Principal Issues: 1) Would income derived "in connection with" a U.S. trade or business include income derived from a "complementary business" as described in the 2006 U.S. Model Technical Explanation? 2) How does Article XXIX A(3) apply if a resident of the U.S. realizes a capital gain from the disposition of shares of a Canadian corporation and a portion of the value of the shares is not attributable to a connected business?
Position: 1) Yes - in determining whether Canadian-source income is derived in connection with an active U.S. trade or business the CRA will be guided by the Technical Explanation to Article XXIX A(3) of the Canada-U.S. Treaty and by the 2006 U.S. Model Technical Explanation to Article 22 of the U.S. Model Income Tax Convention; 2) A portion of the gain would be considered not to be derived in connection with the U.S. trade or business.
September 16, 2009
2009 IFA Conference
Questions:
1) Can the CRA confirm that income derived "in connection with" a U.S. trade or business includes income derived from a "complementary business" as described in the U.S. Model Technical Explanation?
2) What is the CRA's position on whether the gain on the sale of shares of a Canadian subsidiary of a U.S. resident corporation can qualify for the active trade or business exception in circumstances where a portion of the value of the shares of the Canadian subsidiary is attributable to a connected business and another portion is attributable to a business that is not connected with the relevant active trade or business in the U.S.?
Response:
1) Paragraph 3 of Article XXIX A extends the benefits of the Treaty to a resident of a Contracting State (other than a qualifying person) with respect to an item of income derived from the other State in connection with, or incidental to, the active conduct of a trade or business (other than certain investment businesses) in the State of residence if that trade or business is substantial in relation to the activity carried on in the other State. This paragraph applies to income derived by a resident of a Contracting State directly or indirectly through one or more persons who are resident in the other Contracting State.
In determining whether Canadian-source income has been derived by a U.S. resident in connection with an active trade or business in the U.S., the CRA will be guided by the commentary set out in the Technical Explanation to the Fifth Protocol and the 2006 U.S. Model Technical Explanation to Article 22 of the 2006 U.S. Model Income Tax Convention. In general terms, we would consider Canadian-source income to be derived "in connection with" a trade or business in the U.S. if the income is derived from an activity in Canada that is a part of, or is complementary to, the trade or business in the U.S.
An activity in Canada will be considered to be part of a trade or business in the U.S. if the trade or business in the U.S. is upstream, downstream or parallel to the activity in Canada. Business activities will generally be considered to be upstream, downstream or parallel to each other if they relate to the production of the same types of products or the provision of the same or similar services. Business activities will generally be considered to be complementary if they are part of the same industry and the activities are interdependent (i.e., success or failure of one activity will tend to result in success or failure of the other).
2) In circumstances where a U.S. resident realizes a gain from the disposition of the shares of a Canadian subsidiary, and the value of the shares of the subsidiary is attributable partly to a connected business and partly to a business that is not connected to the relevant U.S. trade or business, we would consider only the portion of the gain that relates to the connected business to be income described in paragraph XXIX A(3). For example, if 75% of the value of the shares was attributable to assets used in the connected business, we would consider 75% of the taxable capital gain to be income described in paragraph XXIX A(3).