Principal Issues: Whether capital gains realized by a U.S. officer or servant of the U.S. government on sale of his principal residence would be exempt from tax in Canada?
Position: Paragraph 40(2)(b) would not exempt the entire gain. There is no other disposition of the Act providing for an exemption for tax.
Reasons: There is no similar privilege granted by the U.S. to Canadian officer or servant of the Canadian government as required by subparagraph 149(1)(a)(ii). Therefore the conditions of paragraph 149(1)(a) are not met.
January 10, 2007
Ginette La Roche HEADQUARTERS International Audit and Non-Resident Income Tax Rulings Montreal Tax Services Office Directorate 305 West, René-Lévesque blvd Sylvie Labarre, CA Montreal QC H2Z 1A6 (613)957-8953
2006-018960
Officer or Servant of the U.S. government
We are writing in reply to your facsimile of June 5th, 2006 in which you seek our opinion as to whether an officer or a servant of the U.S. government based in Canada is required to pay tax on capital gains realized on the disposition of his privately-owned principal residence.
Where a U.S. resident individual disposes of his principal residence in Canada, any capital gain realized on such disposition would generally be subject to tax in Canada without any tax relief (unless that person could find relief under subsection 149(1), paragraph 40(2)(b) or paragraph 81(1)(a) of the Income Tax Act (the "Act")) because a principal residence is taxable Canadian property within the meaning assigned under subsection 248(1) of the Act and real property for the purposes of the Canada-United States Income Tax Convention (the "Convention").
According to paragraph 5 of Article IV of the Convention, an individual shall be deemed to be a resident of the U.S. if the individual is an employee of the U.S. rendering services in the discharge of functions of a governmental nature in Canada and he is subjected in the U.S. to similar obligations in respect of taxes on income as are residents of the U.S. Considering that provision of the Convention, the officer or the servant of the U.S. government is generally deemed not to be a resident in Canada pursuant to subsection 250(5) of the Act.
As the U.S. servant or officer is deemed not to be a resident of Canada, the principal residence exemption described in paragraph 40(2)(b) of the Act would generally not exempt a large proportion of the capital gain realized on the disposition of the principal residence by the U.S. servant or officer. However, if the property is a principal residence pursuant to section 54 of the Act, a small exemption can be computed by virtue of the fact that the numerator in the formula provided for in subparagraph 40(2)(b)(i) would equal 1 even though he was never a resident in Canada during the time period in question.
Paragraph 81(1)(a) of the Act provides that an amount that is declared to be exempt from income tax by any other enactment of Parliament (other than an amount received or receivable by an individual that is exempt by virtue of a provision contained in a tax convention or agreement with another country that has the force of law in Canada) shall not be included in computing the income of a taxpayer. In the particular situation, there is no other enactment of Parliament exempting the taxable capital gain from a principal residence in Canada of a servant or officer of the U.S. government.
Unless all the conditions described in paragraph 149(1)(a) of the Act are met, the officer or servant of the U.S. government would not be exempt from Part I tax on his taxable income (including capital gains) by virtue of that paragraph during the period he is so employed in Canada by his government. These conditions are:
(i) immediately before assuming those duties, the person resided outside of Canada.
(ii) the U.S. grants a similar privilege to an officer or servant of Canada of the same class,
(iii) he was not, at any time in the period, engaged in a business or performing the duties of an office or employment in Canada other than his position with the U.S. government; and
(iv) he was not during the period a Canadian citizen.
In the particular case, the condition referred in (ii) above is not met. An exemption may be granted by the U.S. in respect of wages, salaries and fees of a servant or officer of Canada but there is no exemption regarding the pension income and other income (including capital gains).
The U.S. has rules to exclude, in computing an individual's income, up to $250,000 of the gain on the sale of the main home of the individual if the ownership and use tests are met (see chapter 4 of IRS Publication 523 or Chapter 15 of IRS Publication 17 for more detail). This exemption is available to every individual including a person who is not resident in the U.S. and is not in any way a servant or an officer of a foreign government. As the exemption granted by the U.S. with respect to an officer or servant of the Canadian government does not cover pension or income that is not compensation and as the exemption in respect of the gain on the sale of the main home is a general exemption available to every individual in the U.S., we conclude that the U.S. does not grant a "similar privilege" to an officer or servant of Canada of the same class as required by subparagraph 149(1)(a)(ii) of the Act .
Your client mentions that the gain on a sale of real property by an officer or servant of the Canadian government would be exempted in the U.S. because of §865 of the U.S. Internal Revenue Code. The sourcing rules of §865 of the U.S. Internal Revenue Code provides the rules for the sourcing of personal property. There is a definition of personal property in IRS Publication 519, which definition provides that personal property is property that is not real property. Therefore, it is our understanding that section §865 of the U.S. Internal Revenue Code would not apply for the purposes of the gain on the sale of real property. The sourcing rules of §861 of the U.S. Internal Revenue Code apply to an interest in a real property that is located in the U.S. and that section provides that the gain on such property comes from a source within the U.S. Therefore, if an officer or servant of the Canadian government had stayed as long as in the particular situation, the gain on the principal residence would have been taxable in the U.S. except for the main home exclusion mentioned above.
Also, the Competent Authority of the Canada Revenue Agency has confirmed with the Competent Authority of the U.S. Internal Revenue Service that a "similar privilege" would not be considered to be given to a Canadian officer or servant of the same class by the U.S. as referred to in subparagraph 149(1)(a)(ii) of the Act noted above.
Therefore, a portion of the capital gain realized by an officer or servant of the U.S. government on the sale of his principal residence in Canada will be subject to tax in Canada. As the sale already occurred, he was required to file a Notice of Disposition (Form T2062) to apply for a certificate of compliance with respect to such a sale. In addition, he will be required to file a Canadian income tax return to report the taxable portion of the capital gain.
Yours truly,
Alain Godin
Section Manager
for the Director
International and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch