Principal Issues: Whether payments made to the widow (a U.S. resident) of a retired partner by a Canadian partnership are subject to the 15% limit in Article XVIII of the Canada-U.S. Income Tax Convention?
Position: No
Reasons: In our view, the payments are business profits under the Convention.
XXXXXXXXXX 2005-014062 S. E. Thomson November 29, 2006
Dear XXXXXXXXXX:
Re: XXXXXXXXXX (the "Taxpayer")
This is in reply to your letter of June 30, 2005 in which you ask for our views on the taxation of payments from a Canadian partnership received by the Taxpayer. You were advised by the International Tax Services Office to contact us. We apologize for the delay in responding.
FACTS
The Taxpayer is a resident of the U.S., and is the widow of a retired partner (the "Retired Partner") of a Canadian partnership (the "Partnership"). The Partnership carries on business through a permanent establishment in Canada. The Retired Partner was receiving payments from the Partnership under its Income Security Program, and upon his death, one-half of the earlier amount continues to be paid to the Taxpayer. For accounting and tax purposes, the amounts are treated as an allocation of the Partnership's income. Therefore, the payments to the Taxpayer are reported to her on a T5013.
You would like to know if Article XVIII(2) (Pensions and Annuities) of the Canada-U.S. Income Tax Convention (the "Convention") limits the rate of Canadian tax on these payments to 15%. You refer to our document 9801445, dated October 13, 1998, in which we said that retirement income paid to a non-resident retired partner did not qualify for the 15% rate under Article XVIII. Part of our reasoning in that document was that the payments to the retired partner were subject to certain conditions that are not usually indicative of a pension. You note that the payments to the Taxpayer, your client, are not subject to these conditions, and accordingly, in your view, qualify for the 15% rate under Article XVIII.
OUR COMMENTS
Where the members of a partnership have agreed to allocate a share of the income or loss of the partnership to any taxpayer who has ceased to be a member of the partnership (or to the taxpayer's spouse), subsection 96(1.1) applies to deem the retired partner (or spouse) to be a member of the partnership and to include the allocated income or loss in the income of the retired partner (or spouse). Further, subsection 96(1.6) deems the retired partner (or spouse) to carry on business in Canada if the partnership carries on business in Canada. A non-resident who carries on business in Canada is taxable on income from the business under Part I of the Act by virtue of subsection 2(3) and subparagraph 115(1)(a)(ii) of the Act. In effect, the scheme of the Act indicates that amounts allocated by a partnership to a retired partner (or spouse) under a retirement program are to be characterized as income from a business, not as pension income, which is generally taxable under section 56.
The characterization as income from a business would apply for purposes of the Convention as well. Article III(2) of the Convention provides:
As regards the application of the Convention by a Contracting State any term not defined therein shall, unless the context otherwise requires and subject to the provisions of Article XXVI (Mutual Agreement Procedure), have the meaning which it has under the law of that State concerning the taxes to which the Convention applies.
Since the term "business profits" in Article VII is not defined in the Convention, Article III(2) directs us to look to Canadian domestic law. As noted above, payments of this nature are deemed by the Act to be income from a business and are consequently subject to Article VII of the Convention. Article VII(6) provides that where business profits include items of income which are dealt with separately in other Articles, then those Articles shall not be affected by Article VII. However, in our view, the definition of "pensions" in Article XVIII(3) is not broad enough to include partnership business profits as described in paragraph 96(1.1)(a) of the Act. Therefore, the 15% limit under Article XVIII(2) of the Convention does not apply to the Taxpayer. Since the Partnership carries on business through a permanent establishment in Canada, the retirement benefits paid by the Partnership to the Taxpayer under the Income Security Program may, pursuant to Article VII of the Convention, be taxed under Part I of the Act and such Part I taxes are not limited by the Convention.
We trust that we have been of some assistance.
Yours truly,
Olli Laurikainen, C.A.
For Director
International & Trusts Division
Income Tax Rulings Directorate
cc: Lingling Wu
Non-Filer / Non-Registrant Program
International Tax Services Office