally in applying subparagraph 3(b)(ii) of Article XIII of the Canada-United States Income Tax Convention?

Position: Not necessarily, depending on the situations.

Reasons: There could be manipulation and abuse if a fixed method of valuation is adopted. The intention of the negotiating parties should be respected.

XXXXXXXXXX 2003-002967

September 5, 2003

Dear Sir:

Re: Article XIII of the Canada-United States Income Tax Convention (the "Convention")

We are writing in reply to your letter of July 15, 2003 in which you requested our confirmation as to

(i) whether, for the purposes of clause 3(b)(ii) of Article XIII of the Convention (the "Article XIII Clause"), in determining whether the shares of a company derive their value principally from real property situated in Canada, one would compare the fair market value of any real property owned by the company situated in Canada to the fair market value of all the property owned by the company without taking into account debts or other liabilities of the company; and

(ii) whether the Canada Customs and Revenue Agency (the "CCRA") is in agreement with the position expressed in paragraph 28.4 of the OECD Commentary on Article 13 of the OECD Model Convention with respect to the approach of determining whether shares of a company derive more than 50% of their value directly or indirectly from immovable property situated in Canada.

The Article XIII Clause reads as follows:

"For the purpose of this Article the term "real property situated in the other Contracting State"

(a) ...

(b) in the case of real property situated in Canada means:

(i) ...

(ii) a share of the capital stock of a company that is a resident in Canada, the value of whose shares is derived principally from real property situated in Canada; and
(iii) ..."

Paragraph 28.4 of the OECD Commentary on Article 13 of the OECD Model Convention reads as follows:

"Paragraph 4 allows the taxation of the entire gain attributable to the shares to which it applies even where part of the value of the shares is derived from property other than immovable property located in the source State. The determination of whether shares of a company derive more than 50 per cent of their value directly or indirectly from immovable property situated in a Contracting State will normally be done by comparing the value of such immovable property to the value of all the property owned by the company without taking into account debts or other liabilities of the company (whether or not secured by mortgages on the relevant immovable property)." (Underlining for emphasis)

Our Comments

As you are aware, we expressed our view with respect to the interpretation of the Article XIII Clause in our response to Question #58 at the Revenue Canada Round Table at the 1984 Canadian Tax Foundation Conference. In answering the question "Is the value of the real property reduced by liabilities that are charged against such property?" in the context of a tax treaty, our response was "The Department will accept a valuation method that assigns debt to the assets to which the debt reasonably relates." This view, in general, has not been changed. In a technical opinion we issued in 1984 with respect to this subject matter, we stated that, generally speaking, the valuation measure to be used in evaluating the assets of the corporation would be the net asset values after assigning the debt where it reasonably relates. We further stated that, "however, we recognize that there will be circumstances where this test can be manipulated and if there is any evidence of manipulation in contemplation of a share sale, our Department would not feel obliged to accept this net value test, particularly in those circumstances where the increase in value of the shares is mainly attributed to an increase in the value of Canadian real estate".

An underlining principle in international tax treaties is that a country generally maintains its right to tax its natural resources including gains realized on real property situated therein. Paragraph 3 of Article XIII of the Convention is simply an extension of that principle. In our opinion, it would not be logical for the CCRA to adopt a restricted definition of the Article XIII Clause that completely ignores the true cause of the underlying value of a particular share and opens the door for abuse. This would seem to defeat the purpose of having a provision in an income tax convention that was intended to ensure that a country does not forgo its right to tax non-residents simply because the non-resident arranged to hold the real property indirectly through a corporate or trust vehicle. Accordingly, as mentioned above, the comments expressed by Revenue Canada in Question #58 at the Revenue Canada Round Table at the 1984 Canadian Tax Foundation Conference still reflect the CCRA's general view and the CCRA will not limit itself by adopting a single valuation method for the purposes of Article XIII of the Convention. Clearly, in most cases, the gross asset value method will be the simpler method (and perhaps quite often the more reasonable method) to make the determination; however, depending on the facts and circumstances of a particular situation, we feel that one can use the gross asset value method, the net asset value method, or any other valuation method that is appropriate in the circumstances in determining whether the value of the shares of a corporation is derived principally from real property situated in Canada. This flexibility will generally be an advantage to taxpayers other than in those situations where there are "questionable transactions" occurring before the disposition of the shares.

The views expressed in paragraph 28.4 of the Commentary on paragraph 4 of Article 13 of the OECD Model Convention will not be reflected by the CCRA as a hard and fast rule, particularly where there is a case of potential abuse.

It should be noted that our view expressed above regarding the Article XIII Clause applies only to that term where it is used in the context of Canada's income tax treaties and does not necessarily apply to terms similar to the Article XIII Clause that are used in the Income Tax Act.

As stated in paragraph 22 of Information Circular 70-6R5 dated May 17, 2002, the opinions expressed in this letter are not rulings and are consequently not binding on the CCRA.

Yours truly,

Jim Wilson
Section Manager
for Division Director
International and Trusts Division
Income Tax Rulings Directorate
Policy and Legislation Branch

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