Principal Issues:
1) Does the Canada-UAE tax treaty apply?
2) Will the profits of Dubai Co qualify as exempt surplus within the meaning of subsection 95(1) of the Income Tax Act?
3) What will be the tax treatment of dividends paid by Dubai Co to Canco under the Act and the Canada-UAE Treaty?
Position: General comments.
Reasons: On the few facts provided, it cannot be determined that Dubai Co will be resident in the UAE for the purposes of the Convention as it cannot be established that it will derive all or substantially all of its income from an active business carried on by it in the UAE and that all or substantially all of the value of its property will be attributable to property used in that business.
XXXXXXXXXX Danielle Bouffard
2007-022626
June 13, 2007
Dear Sir,
Subject: Request for technical interpretation: United Arab Emirates
This is further to your fax of March 5, 2007, requesting our opinion on the tax treatment of a corporation incorporated in Dubai, in the United Arab Emirates.
Facts
1. Canco, a Canadian resident company, will incorporate and own 100% of the shares of Dubai Co;
2. Dubai Co will be incorporated in the United Arab Emirates under the laws of Dubai in what the Dubai authorities refer to as a "tax free zone". Dubai Co will be a "controlled foreign affiliate" of Canco within the meaning of subsection 95(1) of the Income Tax Act (the "Act");
3. The management and control and sole establishment of Dubai Co will be in Dubai; the sole business activity of Dubai Co will be XXXXXXXXXX
4. All profits of Dubai Co will be paid as dividends to Canco.
Our Comments
As stated in paragraph 22 of Information Circular 70-6R5 dated May 17, 2002, it is the practice of the Canada Revenue Agency (the "CRA") not to issue written opinions on proposed transactions otherwise than through advance rulings. Furthermore, when it comes to determining whether a completed transaction has received appropriate tax treatment, that determination is made first by our Tax Services Offices as a result of their review of all facts and documents, which is usually performed as part of an audit engagement. However, we can offer the following general comments that we hope may be helpful to you. These comments may, however, under certain circumstances, not apply to your particular situation.
Question 1
Does the Canada-UAE Tax Convention (the "CAN-UAE Convention") apply to such a fact situation?
Our Comments
As stated in Income Tax Technical News No. 35, dated 26 February 2007, in order to access the benefits of a tax treaty, a person, such as Dubai Co, must be resident in a Contracting State under the tax treaty in question.
According to Article 4(1)(b)(ii) of the CAN-UAE Convention, the term "resident of a Contracting State", in the case of the United Arab Emirates, means:
(ii) a company which is incorporated in the United Arab Emirates, provided such company can establish that:
(A) [...], or
(B) all or substantially all of the company’s income is derived by the company from the active conduct of a trade or business, other than an investment business, in the United Arab Emirates and all or substantially all of the value of the company’s property is attributable to property used in that trade or business.
The terms "all or substantially all" and "active conduct of a trade or business" are not defined in the CAN-UAE Convention. As stated in Article 3(2) of the CAN-UAE Convention: “As regards the application of the Convention by a Contracting State at any time, any term not defined therein shall, unless the context otherwise requires, have the meaning that it has at that time under the law of that State for the purposes of the taxes to which the Convention applies.” In the light of the foregoing, expressions not defined for the purposes of the CAN-UAE Convention shall, unless the context otherwise requires, have the meaning which they have for the purposes of the Act.
The CRA's administrative position is that the "all or substantially all" test is usually considered to be satisfied where a level of 90% or more is reached. However, the "all or substantially all" test could, depending on the circumstances and context, be satisfied even if the 90% level is not strictly met. Where the 90% level is not satisfied, the CRA must consider each case in its particular context and determine whether in a particular situation a threshold of less than 90% can be considered to satisfy the "substantially all" test. On the other hand, "active business" as defined in subsection 95(1) means any business carried on by a foreign affiliate other than a business excluded by paragraphs (a) and (b) of that definition.
