Principal Issues: Whether to allow the flow-through of treaty benefits to partnerships where partnership is transparent for Canadian tax purposes and a "corporation" for foreign tax purposes.
Position: Position is being revisited.
Reasons: The current position (that allows benefits to flow-through) is in direct conflict with the OECD Commentary to Article 1 (see Commentary paragraph 6.2 and 6.3).
MEMO TO FILE
FILE: 2004-007238 DATE: June 17, 2004 OFFICER: Eliza Erskine SUBJECT: International Fiscal Association (IFA) Conference, 2004, Montreal RE: Flow-through of treaty benefits to a partnership
The following question and response was prepared for the above-noted conference. As this conference is now over and final responses have been confirmed and sent out, we hereby close this file.
Q.2 Partnerships and Tax Treaties
In a recent technical interpretation, the Agency noted that its position with respect to partnerships and treaties was not consistent with recent pronouncements of the OECD (2003-00390515). Could the Agency outline the nature of its concerns with respect to partnerships and treaties?
Response
The issue that we are revisiting with respect to partnerships and treaties is whether Canada should continue to give treaty benefits to partners resident in a treaty country (for purposes of the applicable treaty), where the partnership is formed in Canada and is transparent for Canadian tax purposes, but is considered to be a foreign corporation for purposes of the treaty country's tax system and the partners are not actually taxable on the partnership income in the treaty country. The typical situation involves a partnership established in Canada by two U.S. companies who have elected to have the partnership treated as a foreign corporation for purposes of the Internal Revenue Code. We note that our current position, that the partners are entitled to treaty benefits in this situation, continues to apply on a "business-as-usual" basis. Also, we are not revisiting our general position that treaty benefits flow through to partners where both Canada and the other country view the partnership as a transparent vehicle.
Paragraph 6.2 was added to the OECD Commentary on Article 1 in 2000. It was part of a set of additions to the Commentary arising from a lengthy report on partnership and treaty issues put together by the OECD. Applied to transactions involving Canada as a source state, this paragraph provides that partners of a partnership set up in Canada cannot claim the benefits of a tax treaty between the partners' state of residence and Canada if the partnership is a non-transparent entity for purposes of the tax laws of the partners' state of residence. In other words, treaty benefits are denied if the partnership is treated as a foreign corporation for tax purposes in the other state such that the partners are not taxable on the partnership income in the other state at the same time that they are taxable on such income in Canada. The Agency's current position as described above is clearly contrary to this part of the OECD Commentary.
The Agency has three general concerns with maintaining the current position. The first is that maintaining the position may be inconsistent with Agency practice in other areas; the Agency has followed or relied on OECD Commentary with respect to treaty interpretation for a number of other issues. While the weight to be given to Commentary on any particular subject will always depend in part on the overall Canadian tax context, the Agency should be consistent to the greatest extent possible on how Commentary is used in establishing interpretative positions. The second concern is with Canadian tax policy. Canada has not entered an Observation with respect to the particular OECD Commentary in question, which may indicate that Canada agrees with the OECD that treaty benefits should not be given to partners of a partnership where the partnership is treated as a transparent entity in the source state and as a separate legal entity by the partner's state of residence. Our third concern is that Canadian courts are taking notice of and applying OECD Commentary in a growing number of situations. At the same time, we recognize that the weight to be given to OECD Commentary remains in issue, especially where the Commentary in question has been adopted after Canada has entered into the relevant tax treaty. However, the Introduction to the OECD Commentary states that new Commentary should be taken into account when interpreting an existing tax treaty as long as the new Commentary is merely clarifying in nature. It is our understanding that new paragraphs 2-6 and 6.1 et seq. of the Article 1 Commentary are intended to be merely clarifying in nature, that is, these new comments were simply intended to say explicitly what had been understood implicitly before.
In summary, we are revisiting the issue of whether a partner resident in a treaty country should receive the benefits of a tax treaty between Canada and that treaty country where the partner is not liable for tax on the particular income in the treaty country because the partnership is treated as a separate taxable entity by that country. Our review will focus specifically on this issue and not on general partnership issues. Our main concern is that our current position is directly contrary to specific, applicable OECD Commentary on which Canada has not entered an Observation. The results of our review will be announced in a future Income Tax Technical News. Comments on this matter should be forwarded to Eliza Erskine of the Income Tax Rulings Directorate by email at Eliza.Erskine@ccra-adrc.gc.ca or by phone at (613) 952-1361. Written comments on this particular issue are appreciated, however, inquiries not directly connected to this issue will be dealt with as ordinary technical interpretation requests.
Presenter: Jim Wilson
Division: Income Tax Rulings Directorate
prepared by: Eliza Erskine