Technical Explanation of Protocol Amending the Convention… US and Canada… Taxes on Income and Capital, September 21, 2007

DEPARTMENT OF THE TREASURY
TECHNICAL EXPLANATION OF
THE PROTOCOL DONE AT CHELSEA ON SEPTEMBER 21, 2007
AMENDING THE CONVENTION BETWEEN
THE UNITED STATES OF AMERICA AND CANADA
WITH RESPECT TO TAXES ON INCOME AND ON CAPITAL
DONE AT WASHINGTON ON SEPTEMBER 26, 1980,
AS AMENDED BY THE PROTOCOLS DONE ON
JUNE 14, 1983, MARCH 28, 1994, MARCH 17, 1995, AND JULY 29, 1997
INTRODUCTION
This is a Technical Explanation of the Protocol signed at Chelsea on September
21, 2007 (the “Protocol”), amending the Convention between the United States of
America and Canada with Respect to Taxes on Income and on Capital done at
Washington on September 26, 1980, as amended by the Protocols done on June 14, 1983,
March 28, 1994, March 17, 1995, and July 29, 1997 (the “existing Convention”). The
existing Convention as modified by the Protocol shall be referred to as the “Convention.”
Negotiation of the Protocol took into account the U.S. Treasury Department’s
current tax treaty policy and the Treasury Department’s Model Income Tax Convention,
published on November 15, 2006 (the “U.S. Model”). Negotiations also took into
account the Model Tax Convention on Income and on Capital, published by the
Organisation for Economic Cooperation and Development (the “OECD Model”), and
recent tax treaties concluded by both countries.
The Technical Explanation is an official United States guide to the Protocol. The
Government of Canada has reviewed this document and subscribes to its contents. In the
view of both governments, this document accurately reflects the policies behind
particular Protocol provisions, as well as understandings reached with respect to the
application and interpretation of the Protocol and the Convention.
References made to the “existing Convention” are intended to put various
provisions of the Protocol into context. The Technical Explanation does not, however,
provide a complete comparison between the provisions of the existing Convention and
the amendments made by the Protocol. The Technical Explanation is not intended to
provide a complete guide to the existing Convention as amended by the Protocol. To the
extent that the existing Convention has not been amended by the Protocol, the prior
technical explanations of the Convention remain the official explanations. References in
this Technical Explanation to "he"' or "his" should be read to mean "he or she" or "his or
her." References to the “Code” are to the Internal Revenue Code.
On the date of signing of the Protocol, the United States and Canada exchanged
two sets of diplomatic notes. Each of these notes sets forth provisions and
understandings related to the Protocol and the Convention, and comprises an integral part
of the overall agreement between the United States and Canada. The first note, the

“Arbitration Note,” relates to the implementation of new paragraphs 6 and 7 of Article
XXVI (Mutual Agreement Procedure), which provide for binding arbitration of certain
disputes between the competent authorities. The second note, the “General Note,” relates
more generally to issues of interpretation or application of various provisions of the
Protocol.
Article 1
Article 1 of the Protocol adds subparagraph 1(k) to Article III (General
Definitions) to address the definition of “national” of a Contracting State as used in the
Convention. The Contracting States recognize that Canadian tax law does not draw
distinctions based on nationality as such. Nevertheless, at the request of the United
States, the definition was added and contains references to both citizenship and
nationality. The definition includes any individual possessing the citizenship or
nationality of a Contracting State and any legal person, partnership or association whose
status is determined by reference to the laws in force in a Contracting State. The existing
Convention contains one reference to the term “national” in paragraph 1 of Article XXVI
(Mutual Agreement Procedure). The Protocol adds another reference in paragraph 1 of
Article XXV (Non-Discrimination) to ensure that nationals of the United States are
covered by the non-discrimination provisions of the Convention. The definition added by
the Protocol is consistent with the definition provided in other U.S. tax treaties.
The General Note provides that for purposes of paragraph 2 of Article III, as
regards the application at any time of the Convention, any term not defined in the
Convention shall, unless the context otherwise requires or the competent authorities
otherwise agree to a common meaning pursuant to Article XXVI (Mutual Agreement
Procedure), have the meaning which it has at that time under the law of that State for the
purposes of the taxes to which the Convention apply, any meaning under the applicable
tax laws of that State prevailing over a meaning given to the term under other laws of that
State.
Article 2
Article 2 of the Protocol replaces paragraph 3 of Article IV (Residence) of the
existing Convention to address the treatment of so-called dual resident companies.
Article 2 of the Protocol also adds new paragraphs 6 and 7 to Article IV to determine
whether income is considered to be derived by a resident of a Contracting State when
such income is derived through a fiscally transparent entity.
Paragraph 3 of Article IV – Dual resident companies
Paragraph 3, which addresses companies that are otherwise considered resident in
each of the Contracting States, is replaced. The provisions of paragraph 3, and the date
upon which these provisions are effective, are consistent with an understanding reached
between the United States and Canada on September 18, 2000, to clarify the residence of
a company under the Convention when the company has engaged in a so-called corporate
“continuance” transaction. The paragraph applies only where, by reason of the rules set
forth in paragraph 1 of Article IV (Residence), a company is a resident of both
Contracting States.
Subparagraph 3(a) provides a rule to address the situation when a company is a
resident of both Contracting States but is created under the laws in force in only one of
the Contracting States. In such a case, the rule provides that the company is a resident
only of the Contracting State under which it is created. For example, if a company is
incorporated in the United States but the company is also otherwise considered a resident
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of Canada because the company is managed in Canada, subparagraph 3(a) provides that
the company shall be considered a resident only of the United States for purposes of the
Convention. Subparagraph 3(a) is intended to operate in a manner similar to the first
sentence of former paragraph 3. However, subparagraph 3(a) clarifies that such a
company must be considered created in only one of the Contracting States to fall within
the scope of subparagraph 3(a). In some cases, a company may engage in a corporate
continuance transaction and retain its charter in the Contracting State from which it
continued, while also being considered as created in the State to which the company
continued. In such cases, the provisions of subparagraph 3(a) shall not apply because the
company would be considered created in both of the Contracting States.
Subparagraph 3(b) addresses all cases involving a dual resident company that are
not addressed in subparagraph 3(a). Thus, subparagraph 3(b) applies to continuance
transactions occurring between the Contracting States if, as a result, a company otherwise
would be considered created under the laws of each Contracting State, e.g., because the
corporation retained its charter in the first State. Subparagraph 3(b) would also address
so-called serial continuance transactions where, for example, a company continues from
one of the Contracting States to a third country and then continues into the other
Contracting State without having ceased to be treated as resident in the first Contracting
State.
Subparagraph 3(b) provides that if a company is considered to be a resident of
both Contracting States, and the residence of such company is not resolved by
subparagraph 3(a), then the competent authorities of the Contracting States shall
endeavor to settle the question of residency by a mutual agreement procedure and
determine the mode of application of the Convention to such company. Subparagraph
3(b) also provides that in the absence of such agreement, the company shall not be
considered a resident of either Contracting State for purposes of claiming any benefits
under the Convention.
Paragraphs 6 and 7 of Article IV – income, profit, or gain derived through fiscally
transparent entities
New paragraphs 6 and 7 are added to Article IV to provide specific rules for the
treatment of amounts of income, profit or gain derived through or paid by fiscally
transparent entities such as partnerships and certain trusts. Fiscally transparent entities,
as explained more fully below, are in general entities the income of which is taxed at the
beneficiary, member, or participant level. Entities that are subject to tax, but with respect
to which tax may be relieved under an integrated system, are not considered fiscally
transparent entities. Entities that are fiscally transparent for U.S. tax purposes include
partnerships, common investment trusts under section 584, grantor trusts, and business
entities such as a limited liability company (“LLC”) that is treated as a partnership or is
disregarded as an entity separate from its owner for U.S. tax purposes. Entities falling
within this description in Canada are (except to the extent the law provides otherwise)
partnerships and what are known as “bare” trusts.
United States tax law also considers a corporation that has made a valid election
to be taxed under Subchapter S of Chapter 1 of the Internal Revenue Code (an “S
corporation”) to be fiscally transparent within the meaning explained below. Thus, if a
U.S. resident derives income from Canada through an S corporation, the U.S. resident
will under new paragraph 6 be considered for purposes of the Convention as the person
who derived the income. Exceptionally, because Canada will ordinarily accept that an S
corporation is itself resident in the United States for purposes of the Convention, Canada
will allow benefits under the Convention to the S corporation in its own right. In a
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reverse case, however – that is, where the S corporation is owned by a resident of Canada
and has U.S.-source income, profits or gains – the Canadian resident will not be
considered as deriving the income by virtue of subparagraph 7 (a) as Canada does not see
the S corporation as fiscally transparent.
Under both paragraph 6 and paragraph 7, it is relevant whether the treatment of an
amount of income, profit or gain derived by a person through an entity under the tax law
of the residence State is “the same as its treatment would be if that amount had been
derived directly.” For purposes of paragraphs 6 and 7, whether the treatment of an
amount derived by a person through an entity under the tax law of the residence State is
the same as its treatment would be if that amount had been derived directly by that person
shall be determined in accordance with the principles set forth in Code section 894 and
the regulations under that section concerning whether an entity will be treated as fiscally
transparent with respect to an item of income received by the entity. Treas. Reg. section
1.894-1(d)(3)(iii) provides that an entity will be fiscally transparent under the laws of an
interest holder’s jurisdiction with respect to an item of income to the extent that the laws
of that jurisdiction require the interest holder resident in that jurisdiction to separately
take into account on a current basis the interest holder’s respective share of the item of
income paid to the entity, whether or not distributed to the interest holder, and the
character and source of the item in the hands of the interest holder are determined as if
such item were realized directly from the source from which realized by the entity.
Although Canada does not have analogous provisions in its domestic law, it is anticipated
that principles comparable to those described above will apply.
Paragraph 6
Under paragraph 6, an amount of income, profit or gain is considered to be
derived by a resident of a Contracting State (residence State) if 1) the amount is derived
by that person through an entity (other than an entity that is a resident of the other
Contracting State (source State), and 2) by reason of that entity being considered fiscally
transparent under the laws of the residence State, the treatment of the amount under the
tax law of the residence State is the same as its treatment would be if that amount had
been derived directly by that person. These two requirements are set forth in
subparagraphs 6(a) and 6(b), respectively.
For example, if a U.S. resident owns a French entity that earns Canadian-source
dividends and the entity is considered fiscally transparent under U.S. tax law, the U.S.
resident is considered to derive the Canadian-source dividends for purposes of Article IV
(and thus, the dividends are considered as being “paid to” the resident) because the U.S.
resident is considered under the tax law of the United States to have derived the dividend
through the French entity and, because the entity is treated as fiscally transparent under
U.S. tax law, the treatment of the income under U.S. tax law is the same as its treatment
would be if that amount had been derived directly by the U.S. resident. This result
obtains even if the French entity is viewed differently under the tax laws of Canada or of
France (i.e., the French entity is treated under Canadian law or under French tax law as
not fiscally transparent).
Similarly, if a Canadian resident derives U.S.-source income, profit or gain
through an entity created under Canadian law that is considered a partnership for
Canadian tax purposes but a corporation for U.S. tax purposes, U.S.-source income, profit
or gain derived through such entity by the Canadian resident will be considered to be
derived by the Canadian resident in considering the application of the Convention.
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Application of paragraph 6 and related treaty provisions by Canada
In determining the entitlement of a resident of the United States to the benefits of
the Convention, Canada shall apply the Convention within its own legal framework.
For example, assume that from the perspective of Canadian law an amount of
income is seen as being paid from a source in Canada to USLLC, an entity that is entirely
owned by U.S. persons and is fiscally transparent for U.S. tax purposes, but that Canada
considers a corporation and, thus, under Canadian law, a taxpayer in its own right. Since
USLLC is not itself taxable in the United States, it is not considered to be a U.S. resident
under the Convention; but for new paragraph 6 Canada would not apply the Convention
in taxing the income.
If new paragraph 6 applies in respect of an amount of income, profit or gain, such
amount is considered as having been derived by one or more U.S. resident shareholders
of USLLC, and Canada shall grant benefits of the Convention to the payment to USLLC
and eliminate or reduce Canadian tax as provided in the Convention. The effect of the
rule is to suppress Canadian taxation of USLLC to give effect to the benefits available
under the Convention to the U.S. residents in respect of the particular amount of income,
profit or gain.
However, for Canadian tax purposes, USLLC remains the only “visible” taxpayer
in relation to this amount. In other words, the Canadian tax treatment of this taxpayer
(USLLC) is modified because of the entitlement of its U.S. resident shareholders to
benefits under the Convention, but this does not alter USLLC’s status under Canadian
law. Canada does not, for example, treat USLLC as though it did not exist, substituting
the shareholders for it in the role of taxpayer under Canada’s system.
Some of the implications of this are as follows. First, Canada will not require the
shareholders of USLLC to file Canadian tax returns in respect of income that benefits
from new paragraph 6. Instead, USLLC itself will file a Canadian tax return in which it
will claim the benefit of the paragraph and supply any documentation required to support
the claim. (The Canada Revenue Agency will supply additional practical guidance in this
regard, including instructions for seeking to establish entitlement to Convention benefits
in advance of payment.) Second, as is explained in greater detail below, if the income in
question is business profits, it will be necessary to determine whether the income was
earned through a permanent establishment in Canada. This determination will be based
on the presence and activities in Canada of USLLC itself, not of its shareholders acting in
their own right.
Determination of the existence of a permanent establishment from the business activities
of a fiscally transparent entity
New paragraph 6 applies not only in respect of amounts of dividends, interest and
royalties, but also profit (business income), gains and other income. It may thus be
relevant in cases where a resident of one Contracting State carries on business in the
other State through an entity that has a different characterization in each of the two
Contracting States.
Application of new paragraph 6 and the provisions of Article V (Permanent
Establishment) by Canada
Assume, for instance, that a resident of the United States is part owner of a U.S.
limited liability company (USLLC) that is treated in the United States as a fiscally
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transparent entity, but in Canada as a corporation. Assume one of the other two
shareholders of USLLC is resident in a country that does not have a tax treaty with
Canada and that the remaining shareholder is resident in a country with which Canada
does have a tax treaty, but that the treaty does not include a provision analogous to
paragraph 6.
Assume further that USLLC carries on business in Canada, but does not do so
through a permanent establishment there. (Note that from the Canadian perspective, the
presence or absence of a permanent establishment is evaluated with respect to USLLC
only, which Canada sees as a potentially taxable entity in its own right.) Regarding
Canada’s application of the provisions of the Convention, the portion of USLLC’s profits
that belongs to the U.S. resident shareholder will not be taxable in Canada, provided that
the U.S. resident meets the Convention’s limitation on benefits provisions. Under
paragraph 6, that portion is seen as having been derived by the U.S. resident shareholder,
who is entitled to rely on Article VII (Business Profits). The balance of USLLC’s profits
will, however, remain taxable in Canada. Since USLLC is not itself resident in the
United States for purposes of the Convention, in respect of that portion of its profits that
is not considered to have been derived by a U.S. resident (or a resident of another country
whose treaty with Canada includes a rule comparable to paragraph 6) it is not relevant
whether or not it has a permanent establishment in Canada.
Another example would be the situation where a USLLC that is wholly owned by
a resident of the U.S. carries on business in Canada through a permanent establishment.
If the USLLC is fiscally transparent for U.S. tax purposes (and therefore, the conditions
for the application of paragraph 6 are satisfied) then the USLLC’s profits will be treated
as having been derived by its U.S. resident owner inclusive of all attributes of that
income (e.g., such as having been earned through a permanent establishment). However,
since the USLLC remains the only “visible” taxpayer for Canadian tax purposes, it is the
USLLC, and not the U.S. shareholder, that is subject to tax on the profits that are
attributable to the permanent establishment.
Application of new paragraph 6 and the provisions of Article V (Permanent
Establishment) by the United States
It should be noted that in the situation where a person is considered to derive
income through an entity, the United States looks in addition to such person’s activities in
order to determine whether he has a permanent establishment. Assume that a Canadian
resident and a resident in a country that does not have a tax treaty with the United States
are owners of CanLP. Assume further that Can LP is an entity that is considered fiscally
transparent for Canadian tax purposes but is not considered fiscally transparent for U.S.
tax purposes, and that CanLP carries on business in the United States. If CanLP carries
on the business through a permanent establishment, that permanent establishment may be
attributed to the partners. Moreover, in determining whether there is a permanent
establishment, the activities of both the entity and its partners will be considered. If
CanLP does not carry on the business through a permanent establishment, the Canadian
resident, who derives income through the partnership, may claim the benefits of Article
VII (Business Profits) of the Convention with respect to such income, assuming that the
income is not otherwise attributable to a permanent establishment of the partner. In any
case, the third country partner cannot claim the benefits of Article VII of the Convention
between the United States and Canada.
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Paragraph 7
Paragraph 7 addresses situations where an item of income, profit or gain is
considered not to be paid to or derived by a person who is a resident of a Contracting
State. The paragraph is divided into two subparagraphs.
Under subparagraph 7(a), an amount of income, profit or gain is considered not to
be paid to or derived by a person who is a resident of a Contracting State (the residence
State) if (1) the other Contracting State (the source State) views the person as deriving the
amount through an entity that is not a resident of the residence State, and (2) by reason of
the entity not being treated as fiscally transparent under the laws of the residence State,
the treatment of the amount under the tax law of the residence State is not the same as its
treatment would be if that amount had been derived directly by the person.
For example, assume USCo, a company resident in the United States, is a part
owner of CanLP, an entity that is considered fiscally transparent for Canadian tax
purposes, but is not considered fiscally transparent for U.S. tax purposes. CanLP
receives a dividend from a Canadian company in which it owns stock. Under Canadian
tax law USCo is viewed as deriving a Canadian-source dividend through CanLP. For
U.S. tax purposes, CanLP, and not USCo, is viewed as deriving the dividend. Because
the treatment of the dividend under U.S. tax law in this case is not the same as the
treatment under U.S. law if USCo derived the dividend directly, subparagraph 7(a)
provides that USCo will not be considered as having derived the dividend. The result
would be the same if CanLP were a third-country entity that was viewed by the United
States as not fiscally transparent, but was viewed by Canada as fiscally transparent.
Similarly, income from U.S. sources received by an entity organized under the laws of
the United States that is treated for Canadian tax purposes as a corporation and is owned
by shareholders who are residents of Canada is not considered derived by the
shareholders of that U.S. entity even if, under U.S. tax law, the entity is treated as fiscally
transparent.
Subparagraph 7(b) provides that an amount of income, profit or gain is not
considered to be paid to or derived by a person who is a resident of a Contracting State
(the residence State) where the person is considered under the tax law of the other
Contracting State (the source State) to have received the amount from an entity that is a
resident of that other State (the source State), but by reason of the entity being treated as
fiscally transparent under the laws of the Contracting State of which the person is resident
(the residence State), the treatment of such amount under the tax law of that State (the
residence State) is not the same as the treatment would be if that entity were not treated
as fiscally transparent under the laws of that State (the residence State).
That is, under subparagraph 7(b), an amount of income, profit or gain is not
considered to be paid to or derived by a resident of a Contracting State (the residence
State) if: (1) the other Contracting State (the source State) views such person as receiving
the amount from an entity resident in the source State; (2) the entity is viewed as fiscally
transparent under the laws of the residence State; and (3) by reason of the entity being
treated as fiscally transparent under the laws of the residence State, the treatment of the
amount received by that person under the tax law of the residence State is not the same as
its treatment would be if the entity were not treated as fiscally transparent under the laws
of the residence State.
For example, assume that USCo, a company resident in the United States is the
sole owner of CanCo, an entity that is considered under Canadian tax law to be a
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corporation that is resident in Canada but is considered under U.S. tax law to be
disregarded as an entity separate from its owner. Assume further that USCo is
considered under Canadian tax law to have received a dividend from CanCo.
In such a case, Canada, the source State, views USCo as receiving income (i.e., a
dividend) from a corporation that is a resident of Canada (CanCo), CanCo is viewed as
fiscally transparent under the laws of the United States, the residence State, and by reason
of CanCo being disregarded under U.S. tax law, the treatment under U.S. tax law of the
payment is not the same as its treatment would be if the entity were regarded as a
corporation under U.S. tax law. That is, the payment is disregarded for U.S. tax
purposes, whereas if U.S. tax law regarded CanCo as a corporation, the payment would
be treated as a dividend. Therefore, subparagraph 7(b) would apply to provide that the
income is not considered to be paid to or derived by USCo.
The same result obtains if, in the above example, USCo is considered under
Canadian tax law to have received an interest or royalty payment (instead of a dividend)
from CanCo. Under U.S. law, because CanCo is disregarded as an entity separate from
its owner, the payment is disregarded, whereas if CanCo were treated as not fiscally
transparent, the payment would be treated as interest or a royalty, as the case may be.
Therefore, subparagraph 7(b) would apply to provide that such amount is not considered
to be paid to or derived by USCo.
The application of subparagraph 7(b) differs if, in the above example, USCo (as
well as other persons) are owners of CanCo, a Canadian entity that is considered under
Canadian tax law to be a corporation that is resident in Canada but is considered under
U.S. tax law to be a partnership (as opposed to being disregarded). Assume that USCo is
considered under Canadian tax law to have received a dividend from CanCo. Such
payment is viewed under Canadian tax law as a dividend, but under U.S. tax law is
viewed as a partnership distribution. In such a case, Canada views USCo as receiving
income (i.e., a dividend) from an entity that is a resident of Canada (CanCo), CanCo is
viewed as fiscally transparent under the laws of the United States, the residence State,
and by reason of CanCo being treated as a partnership under U.S. tax law, the treatment
under U.S. tax law of the payment (as a partnership distribution) is not the same as the
treatment would be if CanCo were not fiscally transparent under U.S. tax law (as a
dividend). As a result, subparagraph 7(b) would apply to provide that such amount is not
considered paid to or derived by the U.S. resident.
As another example, assume that CanCo, a company resident in Canada, is the
owner of USLP, an entity that is considered under U.S. tax law (by virtue of an election)
to be a corporation resident in the United States, but that is considered under Canadian
tax law to be a branch of CanCo. Assume further that CanCo is considered under U.S.
tax law to have received a dividend from USLP. In this case, the United States views
CanCo as receiving income (i.e., a dividend) from an entity that is resident in the United
States (USLP), but by reason of USLP being a branch under Canadian tax law, the
treatment under Canadian tax law of the payment is not the same as its treatment would
be if USLP were a company under Canadian tax law. That is, the payment is treated as a
branch remittance for Canadian tax purposes, whereas if Canadian tax law regarded
USLP as a corporation, the payment would be treated as a dividend. Therefore,
subparagraph 7(b) would apply to provide that the income is not considered to be paid to
or derived by CanCo. The same result would obtain in the case of interest or royalties
paid by USLP to CanCo.
Paragraphs 6 and 7 apply to determine whether an amount is considered to be
derived by (or paid to) a person who is a resident of Canada or the United States. If, as a
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result of paragraph 7, a person is not considered to have derived or received an amount of
income, profit or gain, that person shall not be entitled to the benefits of the Convention
with respect to such amount. Additionally, for purposes of application of the Convention
by the United States, the treatment of such payments under Code section 894(c) and the
regulations thereunder would not be relevant.
New paragraphs 6 and 7 are not an exception to the saving clause of paragraph 2
of Article XXIX (Miscellaneous Rules). Accordingly, subparagraph 7(b) does not
prevent a Contracting State from taxing an entity that is treated as a resident of that State
under its tax law. For example, if a U.S. partnership with members who are residents of
Canada elects to be taxed as a corporation for U.S. tax purposes, the United States will
tax that partnership on its worldwide income on a net basis, even if Canada views the
partnership as fiscally transparent.
Interaction of paragraphs 6 and 7 with the determination of “beneficial ownership”
With respect to payments of income, profits or gain arising in a Contracting State
and derived directly by a resident of the other Contracting State (and not through a
fiscally transparent entity), the term “beneficial owner” is defined under the internal law
of the country imposing tax (i.e., the source State). Thus, if the payment arising in a
Contracting State is derived by a resident of the other State who under the laws of the
first-mentioned State is determined to be a nominee or agent acting on behalf of a person
that is not a resident of that other State, the payment will not be entitled to the benefits of
the Convention. However, payments arising in a Contracting State and derived by a
nominee on behalf of a resident of that other State would be entitled to benefits. These
limitations are confirmed by paragraph 12 of the Commentary to Article 10 of the OECD
Model.
Special rules apply in the case of income, profits or gains derived through a
fiscally transparent entity, as described in new paragraph 6 of Article IV. Residence
State principles determine who derives the income, profits or gains, to assure that the
income, profits or gains for which the source State grants benefits of the Convention will
be taken into account for tax purposes by a resident of the residence State. Source
country principles of beneficial ownership apply to determine whether the person who
derives the income, profits or gains, or another resident of the other Contracting State, is
the beneficial owner of the income, profits or gains. The source State may conclude that
the person who derives the income, profits or gains in the residence State is a mere
nominee, agent, conduit, etc., for a third country resident and deny benefits of the
Convention. If the person who derives the income, profits or gains under paragraph 6 of
Article IV would not be treated under the source State’s principles for determining
beneficial ownership as a nominee, agent, custodian, conduit, etc., that person will be
treated as the beneficial owner of the income, profits or gains for purposes of the
Convention.
Assume, for instance, that interest arising in the United States is paid to CanLP,
an entity established in Canada which is treated as fiscally transparent for Canadian tax
purposes but is treated as a company for U.S. tax purposes. CanCo, a company
incorporated in Canada, is the sole interest holder in CanLP. Paragraph 6 of Article IV
provides that CanCo derives the interest. However, if under the laws of the United States
regarding payments to nominees, agents, custodians and conduits, CanCo is found be a
nominee, agent, custodian or conduit for a person who is not a resident of Canada, CanCo
will not be considered the beneficial owner of the interest and will not be entitled to the
benefits of Article XI with respect to such interest. The payment may be entitled to
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benefits, however, if CanCo is found to be a nominee, agent, custodian or conduit for a
person who is a resident of Canada.
With respect to Canadian-source income, profit or gains, beneficial ownership is
to be determined under Canadian law. For example, assume that LLC, an entity that is
treated as fiscally transparent for U.S. tax purposes, but as a corporation for Canadian tax
purposes, is owned by USCo, a U.S. resident company. LLC receives Canadian-source
income. The question of the beneficial ownership of the income received by LLC is
determined under Canadian law. If LLC is considered the beneficial owner of the income
under Canadian law, paragraph 6 shall apply to extend benefits of the Convention to the
income received by LLC to the extent that the Canadian-source income is derived by U.S.
resident members of LLC.
Article 3
Article 3 of the Protocol amends Article V (Permanent Establishment) of the
Convention. Paragraph 1 of Article 3 of the Protocol adds a reference in Paragraph 6 of
Article IV to new paragraph 9 of Article V. Paragraph 2 of Article 3 of the Protocol sets
forth new paragraphs 9 and 10 of Article V.
Paragraph 9 of Article V
New paragraph 9 provides a special rule (subject to the provisions of paragraph 3)
for an enterprise of a Contracting State that provides services in the other Contracting
State, but that does not have a permanent establishment by virtue of the preceding
paragraphs of the Article. If (and only if) such an enterprise meets either of two tests as
provided in subparagraphs 9(a) and 9(b), the enterprise will be deemed to provide those
services through a permanent establishment in the other State.
The first test as provided in subparagraph 9(a) has two parts. First, the services
must be performed in the other State by an individual who is present in that other State
for a period or periods aggregating 183 days or more in any twelve-month period.
Second, during that period or periods, more than 50 percent of the gross active business
revenues of the enterprise (including revenue from active business activities unrelated to
the provision of services) must consist of income derived from the services performed in
that State by that individual. If the enterprise meets both of these tests, the enterprise will
be deemed to provide the services through a permanent establishment. This test is
employed to determine whether an enterprise is deemed to have a permanent
establishment by virtue of the presence of a single individual (i.e., a natural person).
For the purposes of subparagraph 9(a), the term “gross active business revenues”
shall mean the gross revenues attributable to active business activities that the enterprise
has charged or should charge for its active business activities, regardless of when the
actual billing will occur or of domestic law rules concerning when such revenues should
be taken into account for tax purposes. Such active business activities are not restricted
to the activities related to the provision of services. However, the term does not include
income from passive investment activities.
As an example of the application of subparagraph 9(a), assume that Mr. X, an
individual resident in the United States, is one of the two shareholders and employees of
USCo, a company resident in the United States that provides engineering services.
During the 12-month period beginning December 20 of Year 1 and ending December 19
of Year 2, Mr. X is present in Canada for periods totaling 190 days, and during those
10

periods, 70 percent of all of the gross active business revenues of USCo attributable to
business activities are derived from the services that Mr. X performs in Canada. Because
both of the criteria of subparagraph 9(a) are satisfied, USCo will be deemed to have a
permanent establishment in Canada by virtue of that subparagraph.
The second test as provided in subparagraph 9(b) provides that an enterprise will
have a permanent establishment if the services are provided in the other State for an
aggregate of 183 days or more in any twelve-month period with respect to the same or
connected projects for customers who either are residents of the other State or maintain a
permanent establishment in the other State with respect to which the services are
provided. The various conditions that have to be satisfied in order for subparagraph 9(b)
to have application are described in detail below.
In addition to meeting the 183-day threshold, the services must be provided for
customers who either are residents of the other State or maintain a permanent
establishment in that State. The intent of this requirement is to reinforce the concept that
unless there is a customer in the other State, such enterprise will not be deemed as
participating sufficiently in the economic life of that other State to warrant being deemed
to have a permanent establishment.
Assume for example, that CanCo, a Canadian company, wishes to acquire USCo,
a company in the United States. In preparation for the acquisition, CanCo hires Canlaw,
a Canadian law firm, to conduct a due diligence evaluation of USCo’s legal and financial
standing in the United States. Canlaw sends a staff attorney to the United States to
perform the due diligence analysis of USCo. That attorney is present and working in the
United States for greater than 183 days. If the remuneration paid to Canlaw for the
attorney’s services does not constitute more than 50 percent of Canlaw’s gross active
business revenues for the period during which the attorney is present in the United States,
Canlaw will not be deemed to provide the services through a permanent establishment in
the United States by virtue of subparagraph 9(a). Additionally, because the services are
being provided for a customer (CanCo) who neither is a resident of the United States nor
maintains a permanent establishment in the United States to which the services are
provided, Canlaw will also not have a permanent establishment in the United States by
virtue of subparagraph 9(b).
Paragraph 9 applies only to the provision of services, and only to services
provided by an enterprise to third parties. Thus, the provision does not have the effect of
deeming an enterprise to have a permanent establishment merely because services are
provided to that enterprise. Paragraph 9 only applies to services that are performed or
provided by an enterprise of a Contracting State within the other Contracting State. It is
therefore not sufficient that the relevant services be merely furnished to a resident of the
other Contracting State. Where, for example, an enterprise provides customer support or
other services by telephone or computer to customers located in the other State, those
would not be covered by paragraph 9 because they are not performed or provided by that
enterprise within the other State. Another example would be that of an architect who is
hired to design blueprints for the construction of a building in the other State. As part of
completing the project, the architect must make site visits to that other State, and his days
of presence there would be counted for purposes of determining whether the 183-day
threshold is satisfied. However, the days that the architect spends working on the
blueprint in his home office shall not count for purposes of the 183-day threshold,
because the architect is not performing or providing those services within the other State.
For purposes of determining whether the time threshold has been met,
subparagraph 9(b) permits the aggregation of services that are provided with respect to
11

connected projects. Paragraph 2 of the General Note provides that for purposes of
subparagraph 9(b), projects shall be considered to be connected if they constitute a
coherent whole, commercially and geographically. The determination of whether
projects are connected should be determined from the point of view of the enterprise (not
that of the customer), and will depend on the facts and circumstances of each case. In
determining the existence of commercial coherence, factors that would be relevant
include: 1) whether the projects would, in the absence of tax planning considerations,
have been concluded pursuant to a single contract; 2) whether the nature of the work
involved under different projects is the same; and 3) whether the same individuals are
providing the services under the different projects. Whether the work provided is
covered by one or multiple contracts may be relevant, but not determinative, in finding
that projects are commercially coherent.
The aggregation rule addresses, for example, potentially abusive situations in
which work has been artificially divided into separate components in order to avoid
meeting the 183-day threshold. Assume for example, that a technology consultant has
been hired to install a new computer system for a company in the other country. The
work will take ten months to complete. However, the consultant purports to divide the
work into two five-month projects with the intention of circumventing the rule in
subparagraph 9(b). In such case, even if the two projects were considered separate, they
will be considered to be commercially coherent. Accordingly, subject to the additional
requirement of geographic coherence, the two projects could be considered to be
connected, and could therefore be aggregated for purposes of subparagraph 9(b). In
contrast, assume that the technology consultant is contracted to install a particular
computer system for a company, and is also hired by that same company, pursuant to a
separate contract, to train its employees on the use of another computer software that is
unrelated to the first system. In this second case, even though the contracts are both
concluded between the same two parties, there is no commercial coherence to the two
projects, and the time spent fulfilling the two contracts may not be aggregated for
purposes of subparagraph 9(b). Another example of projects that do not have commercial
coherence would be the case of a law firm which, as one project provides tax advice to a
customer from one portion of its staff, and as another project provides trade advice from
another portion of its staff, both to the same customer.
Additionally, projects, in order to be considered connected, must also constitute a
geographic whole. An example of projects that lack geographic coherence would be a
case in which a consultant is hired to execute separate auditing projects at different
branches of a bank located in different cities pursuant to a single contract. In such an
example, while the consultant’s projects are commercially coherent, they are not
geographically coherent and accordingly the services provided in the various branches
shall not be aggregated for purposes of applying subparagraph 9(b). The services
provided in each branch should be considered separately for purposes of subparagraph
9(b).
The method of counting days for purposes of subparagraph 9(a) differs slightly
from the method for subparagraph 9(b). Subparagraph 9(a) refers to days in which an
individual is present in the other country. Accordingly, physical presence during a day is
sufficient. In contrast, subparagraph 9(b) refers to days during which services are
provided by the enterprise in the other country. Accordingly, non-working days such as
weekends or holidays would not count for purposes of subparagraph 9(b), as long as no
services are actually being provided while in the other country on those days. For the
purposes of both subparagraphs, even if the enterprise sends many individuals
simultaneously to the other country to provide services, their collective presence during
one calendar day will count for only one day of the enterprise’s presence in the other
12

country. For instance, if an enterprise sends 20 employees to the other country to provide
services to a client in the other country for 10 days, the enterprise will be considered
present in the other country only for 10 days, not 200 days (20 employees x 10 days).
By deeming the enterprise to provide services through a permanent establishment
in the other Contracting State, paragraph 9 allows the application of Article VII (Business
Profits), and accordingly, the taxation of the services shall be on a net-basis. Such
taxation is also limited to the profits attributable to the activities carried on in performing
the relevant services. It will be important to ensure that only the profits properly
attributable to the functions performed and risks assumed by provision of the services
will be attributed to the deemed permanent establishment.
In addition to new paragraph 9, Article 3 of the Protocol amends paragraph 6 of
Article V of the Convention to include a reference to paragraph 9. Therefore, in no case
will paragraph 9 apply to deem services to be provided through a permanent
establishment if the services are limited to those mentioned in paragraph 6 which, if
performed through a fixed place of business, would not make the fixed place of business
a permanent establishment under the provisions of that paragraph.
The competent authorities are encouraged to consider adopting rules to reduce the
potential for excess withholding or estimated tax payments with respect to employee
wages that may result from the application of this paragraph. Further, because paragraph
6 of Article V applies notwithstanding paragraph 9, days spent on preparatory or
auxiliary activities shall not be taken into account for purposes of applying subparagraph
9(b).
Paragraph 10 of Article V
Paragraph 2 of Article 3 of the Protocol also sets forth new paragraph 10 of
Article V. The provisions of new paragraph 10 are identical to paragraph 9 of Article V
as it existed prior to the Protocol. New paragraph 10 provides that the provisions of
Article V shall be applied in determining whether any person has a permanent
establishment in any State.
Article 4
Article 4 of the Protocol replaces paragraph 2 of Article VII (Business Profits).
New paragraph 2 provides that where a resident of either Canada or the United
States carries on (or has carried on) business in the other Contracting State through a
permanent establishment in that other State, both Canada and the United States shall
attribute to permanent establishments in their respective states those business profits
which the permanent establishment might be expected to make if it were a distinct and
separate person engaged in the same or similar activities under the same or similar
conditions and dealing wholly independently with the resident and with any other person
related to the resident. The term “related to the resident” is to be interpreted in
accordance with paragraph 2 of Article IX (Related Persons). The reference to other
related persons is intended to make clear that the test of paragraph 2 is not restricted to
independence between a permanent establishment and a home office.
New paragraph 2 is substantially similar to paragraph 2 as it existed before the
Protocol. However, in addition to the reference to a resident of a Contracting State who
“carries on” business in the other Contracting State, the Protocol incorporates into the
Convention the rule of Code section 864(c)(6) by adding “or has carried on” to address
13

circumstances where, as a result of timing, income may be attributable to a permanent
establishment that no longer exists in one of the Contracting States. In such cases, the
income is properly within the scope of Article VII. Conforming changes are also made in
the Protocol to Articles X (Dividends), XI (Interest), and XII (Royalties) of the
Convention where Article VII would apply. As is explained in paragraph 5 of the
General Note, these revisions to the Convention are only intended to clarify the
application of the existing provisions of the Convention.
The following example illustrates the application of paragraph 2. Assume a
company that is a resident of Canada and that maintains a permanent establishment in the
United States winds up the permanent establishment's business and sells the permanent
establishment’s inventory and assets to a U.S. buyer at the end of year 1 in exchange for
an installment obligation payable in full at the end of year 3. Despite the fact that the
company has no permanent establishment in the United States in year 3, the United States
may tax the deferred income payment recognized by the company in year 3.
The “attributable to” concept of paragraph 2 provides an alternative to the
analogous but somewhat different “effectively connected” concept in Code section
864(c). Depending on the circumstances, the amount of income “attributable to” a
permanent establishment under Article VII may be greater or less than the amount of
income that would be treated as “effectively connected” to a U.S. trade or business under
Code section 864. In particular, in the case of financial institutions, the use of internal
dealings to allocate income within an enterprise may produce results under Article VII
that are significantly different than the results under the effectively connected income
rules. For example, income from interbranch notional principal contracts may be taken
into account under Article VII, notwithstanding that such transactions may be ignored for
purposes of U.S. domestic law. A taxpayer may use the treaty to reduce its taxable
income, but may not use both treaty and Code rules where doing so would thwart the
intent of either set of rules. See Rev. Rul. 84-17, 1984-1 C.B. 308.
The profits attributable to a permanent establishment may be from sources within
or without a Contracting State. However, as stated in the General Note, the business
profits attributable to a permanent establishment include only those profits derived from
the assets used, risks assumed, and activities performed by the permanent establishment.
The language of paragraph 2, when combined with paragraph 3 dealing with the
allowance of deductions for expenses incurred for the purposes of earning the profits,
incorporates the arm's length standard for purposes of determining the profits attributable
to a permanent establishment. The United States and Canada generally interpret the
arm’s length standard in a manner consistent with the OECD Transfer Pricing Guidelines.
Paragraph 9 of the General Note confirms that the arm’s length method of
paragraphs 2 and 3 consists of applying the OECD Transfer Pricing Guidelines, but
taking into account the different economic and legal circumstances of a single legal entity
(as opposed to separate but associated enterprises). Thus, any of the methods used in the
Transfer Pricing Guidelines, including profits methods, may be used as appropriate and in
accordance with the Transfer Pricing Guidelines. However, the use of the Transfer
Pricing Guidelines applies only for purposes of attributing profits within the legal entity.
It does not create legal obligations or other tax consequences that would result from
transactions having independent legal significance. Thus, the Contracting States agree
that the notional payments used to compute the profits that are attributable to a permanent
establishment will not be taxed as if they were actual payments for purposes of other
taxing provisions of the Convention, for example, for purposes of taxing a notional
royalty under Article XII (Royalties).
14

One example of the different circumstances of a single legal entity is that an entity
that operates through branches rather than separate subsidiaries generally will have lower
capital requirements because all of the assets of the entity are available to support all of
the entity’s liabilities (with some exceptions attributable to local regulatory restrictions).
This is the reason that most commercial banks and some insurance companies operate
through branches rather than subsidiaries. The benefit that comes from such lower
capital costs must be allocated among the branches in an appropriate manner. This issue
does not arise in the case of an enterprise that operates through separate entities, since
each entity will have to be separately capitalized or will have to compensate another
entity for providing capital (usually through a guarantee).
Under U.S. domestic regulations, internal “transactions” generally are not
recognized because they do not have legal significance. In contrast, the rule provided by
the General Note is that such internal dealings may be used to attribute income to a
permanent establishment in cases where the dealings accurately reflect the allocation of
risk within the enterprise. One example is that of global trading in securities. In many
cases, banks use internal swap transactions to transfer risk from one branch to a central
location where traders have the expertise to manage that particular type of risk. Under
paragraph 2 as set forth in the Protocol, such a bank may also use such swap transactions
as a means of attributing income between the branches, if use of that method is the “best
method” within the meaning of regulation section 1.482-1(c). The books of a branch will
not be respected, however, when the results are inconsistent with a functional analysis.
So, for example, income from a transaction that is booked in a particular branch (or home
office) will not be treated as attributable to that location if the sales and risk management
functions that generate the income are performed in another location.
The understanding in the General Note also affects the interpretation of paragraph
3 of Article VII. Paragraph 3 provides that in determining the business profits of a
permanent establishment, deductions shall be allowed for the expenses incurred for the
purposes of the permanent establishment, ensuring that business profits will be taxed on a
net basis. This rule is not limited to expenses incurred exclusively for the purposes of the
permanent establishment, but includes expenses incurred for the purposes of the
enterprise as a whole, or that part of the enterprise that includes the permanent
establishment. Deductions are to be allowed regardless of which accounting unit of the
enterprise books the expenses, so long as they are incurred for the purposes of the
permanent establishment. For example, a portion of the interest expense recorded on the
books of the home office in one State may be deducted by a permanent establishment in
the other. The amount of the expense that must be allowed as a deduction is determined
by applying the arm’s length principle.
As noted above, paragraph 9 of the General Note provides that the OECD
Transfer Pricing Guidelines apply, by analogy, in determining the profits attributable to a
permanent establishment. Accordingly, a permanent establishment may deduct payments
made to its head office or another branch in compensation for services performed for the
benefit of the branch. The method to be used in calculating that amount will depend on
the terms of the arrangements between the branches and head office. For example, the
enterprise could have a policy, expressed in writing, under which each business unit
could use the services of lawyers employed by the head office. At the end of each year,
the costs of employing the lawyers would be charged to each business unit according to
the amount of services used by that business unit during the year. Since this has the
characteristics of a cost-sharing arrangement and the allocation of costs is based on the
benefits received by each business unit, such a cost allocation would be an acceptable
15

means of determining a permanent establishment's deduction for legal expenses.
Alternatively, the head office could agree to employ lawyers at its own risk, and to
charge an arm's length price for legal services performed for a particular business unit. If
the lawyers were under-utilized, and the “fees” received from the business units were less
than the cost of employing the lawyers, then the head office would bear the excess cost. If
the "fees" exceeded the cost of employing the lawyers, then the head office would keep
the excess to compensate it for assuming the risk of employing the lawyers. If the
enterprise acted in accordance with this agreement, this method would be an acceptable
alternative method for calculating a permanent establishment's deduction for legal
expenses.
The General Note also makes clear that a permanent establishment cannot be
funded entirely with debt, but must have sufficient capital to carry on its activities as if it
were a distinct and separate enterprise. To the extent that the permanent establishment
has not been attributed capital for profit attribution purposes, a Contracting State may
attribute such capital to the permanent establishment, in accordance with the arm’s length
principle, and deny an interest deduction to the extent necessary to reflect that capital
attribution. The method prescribed by U.S. domestic law for making this attribution is
found in Treas. Reg. section 1.882-5. Both section 1.882-5 and the method prescribed in
the General Note start from the premise that all of the capital of the enterprise supports all
of the assets and risks of the enterprise, and therefore the entire capital of the enterprise
must be allocated to its various businesses and offices.
However, section 1.882-5 does not take into account the fact that some assets
create more risk for the enterprise than do other assets. An independent enterprise would
need less capital to support a perfectly-hedged U.S. Treasury security than it would need
to support an equity security or other asset with significant market and/or credit risk.
Accordingly, in some cases section 1.882-5 would require a taxpayer to allocate more
capital to the United States, and therefore would reduce the taxpayer’s interest deduction
more, than is appropriate. To address these cases, the General Note allows a taxpayer to
apply a more flexible approach that takes into account the relative risk of its assets in the
various jurisdictions in which it does business. In particular, in the case of financial
institutions other than insurance companies, the amount of capital attributable to a
permanent establishment is determined by allocating the institution’s total equity between
its various offices on the basis of the proportion of the financial institution’s risk-
weighted assets attributable to each of them. This recognizes the fact that financial
institutions are in many cases required to risk-weight their assets for regulatory purposes
and, in other cases, will do so for business reasons even if not required to do so by
regulators. However, risk-weighting is more complicated than the method prescribed by
section 1.882-5. Accordingly, to ease this administrative burden, taxpayers may choose
to apply the principles of Treas. Reg. section 1.882-5(c) to determine the amount of
capital allocable to its U.S. permanent establishment, in lieu of determining its allocable
capital under the risk-weighted capital allocation method provided by the General Note,
even if it has otherwise chosen the principles of Article VII rather than the effectively
connected income rules of U.S. domestic law. It is understood that this election is not
binding for purposes of Canadian taxation unless the result is in accordance with the
arm’s length principle.
As noted in the Convention, nothing in paragraph 3 requires a Contracting State to
allow the deduction of any expenditure which, by reason of its nature, is not generally
allowed as a deduction under the tax laws in that State.
16

Article 5
Article 5 makes a number of amendments to Article X (Dividends) of the existing
Convention. As with other benefits of the Convention, the benefits of Article X are
available to a resident of a Contracting State only if that resident is entitled to those
benefits under the provisions of Article XXIX A (Limitation on Benefits).
See the Technical Explanation for new paragraphs 6 and 7 of Article IV
(Residence) for discussion regarding the interaction between domestic law concepts of
beneficial ownership and the treaty rules to determine when a person is considered to
derive an item of income for purposes of obtaining benefits of the Convention such as
withholding rate reductions.
Paragraph 1
Paragraph 1 of Article 5 of the Protocol replaces subparagraph 2(a) of Article X
of the Convention. In general, paragraph 2 limits the amount of tax that may be imposed
on dividends by the Contracting State in which the company paying the dividends is
resident if the beneficial owner of the dividends is a resident of the other Contracting
State. Subparagraph 2(a) limits the rate to 5 percent of the gross amount of the dividends
if the beneficial owner is a company that owns 10 percent or more of the voting stock of
the company paying the dividends.
The Protocol adds a parenthetical to address the determination of the requisite
ownership set forth in subparagraph 2(a) when the beneficial owner of dividends receives
the dividends through an entity that is considered fiscally transparent in the beneficial
owner’s Contracting State. The added parenthetical stipulates that voting stock in a
company paying the dividends that is indirectly held through an entity that is considered
fiscally transparent in the beneficial owner’s Contracting State is taken into account,
provided the entity is not a resident of the other Contracting State. The United States
views the new parenthetical as merely a clarification.
For example, assume USCo, a U.S. corporation, directly owns 2 percent of the
voting stock of CanCo, a Canadian company that is considered a corporation in the
United States and Canada. Further, assume that USCo owns 18 percent of the interests in
LLC, an entity that in turn owns 50 percent of the voting stock of CanCo. CanCo pays a
dividend to each of its shareholders. Provided that LLC is fiscally transparent in the
United States and not considered a resident of Canada, USCo’s 9 percent ownership in
CanCo through LLC (50 percent x 18 percent) is taken into account in determining
whether USCo meets the 10 percent ownership threshold set forth in subparagraph 2(a).
In this example, USCo may aggregate its voting stock interests in CanCo that it owns
directly and through LLC to determine if it satisfies the ownership requirement of
subparagraph 2(a). Accordingly, USCo will be entitled to the 5 percent rate of
withholding on dividends paid with respect to both its voting stock held through LLC and
its voting stock held directly. Alternatively, if, for example, all of the shareholders of
LLC were natural persons, the 5 percent rate would not apply.
Paragraph 2
Paragraph 2 of Article 5 of the Protocol replaces the definition of the term
“dividends” provided in paragraph 3 of Article X of the Convention. The new definition
conforms to the U.S. Model formulation. Paragraph 3 defines the term dividends broadly
and flexibly. The definition is intended to cover all arrangements that yield a return on
17

an equity investment in a corporation as determined under the tax law of the source State,
as well as arrangements that might be developed in the future.
The term dividends includes income from shares, or other corporate rights that are
not treated as debt under the law of the source State, that participate in the profits of the
company. The term also includes income that is subjected to the same tax treatment as
income from shares by the law of the source State. Thus, for example, a constructive
dividend that results from a non-arm's length transaction between a corporation and a
related party is a dividend. In the case of the United States the term “dividend” includes
amounts treated as a dividend under U.S. law upon the sale or redemption of shares or
upon a transfer of shares in a reorganization. See, e.g., Rev. Rul. 92-85, 1992-2 C.B. 69
(sale of foreign subsidiary's stock to U.S. sister company is a deemed dividend to extent
of the subsidiary's and sister company's earnings and profits). Further, a distribution from
a U.S. publicly traded limited partnership that is taxed as a corporation under U.S. law is
a dividend for purposes of Article X. However, a distribution by a limited liability
company is not considered by the United States to be a dividend for purposes of Article
X, provided the limited liability company is not characterized as an association taxable as
a corporation under U.S. law.
Paragraph 3 of the General Note states that distributions from Canadian income
trusts and royalty trusts that are treated as dividends as a result of changes to Canada’s
taxation of income and royalty trusts enacted in 2007 (S.C. 2007, c. 29) shall be treated as
dividends for the purposes of Article X.
Additionally, a payment denominated as interest that is made by a thinly
capitalized corporation may be treated as a dividend to the extent that the debt is
recharacterized as equity under the laws of the source State. At the time the Protocol was
signed, interest payments subject to Canada’s thin-capitalization rules were not
recharacterized as dividends.
Paragraph 3
Paragraph 3 of Article 5 of the Protocol replaces paragraph 4 of Article X. New
paragraph 4 is substantially similar to paragraph 4 as it existed prior to the Protocol. New
paragraph 4, however, adds clarifying language consistent with the changes made in
Articles 4, 6, and 7 of the Protocol with respect to income attributable to a permanent
establishment that has ceased to exist. Paragraph 4 provides that the limitations of
paragraph 2 do not apply if the beneficial owner of the dividends carries on or has carried
on business in the State in which the company paying the dividends is a resident through
a permanent establishment situated there, and the stockholding in respect of which the
dividends are paid is effectively connected to such permanent establishment. In such a
case, the dividends are taxable pursuant to the provisions of Article VII (Business
Profits). Thus, dividends paid in respect of holdings forming part of the assets of a
permanent establishment or which are otherwise effectively connected to such permanent
establishment will be taxed on a net basis using the rates and rules of taxation generally
applicable to residents of the State in which the permanent establishment is situated.
To conform with Article 9 of the Protocol, which deletes Article XIV
(Independent Personal Services) of the Convention, paragraph 4 of Article 5 of the
Protocol also amends paragraph 5 of Article X by omitting the reference to a “fixed
base.”
18

Paragraph 4
To conform with Article 9 of the Protocol, which deletes Article XIV
(Independent Personal Services) of the Convention, paragraph 4 of Article 5 of the
Protocol amends paragraph 5 of Article X by omitting the reference to a “fixed base.”
Paragraph 5
Paragraph 5 of Article 5 of the Protocol replaces subparagraph 7(c) of Article X
of the existing Convention. Consistent with current U.S. tax treaty policy, new
subparagraph 7(c) provides rules that expand the application of subparagraph 2(b) for the
treatment of dividends paid by a Real Estate Investment Trust (REIT). New
subparagraph 7(c) maintains the rule of the existing Convention that dividends paid by a
REIT are not eligible for the 5 percent maximum rate of withholding tax of subparagraph
2(a), and provides that the 15 percent maximum rate of withholding tax of subparagraph
2(b) applies to dividends paid by REITs only if one of three conditions is met.
First, the dividend will qualify for the 15 percent maximum rate if the beneficial
owner of the dividend is an individual holding an interest of not more than 10 percent in
the REIT. For this purpose, subparagraph 7(c) also provides that where an estate or
testamentary trust acquired its interest in a REIT as a consequence of the death of an
individual, the estate or trust will be treated as an individual for the five-year period
following the death. Thus, dividends paid to an estate or testamentary trust in respect of a
holding of less than a 10 percent interest in the REIT also will be entitled to the 15
percent rate of withholding, but only for up to five years after the death.
Second, the dividend will qualify for the 15 percent maximum rate if it is paid
with respect to a class of stock that is publicly traded and the beneficial owner of the
dividend is a person holding an interest of not more than 5 percent of any class of the
REIT's stock.
Third, the dividend will qualify for the 15 percent maximum rate if the beneficial
owner of the dividend holds an interest in the REIT of 10 percent or less and the REIT is
"diversified." A REIT is diversified if the gross value of no single interest in real
property held by the REIT exceeds 10 percent of the gross value of the REIT's total
interest in real property. For purposes of this diversification test, foreclosure property is
not considered an interest in real property, and a REIT holding a partnership interest is
treated as owning its proportionate share of any interest in real property held by the
partnership.
A resident of Canada directly holding U.S. real property would pay U.S. tax either
at a 30 percent rate of withholding tax on the gross income or at graduated rates on the
net income. By placing the real property in a REIT, the investor absent a special rule
could transform real estate income into dividend income, taxable at the rates provided in
Article X, significantly reducing the U.S. tax that otherwise would be imposed.
Subparagraph 7(c) prevents this result and thereby avoids a disparity between the taxation
of direct real estate investments and real estate investments made through REIT conduits.
In the cases in which subparagraph 7(c) allows a dividend from a REIT to be eligible for
the 15 percent maximum rate of withholding tax, the holding in the REIT is not
considered the equivalent of a direct holding in the underlying real property.
19

Article 6
Article 6 of the Protocol replaces Article XI (Interest) of the existing Convention.
Article XI specifies the taxing jurisdictions over interest income of the States of source
and residence and defines the terms necessary to apply Article XI. As with other benefits
of the Convention, the benefits of Article XI are available to a resident of a Contracting
State only if that resident is entitled to those benefits under the provisions of Article
XXIX A (Limitation on Benefits).
Paragraph 1 of Article XI
New paragraph 1 generally grants to the residence State the exclusive right to tax
interest beneficially owned by its residents and arising in the other Contracting State. See
the Technical Explanation for new paragraphs 6 and 7 of Article IV (Residence) for
discussion regarding the interaction between domestic law concepts of beneficial
ownership and the treaty rules to determine when a person is considered to derive an item
of income for purposes of obtaining benefits under the Convention such as withholding
rate reductions.
Subparagraph 3(d) of Article 27 of the Protocol provides an additional rule
regarding the application of paragraph 1 during the first two years that end after the
Protocol’s entry into force. This rule is described in detail in the Technical Explanation
to Article 27.
Paragraph 2 of Article XI
Paragraph 2 of new Article XI is substantially identical to paragraph 4 of Article
XI of the existing Convention.
Paragraph 2 defines the term "interest" as used in Article XI to include, inter alia,
income from debt claims of every kind, whether or not secured by a mortgage. Interest
that is paid or accrued subject to a contingency is within the ambit of Article XI. This
includes income from a debt obligation carrying the right to participate in profits. The
term does not, however, include amounts that are treated as dividends under Article X
(Dividends).
The term “interest” also includes amounts subject to the same tax treatment as
income from money lent under the law of the State in which the income arises. Thus, for
purposes of the Convention, amounts that the United States will treat as interest include
(i) the difference between the issue price and the stated redemption price at maturity of a
debt instrument (i.e., original issue discount (OID)), which may be wholly or partially
realized on the disposition of a debt instrument (section 1273), (ii) amounts that are
imputed interest on a deferred sales contract (section 483), (iii) amounts treated as
interest or OID under the stripped bond rules (section 1286), (iv) amounts treated as
original issue discount under the below-market interest rate rules (section 7872), (v) a
partner's distributive share of a partnership's interest income (section 702), (vi) the
interest portion of periodic payments made under a "finance lease" or similar contractual
arrangement that in substance is a borrowing by the nominal lessee to finance the
acquisition of property, (vii) amounts included in the income of a holder of a residual
interest in a real estate mortgage investment conduit (REMIC) (section 860E), because
these amounts generally are subject to the same taxation treatment as interest under U.S.
tax law, and (viii) interest with respect to notional principal contracts that are re-
characterized as loans because of a “substantial non-periodic payment.”
20

Paragraph 3 of Article XI
Paragraph 3 is in all material respects the same as paragraph 5 of Article XI of the
existing Convention. New paragraph 3 adds clarifying language consistent with the
changes made in Articles 4, 5, and 7 of the Protocol with respect to income attributable to
a permanent establishment that has ceased to exist. Also, consistent with the changes
described in Article 9 of the Protocol, discussed below, paragraph 3 does not contain
references to the performance of independent personal services through a fixed base.
Paragraph 3 provides an exception to the exclusive residence taxation rule of
paragraph 1 in cases where the beneficial owner of the interest carries on business
through a permanent establishment in the State of source and the interest is effectively
connected to that permanent establishment. In such cases the provisions of Article VII
(Business Profits) will apply and the source State will retain the right to impose tax on
such interest income.
Paragraph 4 of Article XI
Paragraph 4 is in all material respects the same as paragraph 6 of Article XI of the
existing Convention. The only difference is that, consistent with the changes described
below with respect to Article 9 of the Protocol, paragraph 4 does not contain references to
a fixed base.
Paragraph 4 establishes the source of interest for purposes of Article XI. Interest
is considered to arise in a Contracting State if the payer is that State, or a political
subdivision, local authority, or resident of that State. However, in cases where the person
paying the interest, whether a resident of a Contracting State or of a third State, has in a
State other than that of which he is a resident a permanent establishment in connection
with which the indebtedness on which the interest was paid was incurred, and such
interest is borne by the permanent establishment, then such interest is deemed to arise in
the State in which the permanent establishment is situated and not in the State of the
payer's residence. Furthermore, pursuant to paragraphs 1 and 4, and Article XXII (Other
Income), Canadian tax will not be imposed on interest paid to a U.S. resident by a
company resident in Canada if the indebtedness is incurred in connection with, and the
interest is borne by, a permanent establishment of the company situated in a third State.
For the purposes of this Article, "borne by" means allowable as a deduction in computing
taxable income.
Paragraph 5 of Article XI
Paragraph 5 is identical to paragraph 7 of Article XI of the existing Convention.
Paragraph 5 provides that in cases involving special relationships between the
payer and the beneficial owner of interest income or between both of them and some
other person, Article XI applies only to that portion of the total interest payments that
would have been made absent such special relationships (i.e., an arm's-length interest
payment). Any excess amount of interest paid remains taxable according to the laws of
the United States and Canada, respectively, with due regard to the other provisions of the
Convention.
21

Paragraph 6 of Article XI
New paragraph 6 provides anti-abuse exceptions to exclusive residence State
taxation in paragraph 1 for two classes of interest payments.
The first class of interest, dealt with in subparagraphs 6(a) and 6(b), is so-called
"contingent interest." With respect to interest arising in the United States, subparagraph
6(a) refers to contingent interest of a type that does not qualify as portfolio interest under
U.S. domestic law. The cross-reference to the U.S. definition of contingent interest,
which is found in Code section 871(h)(4), is intended to ensure that the exceptions of
Code section 871(h)(4)(C) will apply. With respect to Canada, such interest is defined in
subparagraph 6(b) as any interest arising in Canada that is determined by reference to the
receipts, sales, income, profits or other cash flow of the debtor or a related person, to any
change in the value of any property of the debtor or a related person or to any dividend,
partnership distribution or similar payment made by the debtor or a related person.
1
Any
such interest may be taxed in Canada according to the laws of Canada.
Under subparagraph 6(a) or 6(b), if the beneficial owner is a resident of the other
Contracting State, the gross amount of the “contingent interest” may be taxed at a rate not
exceeding 15 percent.
The second class of interest is dealt with in subparagraph 6(c). This exception is
consistent with the policy of Code sections 860E(e) and 860G(b) that excess inclusions
with respect to a real estate mortgage investment conduit (REMIC) should bear full U.S.
tax in all cases. Without a full tax at source, foreign purchasers of residual interests
would have a competitive advantage over U.S. purchasers at the time these interests are
initially offered. Also, absent this rule, the U.S. fisc would suffer a revenue loss with
respect to mortgages held in a REMIC because of opportunities for tax avoidance created
by differences in the timing of taxable and economic income produced by these interests.
Therefore, subparagraph 6(c) provides a bilateral provision that interest that is an
excess inclusion with respect to a residual interest in a REMIC may be taxed by each
State in accordance with its domestic law. While the provision is written reciprocally, at
the time the Protocol was signed, the provision had no application in respect of Canadian-
source interest, as Canada did not have REMICs.
Paragraph 7 of Article XI
Paragraph 7 is in all material respects the same as paragraph 8 of Article XI of the
existing Convention. The only difference is that, consistent with the changes made in
Article 9 of the Protocol, paragraph 7 removes the references to a fixed base.
Paragraph 7 restricts the right of a Contracting State to impose tax on interest paid
by a resident of the other Contracting State. The first State may not impose any tax on
such interest except insofar as the interest is paid to a resident of that State or arises in
that State or the debt claim in respect of which the interest is paid is effectively connected
with a permanent establishment situated in that State.
New subparagraph 6(b) of Article XI erroneously refers to a “similar payment made by the debtor to a
related person.” The correct formulation, which the Contracting States agree to apply, is “similar payment
made by the debtor or a related person.”
22

1

Relationship to other Articles
Notwithstanding the foregoing limitations on source State taxation of interest, the
saving clause of paragraph 2 of Article XXIX (Miscellaneous Rules) permits the United
States to tax its residents and citizens, subject to the special foreign tax credit rules of
paragraph 5 of Article XXIV (Elimination of Double Taxation), as if the Convention had
not come into force.
Article 7
Article 7 of the Protocol amends Article XII (Royalties) of the existing
Convention. As with other benefits of the Convention, the benefits of Article XII are
available to a resident of a Contracting State only if that resident is entitled to those
benefits under the provisions of Article XXIX A (Limitation on Benefits).
See the Technical Explanation for new paragraphs 6 and 7 of Article IV
(Residence) for discussion regarding the interaction between domestic law concepts of
beneficial ownership and the treaty rules to determine when a person is considered to
derive an item of income for purposes of obtaining benefits of the Convention such as
withholding rate reductions.
Paragraph 1
Paragraph 1 of Article 7 of the Protocol replaces paragraph 5 of Article XII of the
Convention. In all material respects, new paragraph 5 is the same as paragraph 5 of
Article XII of the existing Convention. However, new paragraph 5 adds clarifying
language consistent with the changes made in Articles 4, 5, and 6 of the Protocol with
respect to income attributable to a permanent establishment that has ceased to exist. To
conform with Article 9 of the Protocol, which deletes Article XIV (Independent Personal
Services) of the Convention, paragraph 1 of Article 7 of the Protocol also amends
paragraph 5 of Article XII by omitting the reference to a “fixed base.”
New paragraph 5 provides that the 10 percent limitation on tax in the source State
provided by paragraph 2, and the exemption in the source State for certain royalties
provided by paragraph 3, do not apply if the beneficial owner of the royalties carries on
or has carried on business in the source State through a permanent establishment and the
right or property in respect of which the royalties are paid is attributable to such
permanent establishment. In such case, the royalty income would be taxable by the
source State under the provisions of Article VII (Business Profits).
Paragraph 2
Paragraph 2 of Article 7 of the Protocol sets forth a new subparagraph 6(a) of
Article XII that is in all material respects the same as subparagraph 6(a) of Article XII of
the existing Convention. The only difference is that, consistent with the changes made in
Article 9 of the Protocol, new subparagraph 6(a) omits references to a “fixed base.”
Paragraph 3
Paragraph 3 of Article 7 of Protocol amends paragraph 8 of Article XII of the
Convention to remove references to a “fixed base.” In addition, paragraph 8 of the
General Note confirms the intent of the Contracting States that the reference in
subparagraph 3(c) of Article XII of the Convention to information provided in connection
with a franchise agreement generally refers only to information that governs or otherwise
23

deals with the operation (whether by the payer or by another person) of the franchise, and
not to other information concerning industrial, commercial or scientific experience that is
held for resale or license.
Article 8
Paragraph 1
Paragraph 1 of Article 8 of the Protocol replaces paragraph 2 of Article XIII
(Gains) of the existing Convention. Consistent with Article 9 of the Protocol, new
paragraph 2 does not contain any reference to property pertaining to a fixed base or to the
performance of independent personal services.
New paragraph 2 of Article XIII provides that the Contracting State in which a
resident of the other Contracting State has or had a permanent establishment may tax
gains from the alienation of personal property constituting business property if such gains
are attributable to such permanent establishment. Unlike paragraph 1 of Article VII
(Business Profits), paragraph 2 limits the right of the source State to tax such gains to a
twelve-month period following the termination of the permanent establishment.
Paragraph 2
Paragraph 2 of Article 8 of the Protocol replaces paragraph 5 of Article XIII of
the existing Convention. In general, new paragraph 5 provides an exception to the
general rule stated in paragraph 4 that gains from the alienation of any property, other
than property referred to in paragraphs 1, 2, and 3, shall be taxable only in the
Contracting State of which the alienator is a resident. Paragraph 5 provides that a
Contracting State may, according to its domestic law, impose tax on gains derived by an
individual who is a resident of the other Contracting State if such individual was a
resident of the first-mentioned State for 120 months (whether or not consecutive) during
any period of 20 consecutive years preceding the alienation of the property, and was a
resident of that State at any time during the 10-year period immediately preceding the
alienation of the property. Further, the property (or property received in substitution in a
tax-free transaction in the first-mentioned State) must have been owned by the individual
at the time he ceased to be a resident of the first-mentioned State and must not have been
property that the individual was treated as having alienated by reason of ceasing to be a
resident of the first-mentioned State and becoming a resident of the other Contracting
State.
The provisions of new paragraph 5 are substantially similar to paragraph 5 of
Article XIII of the existing Convention. However, the Protocol adds a new requirement
to paragraph 5 that the property not be “a property that the individual was treated as
having alienated by reason of ceasing to be a resident of the first-mentioned State and
becoming a resident of the other Contracting State.” This new requirement reflects the
fact that the main purpose of paragraph 5 – ensuring that gains that accrue while an
individual is resident in a Contracting State remain taxable for the stated time after the
individual has moved to the other State – is met if that pre-departure gain is taxed in the
first State immediately before the individual’s emigration. This rule applies whether or
not the individual makes the election provided by paragraph 7 of Article XIII, as
amended, which is described below.
Paragraph 3
Paragraph 3 of Article 8 of the Protocol replaces paragraph 7 of Article XIII.
24

The purpose of paragraph 7, in both its former and revised form, is to provide a
rule to coordinate U.S. and Canadian taxation of gains in the case of a timing mismatch.
Such a mismatch may occur, for example, where a Canadian resident is deemed, for
Canadian tax purposes, to recognize capital gain upon emigrating from Canada to the
United States, or in the case of a gift that Canada deems to be an income producing event
for its tax purposes but with respect to which the United States defers taxation while
assigning the donor's basis to the donee. The former paragraph 7 resolved the timing
mismatch of taxable events by allowing the individual to elect to be liable to tax in the
deferring Contracting State as if he had sold and repurchased the property for an amount
equal to its fair market value at a time immediately prior to the deemed alienation.
The election under former paragraph 7 was not available to certain non-U.S.
citizens subject to tax in Canada by virtue of a deemed alienation because such
individuals could not elect to be liable to tax in the United States. To address this
problem, the Protocol replaces the election provided in former paragraph 7, with an
election by the taxpayer to be treated by a Contracting State as having sold and
repurchased the property for its fair market value immediately before the taxable event in
the other Contracting State. The election in new paragraph 7 therefore will be available
to any individual who emigrates from Canada to the United States, without regard to
whether the person is a U.S. citizen immediately before ceasing to be a resident of
Canada. If the individual is not subject to U.S. tax at that time, the effect of the election
will be to give the individual an adjusted basis for U.S. tax purposes equal to the fair
market value of the property as of the date of the deemed alienation in Canada, with the
result that only post-emigration gain will be subject to U.S. tax when there is an actual
alienation. If the Canadian resident is also a U.S. citizen at the time of his emigration
from Canada, then the provisions of new paragraph 7 would allow the U.S. citizen to
accelerate the tax under U.S. tax law and allow tax credits to be used to avoid double
taxation. This would also be the case if the person, while not a U.S. citizen, would
otherwise be subject to taxation in the United States on a disposition of the property.
In the case of Canadian taxation of appreciated property given as a gift, absent
paragraph 7, the donor could be subject to tax in Canada upon making the gift, and the
donee may be subject to tax in the United States upon a later disposition of the property
on all or a portion of the same gain in the property without the availability of any foreign
tax credit for the tax paid to Canada. Under new paragraph 7, the election will be
available to any individual who pays taxes in Canada on a gain arising from the
individual’s gifting of a property, without regard to whether the person is a U.S. taxpayer
at the time of the gift. The effect of the election in such case will be to give the donee an
adjusted basis for U.S. tax purposes equal to the fair market value as of the date of the
gift. If the donor is a U.S. taxpayer, the effect of the election will be the realization of
gain or loss for U.S. purposes immediately before the gift. The acceleration of the U.S.
tax liability by reason of the election in such case enables the donor to utilize foreign tax
credits and avoid double taxation with respect to the disposition of the property.
Generally, the rule does not apply in the case of death. Note, however, that
Article XXIX B (Taxes Imposed by Reason of Death) of the Convention provides rules
that coordinate the income tax that Canada imposes by reason of death with the U.S.
estate tax.
If in one Contracting State there are losses and gains from deemed alienations of
different properties, then paragraph 7 must be applied consistently in the other
Contracting State within the taxable period with respect to all such properties. Paragraph
7 only applies, however, if the deemed alienations of the properties result in a net gain.
25

Taxpayers may make the election provided by new paragraph 7 only with respect
to property that is subject to a Contracting State’s deemed disposition rules and with
respect to which gain on a deemed alienation is recognized for that Contracting State’s
tax purposes in the taxable year of the deemed alienation. At the time the Protocol was
signed, the following were the main types of property that were excluded from the
deemed disposition rules in the case of individuals (including trusts) who cease to be
residents of Canada: real property situated in Canada; interests and rights in respect of
pensions; life insurance policies (other than segregated fund (investment) policies); rights
in respect of annuities; interests in testamentary trusts, unless acquired for consideration;
employee stock options; property used in a business carried on through a permanent
establishment in Canada (including intangibles and inventory); interests in most Canadian
personal trusts; Canadian resource property; and timber resource property.
Paragraph 4
Consistent with the provisions of Article 9 of the Protocol, paragraph 4 of Article
8 of the Protocol amends subparagraph 9(c) of Article XIII of the existing Convention to
remove the words “or pertained to a fixed base.”
Relationship to other Articles
The changes to Article XIII set forth in paragraph 3 were announced in a press
release issued by the Treasury Department on September 18, 2000. Consistent with that
press release, subparagraph 3(e) of Article 27 of the Protocol provides that the changes,
jointly effectuated by paragraphs 2 and 3, will be generally effective for alienations of
property that occur after September 17, 2000.
Article 9
To conform with the current U.S. and OECD Model Conventions, Article 9 of the
Protocol deletes Article XIV (Independent Personal Services) of the Convention. The
subsequent articles of the Convention are not renumbered. Paragraph 4 of the General
Note elaborates that current tax treaty practice omits separate articles for independent
personal services because a determination of the existence of a fixed base is qualitatively
the same as the determination of the existence of a permanent establishment.
Accordingly, the taxation of income from independent personal services is adequately
governed by the provisions of Articles V (Permanent Establishment) and VII (Business
Profits).
Article 10
Article 10 of the Protocol renames Article XV of the Convention as “Income from
Employment” to conform with the current U.S. and OECD Model Conventions, and
replaces paragraphs 1 and 2 of that renamed article consistent with the OECD Model
Convention.
Paragraph 1
New paragraph 1 of Article XV provides that, in general, salaries, wages, and
other remuneration derived by a resident of a Contracting State in respect of an
employment are taxable only in that State unless the employment is exercised in the other
Contracting State. If the employment is exercised in the other Contracting State, the
26

entire remuneration derived therefrom may be taxed in that other State, subject to the
provisions of paragraph 2.
New paragraph 1 of Article XV does not contain a reference to "similar"
remuneration. This change was intended to clarify that Article XV applies to any form of
compensation for employment, including payments in kind. This interpretation is
consistent with paragraph 2.1 of the Commentary to Article 15 (Income from
Employment) of the OECD Model and the Technical Explanation of the 2006 U.S.
Model.
Paragraph 2
New paragraph 2 of Article XV provides two limitations on the right of a source
State to tax remuneration for services rendered in that State. New paragraph 2 is divided
into two subparagraphs that each sets forth a rule which, notwithstanding any contrary
result due to the application of paragraph 1 of Article XV, prevents the source State from
taxing income from employment in that State.
First, subparagraph 2(a) provides a safe harbor rule that the remuneration may not
be taxed in the source State if such remuneration is $10,000 or less in the currency of the
source State. This rule is identical to the rule in subparagraph 2(a) of Article XV of the
existing Convention. It is understood that, consistent with the prior rule, the safe harbor
will apply on a calendar-year basis.
Second, if the remuneration is not exempt from tax in the source State by virtue of
subparagraph 2(a), subparagraph 2(b) provides an additional rule that the source State
may not tax remuneration for services rendered in that State if the recipient is present in
the source State for a period (or periods) that does not exceed in the aggregate 183 days
in any twelve-month period commencing or ending in the fiscal year concerned, and the
remuneration is not paid by or on behalf of a person who is a resident of that other State
or borne by a permanent establishment in that other State. For purposes of this article,
"borne by" means allowable as a deduction in computing taxable income.
Assume, for example, that Mr. X, an individual resident in Canada, is an
employee of the Canadian permanent establishment of USCo, a U.S. company. Mr. X is
sent to the United States to perform services and is present in the United States for less
than 183 days. Mr. X receives more than $10,000 (U.S.) in the calendar year(s) in
question. The remuneration paid to Mr. X for such services is not exempt from U.S. tax
under paragraph 1, because his employer, USCo, is a resident of the United States and
pays his remuneration. If instead Mr. X received less than $10,000 (U.S.), such earnings
would be exempt from tax in the United States, because in all cases where an employee
earns less than $10,000 in the currency of the source State, such earnings are exempt
from tax in the source State.
As another example, assume Ms. Y, an individual resident in the United States is
employed by USCo, a U.S. company. Ms. Y is sent to Canada to provide services in the
Canadian permanent establishment of USCo. Ms. Y is present in Canada for less than
183 days. Ms. Y receives more than $10,000 (Canadian) in the calendar year(s) in
question. USCo charges the Canadian permanent establishment for Ms. Y’s
remuneration, which the permanent establishment takes as a deduction in computing its
taxable income. The remuneration paid to Ms. Y for such services is not exempt from
Canadian tax under paragraph 1, because her remuneration is borne by the Canadian
permanent establishment.
27

New subparagraph 2(b) refers to remuneration that is paid by or on behalf of a
“person” who is a resident of the other Contracting State, as opposed to an “employer.”
This change is intended only to clarify that both the United States and Canada understand
that in certain abusive cases, substance over form principles may be applied to
recharacterize an employment relationship, as prescribed in paragraph 8 of the
Commentary to Article 15 (Income from Employment) of the OECD Model.
Subparagraph 2(b) is intended to have the same meaning as the analogous provisions in
the U.S. and OECD Models.
Paragraph 6 of the General Note
Paragraph 6 of the General Note contains special rules regarding employee stock
options. There are no similar rules in the U.S. Model or the OECD Model, although the
issue is discussed in detail in paragraph 12 of the Commentary to Article 15 (Income
from Employment) of the OECD Model.
The General Note sets forth principles that apply for purposes of applying Article
XV and Article XXIV (Elimination of Double Taxation) to income of an individual in
connection with the exercise or other disposal (including a deemed exercise or disposal)
of an option that was granted to the individual as an employee of a corporation or mutual
fund trust to acquire shares or units (“securities”) of the employer in respect of services
rendered or to be rendered by such individual, or in connection with the disposal
(including a deemed disposal) of a security acquired under such an option. For this
purpose, the term “employer” is considered to include any entity related to the service
recipient. The reference to a disposal (or deemed disposal) reflects the fact that under
Canadian law and under certain provisions of U.S. law, income or gain attributable to the
granting or exercising of the option may, in some cases, not be recognized until
disposition of the securities.
Subparagraph 6(a) of the General Note provides a specific rule to address
situations where, under the domestic law of the Contracting States, an employee would
be taxable by both Contracting States in respect of the income in connection with the
exercise or disposal of the option. The rule provides an allocation of taxing rights where
(1) an employee has been granted a stock option in the course of employment in one of
the Contracting States, and (2) his principal place of employment has been situated in one
or both of the Contracting States during the period between grant and exercise (or
disposal) of the option. In this situation, each Contracting State may tax as Contracting
State of source only that proportion of the income that relates to the period or periods
between the grant and the exercise (or disposal) of the option during which the
individual’s principal place of employment was situated in that Contracting State. The
proportion attributable to a Contracting State is determined by multiplying the income by
a fraction, the numerator of which is the number of days between the grant and exercise
(or disposal) of the option during which the employee’s principal place of employment
was situated in that Contracting State and the denominator of which is the total number of
days between grant and exercise (or disposal) of the option that the employee was
employed by the employer.
If the individual is a resident of one of the Contracting States at the time he
exercises the option, that Contracting State will have the right, as the State of residence,
to tax all of the income under the first sentence of paragraph 1 of Article XV. However,
to the extent that the employee renders his employment in the other Contracting State for
some period of time between the date of the grant of the option and the date of the
exercise (or disposal) of the option, the proportion of the income that is allocated to the
other Contracting State under subparagraph 6(a) of the General Note will, subject to
28

paragraph 2, be taxable by that other State under the second sentence of paragraph 1 of
Article XV of the Convention. For this purpose, the tests of paragraph 2 of Article XV
are applied to the year or years in which the relevant services were performed in the other
Contracting State (and not to the year in which the option is exercised or disposed). To
the extent the same income is subject to taxation in both Contracting States after
application of Article XV, double taxation will be alleviated under the rules of Article
XXIV (Elimination of Double Taxation).
Subparagraph 6(b) of the General Note provides that notwithstanding
subparagraph 6(a), if the competent authorities of both Contracting States agree that the
terms of the option were such that the grant of the option is appropriately treated as
transfer of ownership of the securities (e.g., because the options were in-the-money or not
subject to a substantial vesting period), then they may agree to attribute income
accordingly.
Article 11
Consistent with Article 9 and paragraph 1 of Article 10 of the Protocol,
paragraphs 1, 2, and 3 of Article 11 of the Protocol revise paragraphs 1, 2, and 4 of
Article XVI (Artistes and Athletes) of the existing Convention by deleting references to
former Article XIV (Independent Personal Services) of the Convention and deleting and
replacing other language in acknowledgement of the renaming of Article XV (Income
from Employment).
Article 12
Article 12 of the Protocol deletes Article XVII (Withholding of Taxes in Respect
of Personal Services) from the Convention. However, the subsequent Articles are not
renumbered.
Article 13
Article 13 of the Protocol replaces paragraphs 3, 4, and 7 and adds paragraphs 8
through 17 to Article XVIII (Pensions and Annuities) of the Convention.
Paragraph 1
Roth IRAs
Paragraph 1 of Article 13 of the Protocol separates the provisions of paragraph 3
of Article XVIII into two subparagraphs. Subparagraph 3(a) contains the existing
definition of the term “pensions,” while subparagraph 3(b) adds a new rule to address the
treatment of Roth IRAs or similar plan (as described below).
Subparagraph 3(a) of Article XVIII provides that the term "pensions" for
purposes of the Convention includes any payment under a superannuation, pension, or
other retirement arrangement, Armed-Forces retirement pay, war veterans pensions and
allowances, and amounts paid under a sickness, accident, or disability plan, but does not
include payments under an income-averaging annuity contract (which are subject to
Article XXII (Other Income)) or social security benefits, including social security
benefits in respect of government services (which are subject to paragraph 5 of Article
XVIII). Thus, the term “pensions” includes pensions paid by private employers
(including pre-tax and Roth 401(k) arrangements) as well as any pension paid in respect
29

of government services. Further, the definition of “pensions” includes, for example,
payments from individual retirement accounts (IRAs) in the United States and from
registered retirement savings plans (RRSPs) and registered retirement income funds
(RRIFs) in Canada.
Subparagraph 3(b) of Article XVIII provides that the term “pensions” generally
includes a Roth IRA, within the meaning of Code section 408A (or a similar plan
described below). Consequently, under paragraph 1 of Article XVIII, distributions from a
Roth IRA to a resident of Canada generally continue to be exempt from Canadian tax to
the extent they would have been exempt from U.S. tax if paid to a resident of the United
States. In addition, residents of Canada generally may make an election under paragraph
7 of Article XVIII to defer any taxation in Canada with respect to income accrued in a
Roth IRA but not distributed by the Roth IRA, until such time as and to the extent that a
distribution is made from the Roth IRA or any plan substituted therefore. Because
distributions will be exempt from Canadian tax to the extent they would have been
exempt from U.S. tax if paid to a resident of the United States, the effect of these rules is
that, in most cases, no portion of the Roth IRA will be subject to taxation in Canada.
However, subparagraph 3(b) also provides that if an individual who is a resident
of Canada makes contributions to his or her Roth IRA while a resident of Canada, other
than rollover contributions from another Roth IRA (or a similar plan described below),
the Roth IRA will cease to be considered a pension at that time with respect to
contributions and accretions from such time and accretions from such time will be subject
to tax in Canada in the year of accrual. Thus, the Roth IRA will in effect be bifurcated
into a “frozen” pension that continues to be subject to the rules of Article XVIII and a
savings account that is not subject to the rules of Article XVIII. It is understood by the
Contracting States that, following a rollover contribution from a Roth 401(k) arrangement
to a Roth IRA, the Roth IRA will continue to be treated as a pension subject to the rules
of Article XVIII.
Assume, for example, that Mr. X moves to Canada on July 1, 2008. Mr. X has a
Roth IRA with a balance of 1,100 on July 1, 2008. Mr. X elects under paragraph 7 of
Article XVIII to defer any taxation in Canada with respect to income accrued in his Roth
IRA while he is a resident of Canada. Mr. X makes no additional contributions to his
Roth IRA until July 1, 2010, when he makes an after-tax contribution of 100. There are
accretions of 20 during the period July 1, 2008 through June 30, 2010, which are not
taxed in Canada by reason of the election under paragraph 7 of Article XVIII. There are
additional accretions of 50 during the period July 1, 2010 through June 30, 2015, which
are subject to tax in Canada in the year of accrual. On July 1, 2015, while Mr. X is still a
resident of Canada, Mr. X receives a lump-sum distribution of 1,270 from his Roth IRA.
The 1,120 that was in the Roth IRA on June 30, 2010 is treated as a distribution from a
pension plan that, pursuant to paragraph 1 of Article XVIII, is exempt from tax in Canada
provided it would be exempt from tax in the United States under the Internal Revenue
Code if paid to a resident of the United States. The remaining 150 comprises the after-
tax contribution of 100 in 2010 and accretions of 50 that were subject to Canadian tax in
the year of accrual.
The rules of new subparagraph 3(b) of Article XVIII also will apply to any plan
or arrangement created pursuant to legislation enacted by either Contracting State after
September 21, 2007 (the date of signature of the Protocol) that the competent authorities
agree is similar to a Roth IRA.
30

Source of payments under life insurance and annuity contracts
Paragraph 1 of Article 13 also replaces paragraph 4 of Article XVIII.
Subparagraph 4(a) contains the existing definition of annuity, while subparagraph 4(b)
adds a source rule to address the treatment of certain payments by branches of insurance
companies.
Subparagraph 4(a) provides that, for purposes of the Convention, the term
"annuity" means a stated sum paid periodically at stated times during life or during a
specified number of years, under an obligation to make the payments in return for
adequate and full consideration other than services rendered. The term does not include a
payment that is not periodic or any annuity the cost of which was deductible for tax
purposes in the Contracting State where the annuity was acquired. Items excluded from
the definition of "annuity" and not dealt with under another Article of the Convention are
subject to the rules of Article XXII (Other Income).
Under the existing Convention, payments under life insurance and annuity
contracts to a resident of Canada by a Canadian branch of a U.S. insurance company are
subject to either a 15-percent withholding tax under subparagraph 2(b) of Article XVIII
or, unless dealt with under another Article of the Convention, an unreduced 30-percent
withholding tax under paragraph 1 of Article XXII, depending on whether the payments
constitute annuities within the meaning of paragraph 4 of Article XVIII.
On July 12, 2004, the Internal Revenue Service issued Revenue Ruling 2004-75,
2004-2 C.B. 109, which provides in relevant part that annuity payments under, and
withdrawals of cash value from, life insurance or annuity contracts issued by a foreign
branch of a U.S. life insurance company are U.S.-source income that, when paid to a
nonresident alien individual, is generally subject to a 30-percent withholding tax under
Code sections 871(a) and 1441. Revenue Ruling 2004-97, 2004-2 C.B. 516, provided
that Revenue Ruling 2004-75 would not be applied to payments that were made before
January 1, 2005, provided that such payments were made pursuant to binding life
insurance or annuity contracts issued on or before July 12, 2004.
Under new subparagraph 4(b) of Article XVIII, an annuity or other amount paid
in respect of a life insurance or annuity contract (including a withdrawal in respect of the
cash value thereof), will generally be deemed to arise in the Contracting State where the
person paying the annuity or other amount (the “payer”) is resident. However, if the
payer, whether a resident of a Contracting State or not, has a permanent establishment in
a Contracting State other than a Contracting State in which the payer is a resident, the
payment will be deemed to arise in the Contracting State in which the permanent
establishment is situated if both of the following requirements are satisfied: (i) the
obligation giving rise to the annuity or other amount must have been incurred in
connection with the permanent establishment, and (ii) the annuity or other amount must
be borne by the permanent establishment. When these requirements are satisfied,
payments by a Canadian branch of a U.S. insurance company will be deemed to arise in
Canada.
Paragraph 2
Paragraph 2 of Article 13 of the Protocol replaces paragraph 7 of Article XVIII of
the existing Convention. Paragraph 7 continues to provide a rule with respect to the
taxation of a natural person on income accrued in a pension or employee benefit plan in
the other Contracting State. Thus, paragraph 7 applies where an individual is a citizen or
resident of a Contracting State and is a beneficiary of a trust, company, organization, or
31

other arrangement that is a resident of the other Contracting State, where such trust,
company, organization, or other arrangement is generally exempt from income taxation
in that other State, and is operated exclusively to provide pension, or employee benefits.
In such cases, the beneficiary may elect to defer taxation in his State of residence on
income accrued in the plan until it is distributed from the plan (or from another plan in
that other Contracting State to which the income is transferred pursuant to the domestic
law of that other Contracting State).
Paragraph 2 of Article 13 of the Protocol makes two changes to paragraph 7 of
Article XVIII of the existing Convention. The first change is that the phrase “pension,
retirement or employee benefits” is changed to “pension or employee benefits” solely to
reflect the fact that in certain cases, discussed above, Roth IRAs will not be treated as
pensions for purposes of Article XVIII. The second change is that “under” is changed to
“subject to” to make it clear that an election to defer taxation with respect to
undistributed income accrued in a plan may be made whether or not the competent
authority of the first-mentioned State has prescribed rules for making an election. For the
U.S. rules, see Revenue Procedure 2002-23, 2002-1 C.B. 744. As of the date the Protocol
was signed, the competent authority of Canada had not prescribed rules.
Paragraph 3
Paragraph 3 of Article 13 of the Protocol adds paragraphs 8 through 17 to Article
XVIII to deal with cross-border pension contributions. These paragraphs are intended to
remove barriers to the flow of personal services between the Contracting States that could
otherwise result from discontinuities in the laws of the Contracting States regarding the
deductibility of pension contributions. Such discontinuities may arise where a country
allows deductions or exclusions to its residents for contributions, made by them or on
their behalf, to resident pension plans, but does not allow deductions or exclusions for
payments made to plans resident in another country, even if the structure and legal
requirements of such plans in the two countries are similar.
There is no comparable set of rules in the OECD Model, although the issue is
discussed in detail in the Commentary to Article 18 (Pensions). The 2006 U.S. Model
deals with this issue in paragraphs 2 through 4 of Article 18 (Pension Funds).
Workers on short-term assignments in the other Contracting State
Paragraphs 8 and 9 of Article XVIII address the case of a short-term assignment
where an individual who is participating in a “qualifying retirement plan” (as defined in
paragraph 15 of Article XVIII) in one Contracting State (the “home State”) performs
services as an employee for a limited period of time in the other Contracting State (the
“host State”). If certain requirements are satisfied, contributions made to, or benefits
accrued under, the plan by or on behalf of the individual will be deductible or excludible
in computing the individual’s income in the host State. In addition, contributions made to
the plan by the individual’s employer will be allowed as a deduction in computing the
employer’s profits in the host State.
In order for paragraph 8 to apply, the remuneration that the individual receives
with respect to the services performed in the host State must be taxable in the host State.
This means, for example, that where the United States is the host State, paragraph 8
would not apply if the remuneration that the individual receives with respect to the
services performed in the United States is exempt from taxation in the United States
under Code section 893.
32

The individual also must have been participating in the plan, or in another similar
plan for which the plan was substituted, immediately before he began performing
services in the host State. The rule regarding a successor plan would apply if, for
example, the employer has been acquired by another corporation that replaces the
existing plan with its own plan, transferring membership in the old plan over into the new
plan.
In addition, the individual must not have been a resident (as determined under
Article IV (Residence)) of the host State immediately before he began performing
services in the host State. It is irrelevant for purposes of paragraph 8 whether the
individual becomes a resident of the host State while he performs services there. A
citizen of the United States who has been a resident of Canada may be entitled to benefits
under paragraph 8 if (a) he performs services in the United States for a limited period of
time and (b) he was a resident of Canada immediately before he began performing such
services.
Benefits are available under paragraph 8 only for so long as the individual has not
performed services in the host State for the same employer (or a related employer) for
more than 60 of the 120 months preceding the individual’s current taxable year. The
purpose of this rule is to limit the period of time for which the host State will be required
to provide benefits for contributions to a plan from which it is unlikely to be able to tax
the distributions. If the individual continues to perform services in the host State beyond
this time limit, he is expected to become a participant in a plan in the host State.
Canada’s domestic law provides preferential tax treatment for employer contributions to
foreign pension plans in respect of services rendered in Canada by short-term residents,
but such treatment ceases once the individual has been resident in Canada for at least 60
of the preceding 72 months.
The contributions and benefits must be attributable to services performed by the
individual in the host State, and must be made or accrued during the period in which the
individual performs those services. This rule prevents individuals who render services in
the host State for a very short period of time from making disproportionately large
contributions to home State plans in order to offset the tax liability associated with the
income earned in the host State. In the case where the United States is the host State,
contributions will be deemed to have been made on the last day of the preceding taxable
year if the payment is on account of such taxable year and is treated under U.S. law as a
contribution made on the last day of the preceding taxable year.
If an individual receives benefits in the host State with respect to contributions to
a plan in the home State, the services to which the contributions relate may not be taken
into account for purposes of determining the individual’s entitlement to benefits under
any trust, company, organization, or other arrangement that is a resident of the host State,
generally exempt from income taxation in that State and operated to provide pension or
retirement benefits. The purpose of this rule is to prevent double benefits for
contributions to both a home State plan and a host State plan with respect to the same
services. Thus, for example, an individual who is working temporarily in the United
States and making contributions to a qualifying retirement plan in Canada with respect to
services performed in the United States may not make contributions to an individual
retirement account (within the meaning of Code section 408(a)) in the United States with
respect to the same services.
Paragraph 8 states that it applies only to the extent that the contributions or
benefits would qualify for tax relief in the home State if the individual were a resident of
and performed services in that State. Thus, benefits would be limited in the same fashion
33

as if the individual continued to be a resident of the home State. However, paragraph 9
provides that if the host State is the United States and the individual is a citizen of the
United States, the benefits granted to the individual under paragraph 8 may not exceed
the benefits that would be allowed by the United States to its residents for contributions
to, or benefits otherwise accrued under, a generally corresponding pension or retirement
plan established in and recognized for tax purposes by the United States. Thus, the lower
of the two limits applies. This rule ensures that U.S. citizens working temporarily in the
United States and participating in a Canadian plan will not get more favorable U.S. tax
treatment than U.S. citizens participating in a U.S. plan.
Where the United States is the home State, the amount of contributions that may
be excluded from the employee’s income under paragraph 8 for Canadian purposes is
limited to the U.S. dollar amount specified in Code section 415 or the U.S. dollar amount
specified in Code section 402(g)(1) to the extent contributions are made from the
employee’s compensation. For this purpose, the dollar limit specified in Code section
402(g)(1) means the amount applicable under Code section 402(g)(1) (including the age
50 catch-up amount in Code section 402(g)(1)(C)) or, if applicable, the parallel dollar
limit applicable under Code section 457(e)(15) plus the age 50 catch-up amount under
Code section 414(v)(2)(B)(i) for a Code section 457(g) trust.
Where Canada is the home State, the amount of contributions that may be excluded
from the employee’s income under paragraph 8 for U.S. purposes is subject to the
limitations specified in subsections 146(5), 147(8), 147.1(8) and (9) and 147.2(1) and (4)
of the Income Tax Act and paragraph 8503(4)(a) of the Income Tax Regulations, as
applicable. If the employee is a citizen of the United States, then the amount of
contributions that may be excluded is the lesser of the amounts determined under the
limitations specified in the previous sentence and the amounts specified in the previous
paragraph.
The provisions described above provide benefits to employees. Paragraph 8 also
provides that contributions made to the home State plan by an individual’s employer will
be allowed as a deduction in computing the employer’s profits in the host State, even
though such a deduction might not be allowable under the domestic law of the host State.
This rule applies whether the employer is a resident of the host State or a permanent
establishment that the employer has in the host State. The rule also applies to
contributions by a person related to the individual’s employer, such as contributions by a
parent corporation for its subsidiary, that are treated under the law of the host State as
contributions by the individual’s employer. For example, if an individual who is
participating in a qualifying retirement plan in Canada performs services for a limited
period of time in the United States for a U.S. subsidiary of a Canadian company, a
contribution to the Canadian plan by the parent company in Canada that is treated under
U.S. law as a contribution by the U.S. subsidiary would be covered by the rule.
The amount of the allowable deduction is to be determined under the laws of the
home State. Thus, where the United States is the home State, the amount of the
deduction that is allowable in Canada will be subject to the limitations of Code section
404 (including the Code section 401(a)(17) and 415 limitations). Where Canada is the
home State, the amount of the deduction that is allowable in the United States is subject
to the limitations specified in subsections 147(8), 147.1(8) and (9) and 147.2(1) of the
Income Tax Act, as applicable.
34