According to paragraph 3 of the facts described herein, on the one hand, the sole place of business and the management and control of Dubai Co will be located in Dubai and, on the other hand, the sole business activity of Dubai Co, XXXXXXXXXX, outside Dubai. Although it is assumed that XXXXXXXXXX will be the sole business of Dubai Co and will constitute the operation of an active business, it is not clear whether such business will be operated inside or outside the UAE. Consequently, on the basis of these few facts alone, we cannot determine whether Dubai Co is resident in the UAE for the purposes of the CAN-UAE Convention since it cannot be established that it will derive all or substantially all of its income from an active business carried on by it in the UAE and that all or substantially all of the value of its property will be attributable to property used in that business.
Question 2
Will Dubai Co's profits qualify as exempt surplus?
Our Comments
The term "exempt surplus" is defined in subsection 5907(1) of the Income Tax Regulations (the "Regulations"). The exempt surplus of a foreign affiliate ("FA") is calculated over a period of time. In calculating the exempt surplus of a FA, the "exempt earnings" of the FA must be considered.
The term "exempt earnings" is also defined in subsection 5907(1) of the Regulations. In determining the "exempt earnings" of an FA, subparagraph (d)(i) of that definition requires consideration of the foreign affiliate's "net earnings" (as defined in subsection 5907(1) of the Regulations, which includes its income for the year from an active business carried on by it in a designated treaty country net of taxes paid on that income by the FA) for the year from its active business carried on in Canada or in a "designated treaty country".
The term "designated treaty country" is defined in subsection 5907(11) of the Regulations. Subsection 5907(11) of the Regulations provides that a "designated treaty country" for a taxation year of an FA of a corporation is a country that has entered into a comprehensive agreement or convention for the elimination of double taxation on income with Canada (the “Convention”) that has entered into force and has effect for that taxation year. In addition, under paragraph 5907(11.2)(a) of the Regulations, an FA is deemed not to be a resident of a designated country if it is not a resident of that country for the purpose of the Convention. Thus, under paragraph 5907(11.2)(a) of the Regulations, if an FA is resident in a country with which Canada has a treaty but for the purposes of that treaty the FA is not considered to be resident of that country, it will be deemed not to be a resident of the designated treaty country for the purposes of section 5907 of the Regulations.
It is stated in paragraph 3 of the facts that the management and control of Dubai Co will be located in Dubai, one of the states of the United Arab Emirates. As stated in paragraph 15 of Interpretation Bulletin IT-391R, a company is generally resident in the country in which its central management and control is exercised. Taking into account the comments in the previous paragraph, if it is established on the facts of a specific situation that Dubai Co is a resident of the UAE, it will in addition, for the purposes of applying section 5907 of the Regulations, have to be a resident for the purposes of the CAN-UAE Convention.
Question 3
What will be the tax treatment of dividends paid by Dubai Co to Canco under the Act and the CAN-UAE Convention?
Our Comments
Where a corporation resident in Canada receives a dividend on shares it holds of the capital stock of a FA out of the FA's exempt surplus, section 90 and paragraph 12(1)(k) provide that the amount of the dividend is included in computing the corporation's income. Alternatively, paragraph 113(1)(a) provides that the amount of such a dividend is deducted in computing the taxable income of the corporation. If Dubai Co pays Canco a dividend out of its exempt surplus, the dividend would therefore be exempt from tax for purposes of the Act.
Since, according to paragraph 1 of the above facts, Canco will own 100% of the shares of Dubai Co, the gross amount of the dividend paid by Dubai Co to Canco will be subject, if applicable, to the withholding tax mechanism in the UAE at the rate of 5% in accordance with paragraph 2(a) of Article 10 of the CAN-USA Convention
These comments are not advance income tax rulings and do not bind the CRA with respect to any particular factual situation.
Best regards,
Alain Godin
For the Director
International Operations and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch.