Principal Issues: [TaxInterpretations translation] (1) Are the lump sum payment and the monthly payments subject to tax in Canada or are they non-taxable capital amounts?
(2) Does the CRA consider that the term "other similar payments" in Article 18(4) of the Canada-France Convention refers to "compensation allowances"?
(3) If not, what is the CRA's position on the characterization of the amounts at issue here under the Canada-France Convention?
(4) If either or both of those amounts are not subject to Canadian income tax under Canadian domestic law, will Article 18(4) of the Canada-France Convention still apply?
Position: (1) The lump sum is an amount paid on capital account and is not taxable in Canada. The life annuity is a support payment under subsection 56.1(4) of the Income Tax Act.
(2) N/A. Only the compensatory allowance paid in the form of a life annuity is included under subsection 18(4) of the Canada-France Convention and that is as a support payment.
(3) With respect to compensatory allowance paid in a lump sum, those amounts are governed by subsection 21(2) of the Canada-France Convention.
(4) If subsection 18(4) of the Canada-France Convention applies to an amount but Canadian tax law provides for non-taxation of that amount, that is the end of the story.
Reasons: French civil and tax law; the Income Tax Act; jurisprudence.
XXXXXXXXXX François Bordeleau 2005-012491
March 15, 2006
Dear Sir,
Subject: Request for technical interpretation: Compensatory allowance
This is further to your letter dated April 11, 2005, in which you requested a technical interpretation of the tax treatment under the Income Tax Act (the "Act") of compensatory benefits as defined by the French Civil Code. We apologize for the delay in responding to your question.
CONTEXT
1. Facts
Your letter sets out the following factual situation:
- Prior to the end of XXXXXXXXXX, your client was a resident of France;
- During the months of XXXXXXXXXX, your client visited her daughter in Canada;
- For the taxation year XXXXXXXXXX, your client filed a Canadian income tax return, having earned passive income from Canadian sources during that period;
- For that year, your client also filed a French income tax return;
- In XXXXXXXXXX, your client obtained a divorce from her husband, a resident of France;
- A judgment of the Tribunal de Grande Instance ordered her former spouse to pay her a compensatory allowance as follows:
- A lump sum of XXXXXXXXXX euros paid in two instalments, the first on the date of the divorce judgement, the second one year after the judgement was pronounced;
- A life annuity payable in monthly instalments of XXXXXXXXXX euros
- Your client arrived in Canada at the end of XXXXXXXXXX to settle permanently;
- Withholding tax was levied by the French tax authorities commencing from the month of XXXXXXXXXX on the part of the compensatory allowance paid in the form of a life annuity.
2. French legislative context governing compensatory benefits
Since the compensatory allowance in this case was paid in accordance with French law, it is necessary to refer to its relevant provisions, as reported in your letter.
According to the information you have provided, the former Articles 270 et seq. of the French Civil Code provide that a compensatory allowance is intended to compensate as far as possible for the disparity that the breakdown of the marriage had created in the respective living conditions of the former spouses.
It is only under the new Article 276 of the French Civil Code that a judge can order the payment of a compensatory allowance in the form of a life annuity.
In this case, the portion of the compensatory allowance paid to your client in the form of a capital sum - since it was paid over a period not exceeding 12 months - was not taxable under French tax law. According to this same law, the portion of the compensatory allowance - paid in the form of a life annuity - was deductible for the payer and taxable in the hands of the recipient of the payments.
Questions
In relation to the above facts, you asked the following questions:
(1) Are the lump sum payment and the monthly payments subject to tax in Canada or are they non-taxable capital amounts?
(2) Does the CRA consider that the term "other similar payments" in Article 18(4) of the Canada-France Convention refers to "compensatory allowances"?
(3) If not, what is the CRA's position on the characterization of the amounts at issue here under the Canada-France Convention?
(4) If either or both of those amounts are not subject to Canadian income tax under Canadian domestic law, will Article 18(4) of the Canada-France Convention still apply?
Analysis
Answer to Question (1)
Given that the concept of "prestation compensatoire" [compensatory allowance] under the French Civil Code has a somewhat different meaning than under Canadian law (in particular, the Civil Code of Québec (the "CCQ")), it is necessary to apply the legal and tax concepts applicable in Canada to the French compensatory benefit. In other words, we must determine whether the amounts paid under a French compensatory allowance are similar to one of the items that must be included in computing a taxpayer's income for the purposes of the Act. That analysis will assist both in determining the tax treatment of the amounts paid to your client and in applying the Convention between Canada and France for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and on Capital (the "Canada-France Convention").
This approach was confirmed in The Queen v. Melford Developments Inc.1 where the taxpayer - a Canadian resident - had paid a guarantee fee to a bank resident in Germany. For the purposes of the Canada-Germany Tax Convention, it was necessary to determine whether this payment constituted interest for the purposes of Part XIII of the Act. In other words, in order to determine whether Canada could tax the amount paid to the German bank, the Supreme Court applied the Canadian tax concepts in force at the time.
We also believe that our approach is legitimized by the decision of the Supreme Court of Canada in Backman v. Canada2 where the appellant and other Canadians acquired the interests of American partners in a Texas partnership. That partnership operated apartments. The Canadians then sold the apartments to the original American partners, resulting in the Canadians acquiring and realizing book losses. The Canadians sought to deduct those losses in computing their taxable income under section 96. Here is what the Supreme Court had to say:
We are of the view that, where a taxpayer seeks to deduct Canadian partnership losses through s. 96 of the Act, the taxpayer must satisfy the definition of partnership that exists under the relevant provincial or territorial law.
In the present situation, under French law, a compensatory allowance is paid by one of the former spouses to the other spouse and has the following characteristics3:
- It is paid in order to compensate for the disparity in the living conditions of the former spouses caused by the marriage breakdown.
- Normally, the benefit is a lump sum;
- It takes the form of a lump sum which can be paid over a period of eight years;
- Its amount is normally fixed by a judge;
- It is determined according to the needs of the spouse to whom it is paid and the resources of the person paying it, including
o The age and health of the spouses;
o The duration of the marriage;
o The time spent or to be spent raising the children;
o Their qualifications and employment status in the labour market;
o Their availability for new jobs;
o Their existing and foreseeable rights;
o Their respective pension situations;
o Their assets after the liquidation of the matrimonial regime
- It may take the form of a life annuity if the age or state of health of the creditor justifies it;
- The compensatory allowance paid in the form of an annuity may be revised, suspended or withdrawn in the event of a significant change in the parties' resources or needs;
- A judge may refuse to grant a compensatory allowance when the divorce is granted to the exclusive detriment of the spouse requesting the benefit.
What is called a compensatory allowance in France cannot be equated with a compensatory allowance as defined by the C.C.Q. Under the C.C.Q., the court may order one spouse to pay a compensatory allowance to the other spouse, in compensation for the latter's contribution, in property or services, to the enrichment of the spouse's patrimony. The C.C.Q. provides that a compensatory allowance may be paid either in cash or in instalments. Thus, we do not believe that the tax treatment of the Quebec compensatory allowance is particularly relevant for the purposes of determining the tax treatment of the compensatory allowance received by your client.
Our analysis must therefore address the following question: to which Canadian concept is the French compensatory allowance comparable?
In our view, the only tax concept that comes close to the French prestation compensatoire is the support amount as defined in subsection 56.1(4). Under that provision, a support amount has the following characteristics:
- It is payable to the beneficiary;
- It is payable as an allowance to support the beneficiary;
- It is payable periodically;
- The beneficiary may use that allowance at the individual’s discretion;
- The amount is payable under the order of a competent court or under a written agreement;
- The amount is payable under the order of a court of competent jurisdiction or under a written agreement; The recipient and the payer are living apart from each other due to marriage breakdown.
At first glance, we believe we can easily distinguish between compensatory allowance paid in a lump sum and a support amount as defined in Canadian tax law. Indeed, the French compensatory allowance does not seem to be paid to provide for the needs of the recipient of the payment but rather to equalize the resources of the two spouses following the dissolution of the marriage. As such, the compensatory allowance paid in a lump sum could be more akin to a family property equalization arrangement.4
Subsection 73(1) deals with transfers of capital property between former spouses, including transfers between former spouses in settlement of rights arising out of their marriage. In your client's case, subsection 73(1) does not apply because no capital property was transferred.
Consequently, we are of the view that the compensatory allowance, paid in a lump sum, is a payment on account of capital and that no Canadian tax should be levied on it.
This conclusion may differ in the case of compensatory allowance paid in the form of a life annuity. In light of the divorce decree and the homologation of the final agreement that you sent us, and under the terms of French law on the subject, we are of the view that the compensatory allowance paid in the form of a life annuity could be taxed in Canada as a support amount. The payments received by your client appear to fall within the definition of support amount in section 56.1(4) for the following reasons:
- This is a payment to support your client;
- She has full discretion as to the use of the funds;
- It is payable periodically, pursuant to an order of a court of competent jurisdiction;
- The payee and payor are living separate and apart due to marriage breakdown.
Thus, we are of the view that the compensatory allowance received by your client in the form of a life annuity must fall within the definition of "support amount" in subsection 56.1(4).
Response to Question (2)
Notwithstanding our conclusion above, in order to determine the tax treatment of the compensatory allowance received by your client - whether in a lump sum or in the form of a life annuity - it is necessary to apply the terms of the Canada-France Convention.
The provision providing the rules for the taxation of support payments is Article 18(4) of the Canada-France Convention, which reads as follows:
Alimony and other similar payments arising in a Contracting State and paid to a resident of the other Contracting State who is subject to tax therein in respect thereof, shall be taxable only in that other State.
However, since the term "compensatory allowance" [alimony] is not defined in the Canada-France Convention, it is necessary to refer to Article 3(2) of the Convention which reads as follows:
As regards the application of the Convention by a Contracting State any term not defined therein shall, unless the context otherwise requires, have the meaning which it has under the law of that State concerning the taxes to which the Convention applies, any meaning under the tax laws of that State prevailing over a meaning given to the term under other laws of that State.
From our analysis above, we have already determined that the compensatory allowance paid in the form of a life annuity is a support payment under section 56. Consequently, Canada has the sole right to tax the amounts received by your client in the form of a life annuity in accordance with the tax treatment of support payments under the Act.
With respect to the lump sum compensatory award, we do not believe that it is a payment that falls within Article 18(4) of the Canada-France Convention. As illustrated earlier in this document, the purpose of such an award is not to provide for the future needs of one spouse but rather to correct the disparities created by the marriage breakdown. In that sense, it could not be an alimony or similar payment within the meaning of the Convention.
Response to Question (3)
For any income not specifically mentioned in the Articles of the Canada-France Convention, Article 21(1) of the Convention provides as follows:
Subject to the provisions of paragraph 2 of this Article, items of income of a resident of a Contracting State which are not expressly mentioned in the foregoing Articles of this Convention shall be taxable only in that State.
Paragraph 2 of Article 21 states:
However, if such income is derived by a resident of a Contracting State from sources in the other Contracting State, it may also be taxed in the State in which it arises, and according to the law of that State. [...]
In your letter, you indicated that the compensatory allowance, paid in a lump sum over a period not exceeding twelve months - which is the case here - provides a tax reduction for the debtor and is not taxable to the recipient.
Consequently, under the Canada-France Convention, the compensatory allowance paid in a lump sum is neither taxable in Canada - because of article 21(2) of the Convention - nor taxable in France under the Code général des impôts.
Response to Question (4)
Article 18(4) of the Canada-France Convention applies only in the case of alimony and other similar payments originating in one Contracting State (either France or Canada) and paid to a resident of the other Contracting State. If Canadian domestic law provides for the non-taxation of such amounts (which is not otherwise the case), this would be the end of the story in our view.
Conclusion
We therefore confirm that the compensatory allowance, paid in a lump sum, is not covered by Article 18(4) of the Canada-France Convention but rather by Article 21(2) of the said Convention. We are of the view that that benefit is tax-free to your client.
On the other hand, we are of the opinion that the compensatory allowance paid in the form of a life annuity constitutes a support amount that must be taxed under the support regime, as provided for in section 56.
Best regards,
Phil Jolie
Director
Business and Partnerships Division
Income Tax Rulings Directorate
ENDNOTES
1 [1982] 2 S.C.R. 504
2 [2001] 1 S.C.R. 367
3 See Articles 270 to 281 of the French Civil Code, as amended by Law No 2004-439 of May 26, 2004, in force on January 1, 2005. According to our understanding, those articles do not substantially modify the nature of the compensatory allowance as enacted under the former Articles 270 to 280-1 of the French Civil Code.
4 For example, see Article 416 of the C.C.Q.