Cross-border commuters
Paragraphs 10, 11, and 12 of Article XVIII address the case of a commuter who is
a resident of one Contracting State (the “residence State”) and performs services as an
employee in the other Contracting State (the “services State”) and is a member of a
“qualifying retirement plan” (as defined in paragraph 15 of Article XVIII) in the services
State. If certain requirements are satisfied, contributions made to, or benefits accrued
under, the qualifying retirement plan by or on behalf of the individual will be deductible
or excludible in computing the individual’s income in the residence State.
In order for paragraph 10 to apply, the individual must perform services as an
employee in the services State the remuneration from which is taxable in the services
State and is borne by either an employer who is a resident of the services State or by a
permanent establishment that the employer has in the services State. The contributions
and benefits must be attributable to those services and must be made or accrued during
the period in which the individual performs those services. In the case where the United
States is the residence State, contributions will be deemed to have been made on the last
day of the preceding taxable year if the payment is on account of such taxable year and is
treated under U.S. law as a contribution made on the last day of the preceding taxable
year.
Paragraph 10 states that it applies only to the extent that the contributions or
benefits qualify for tax relief in the services State. Thus, the benefits granted in the
residence State are available only to the extent that the contributions or benefits accrued
qualify for relief in the services State. Where the United States is the services State, the
amount of contributions that may be excluded under paragraph 10 is the U.S. dollar
amount specified in Code section 415 or the U.S. dollar amount specified in Code section
402(g)(1) (as defined above) to the extent contributions are made from the employee’s
compensation. Where Canada is the services State, the amount of contributions that may
be excluded from the employee’s income under paragraph 10 is subject to the limitations
specified in subsections 146(5), 147(8), 147.1(8) and (9) and 147.2(1) and (4) of the
Income Tax Act and paragraph 8503(4)(a) of the Income Tax Regulations, as applicable.
However, paragraphs 11 and 12 further provide that the benefits granted under
paragraph 10 by the residence State may not exceed certain benefits that would be
allowable under the domestic law of the residence State.
Paragraph 11 provides that where Canada is the residence State, the amount of
contributions otherwise allowable as a deduction under paragraph 10 may not exceed the
individual’s deduction limit for contributions to registered retirement savings plans
(RRSPs) remaining after taking into account the amount of contributions to RRSPs
deducted by the individual under the law of Canada for the year. The amount deducted
by the individual under paragraph 10 will be taken into account in computing the
individual’s deduction limit for subsequent taxation years for contributions to RRSPs.
This rule prevents double benefits for contributions to both an RRSP and a qualifying
retirement plan in the United States with respect to the same services.
Paragraph 12 provides that if the United States is the residence State, the benefits
granted to an individual under paragraph 10 may not exceed the benefits that would be
allowed by the United States to its residents for contributions to, or benefits otherwise
accrued under, a generally corresponding pension or retirement plan established in and
recognized for tax purposes by the United States. For purposes of determining an
individual’s eligibility to participate in and receive tax benefits with respect to a pension
or retirement plan or other retirement arrangement in the United States, contributions
35

made to, or benefits accrued under, a qualifying retirement plan in Canada by or on
behalf of the individual are treated as contributions or benefits under a generally
corresponding pension or retirement plan established in and recognized for tax purposes
by the United States. Thus, for example, the qualifying retirement plan in Canada would
be taken into account for purposes of determining whether the individual is an “active
participant” within the meaning of Code section 219(g)(5), with the result that the
individual’s ability to make deductible contributions to an individual retirement account
in the United States would be limited.
Paragraph 10 does not address employer deductions because the employer is
located in the services State and is already eligible for deductions under the domestic law
of the services State.
U.S. citizens resident in Canada
Paragraphs 13 and 14 of Article XVIII address the special case of a U.S. citizen
who is a resident of Canada (as determined under Article IV (Residence)) and who
performs services as an employee in Canada and participates in a qualifying retirement
plan (as defined in paragraph 15 of Article XVIII) in Canada. If certain requirements are
satisfied, contributions made to, or benefits accrued under, a qualifying retirement plan in
Canada by or on behalf of the U.S. citizen will be deductible or excludible in computing
his or her taxable income in the United States. These provisions are generally consistent
with paragraph 4 of Article 18 of the U.S. Model treaty.
In order for paragraph 13 to apply, the U.S. citizen must perform services as an
employee in Canada the remuneration from which is taxable in Canada and is borne by
an employer who is a resident of Canada or by a permanent establishment that the
employer has in Canada. The contributions and benefits must be attributable to those
services and must be made or accrued during the period in which the U.S. citizen
performs those services. Contributions will be deemed to have been made on the last day
of the preceding taxable year if the payment is on account of such taxable year and is
treated under U.S. law as a contribution made on the last day of the preceding taxable
year.
Paragraph 13 states that it applies only to the extent the contributions or benefits
qualify for tax relief in Canada. However, paragraph 14 provides that the benefits
granted under paragraph 13 may not exceed the benefits that would be allowed by the
United States to its residents for contributions to, or benefits otherwise accrued under, a
generally corresponding pension or retirement plan established in and recognized for tax
purposes by the United States. Thus, the lower of the two limits applies. This rule
ensures that a U.S. citizen living and working in Canada does not receive better U.S.
treatment than a U.S. citizen living and working in the United States. The amount of
contributions that may be excluded from the employee’s income under paragraph 13 is
the U.S. dollar amount specified in Code section 415 or the U.S. dollar amount specified
in Code section 402(g)(1) (as defined above) to the extent contributions are made from
the employee’s compensation. In addition, pursuant to Code section 911(d)(6), an
individual may not claim benefits under paragraph 13 with respect to services the
remuneration for which is excluded from the individual’s gross income under Code
section 911(a).
For purposes of determining the individual’s eligibility to participate in and
receive tax benefits with respect to a pension or retirement plan or other retirement
arrangement established in and recognized for tax purposes by the United States,
contributions made to, or benefits accrued under, a qualifying retirement plan in Canada
36

by or on behalf of the individual are treated as contributions or benefits under a generally
corresponding pension or retirement plan established in and recognized for tax purposes
by the United States. Thus, for example, the qualifying retirement plan in Canada would
be taken into account for purposes of determining whether the individual is an “active
participant” within the meaning of Code section 219(g)(5), with the result that the
individual’s ability to make deductible contributions to an individual retirement account
in the United States would be limited.
Paragraph 13 does not address employer deductions because the employer is
located in Canada and is already eligible for deductions under the domestic law of
Canada.
Definition of “qualifying retirement plan”
Paragraph 15 of Article XVIII provides that for purposes of paragraphs 8 through
14, a “qualifying retirement plan” in a Contracting State is a trust, company,
organization, or other arrangement that (a) is a resident of that State, generally exempt
from income taxation in that State and operated primarily to provide pension or
retirement benefits; (b) is not an individual arrangement in respect of which the
individual’s employer has no involvement; and (c) the competent authority of the other
Contracting State agrees generally corresponds to a pension or retirement plan
established in and recognized for tax purposes in that State. Thus, U.S. individual
retirement accounts (IRAs) and Canadian registered retirement savings plans (RRSPs) are
not treated as qualifying retirement plans unless addressed in paragraph 10 of the General
Note (as discussed below). In addition, a Canadian retirement compensation arrangement
(RCA) is not a qualifying retirement plan because it is not considered to be generally
exempt from income taxation in Canada.
Paragraph 10 of the General Note provides that the types of Canadian plans that
constitute qualifying retirement plans for purposes of paragraph 15 include the following
and any identical or substantially similar plan that is established pursuant to legislation
introduced after the date of signature of the Protocol (September 21, 2007): registered
pension plans under section 147.1 of the Income Tax Act, registered retirement savings
plans under section 146 that are part of a group arrangement described in subsection
204.2(1.32), deferred profit sharing plans under section 147, and any registered
retirement savings plan under section 146, or registered retirement income fund under
section 146.3, that is funded exclusively by rollover contributions from one or more of
the preceding plans.
Paragraph 10 of the General Note also provides that the types of U.S. plans that
constitute qualifying retirement plans for purposes of paragraph 15 include the following
and any identical or substantially similar plan that is established pursuant to legislation
introduced after the date of signature of the Protocol (September 21, 2007): qualified
plans under Code section 401(a) (including Code section 401(k) arrangements),
individual retirement plans that are part of a simplified employee pension plan that
satisfies Code section 408(k), Code section 408(p) simple retirement accounts, Code
section 403(a) qualified annuity plans, Code section 403(b) plans, Code section 457(g)
trusts providing benefits under Code section 457(b) plans, the Thrift Savings Fund (Code
section 7701(j)), and any individual retirement account under Code section 408(a) that is
funded exclusively by rollover contributions from one or more of the preceding plans.
If a particular plan in one Contracting State is of a type specified in paragraph 10
of the General Note with respect to paragraph 15 of Article XVIII, it will not be
necessary for taxpayers to obtain a determination from the competent authority of the
37

other Contracting State that the plan generally corresponds to a pension or retirement
plan established in and recognized for tax purposes in that State. A taxpayer who
believes a particular plan in one Contracting State that is not described in paragraph 10 of
the General Note nevertheless satisfies the requirements of paragraph 15 may request a
determination from the competent authority of the other Contracting State that the plan
generally corresponds to a pension or retirement plan established in and recognized for
tax purposes in that State. In the case of the United States, such a determination must be
requested under Revenue Procedure 2006-54, 2006-49 I.R.B. 655 (or any applicable
analogous provision). In the case of Canada, the current version of Information Circular
71-17 provides guidance on obtaining assistance from the Canadian competent authority.
Source rule
Paragraph 16 of Article XVIII provides that a distribution from a pension or
retirement plan that is reasonably attributable to a contribution or benefit for which a
benefit was allowed pursuant to paragraph 8, 10, or 13 of Article XVIII will be deemed to
arise in the Contracting State in which the plan is established. This ensures that the
Contracting State in which the plan is established will have the right to tax the gross
amount of the distribution under subparagraph 2(a) of Article XVIII, even if a portion of
the services to which the distribution relates were not performed in such Contracting
State.
Partnerships
Paragraph 17 of Article XVIII provides that paragraphs 8 through 16 of Article
XVIII apply, with such modifications as the circumstances require, as though the
relationship between a partnership that carries on a business, and an individual who is a
member of the partnership, were that of employer and employee. This rule is needed
because paragraphs 8, 10, and 13, by their terms, apply only with respect to contributions
made to, or benefits accrued under, qualifying retirement plans by or on behalf of
individuals who perform services as an employee. Thus, benefits are not available with
respect to retirement plans for self-employed individuals, who may be deemed under U.S.
law to be employees for certain pension purposes. Paragraph 17 ensures that partners
participating in a plan established by their partnership may be eligible for the benefits
provided by paragraphs 8, 10, and 13.
Relationship to other Articles
Paragraphs 8, 10, and 13 of Article XVIII are not subject to the saving clause of
paragraph 2 of Article XXIX (Miscellaneous Rules) by reason of the exception in
subparagraph 3(a) of Article XXIX.
Article 14
Consistent with Articles 9 and 10 of the Protocol, Article 14 of the Protocol
amends Article XIX (Government Service) of the Convention by deleting the reference to
“Article XIV (Independent Personal Services)” and replacing such reference with the
reference to “Article VII (Business Profits)” and by reflecting the new name of Article
XV (Income from Employment).
Article 15
Article 15 of the Protocol replaces Article XX (Students) of the Convention.
Article XX provides rules for host-country taxation of visiting students and business
38

trainees. Persons who meet the tests of Article XX will be exempt from tax in the State
that they are visiting with respect to designated classes of income. Several conditions
must be satisfied in order for an individual to be entitled to the benefits of this Article.
First, the visitor must have been, either at the time of his arrival in the host State
or immediately before, a resident of the other Contracting State.
Second, the purpose of the visit must be the full-time education or training of the
visitor. Thus, if the visitor comes principally to work in the host State but also is a part-
time student, he would not be entitled to the benefits of this Article, even with respect to
any payments he may receive from abroad for his maintenance or education, and
regardless of whether or not he is in a degree program. Whether a student is to be
considered full-time will be determined by the rules of the educational institution at
which he is studying.
The host State exemption in Article XX applies to payments received by the
student or business trainee for the purpose of his maintenance, education or training that
arise outside the host State. A payment will be considered to arise outside the host State
if the payer is located outside the host State. Thus, if an employer from one of the
Contracting States sends an employee to the other Contracting State for full-time training,
the payments the trainee receives from abroad from his employer for his maintenance or
training while he is present in the host State will be exempt from tax in the host State.
Where appropriate, substance prevails over form in determining the identity of the payer.
Thus, for example, payments made directly or indirectly by a U.S. person with whom the
visitor is training, but which have been routed through a source outside the United States
(e.g., a foreign subsidiary), are not treated as arising outside the United States for this
purpose.
In the case of an apprentice or business trainee, the benefits of Article XX will
extend only for a period of one year from the time that the individual first arrives in the
host country for the purpose of the individual’s training. If, however, an apprentice or
trainee remains in the host country for a second year, thus losing the benefits of the Arti-
cle, he would not retroactively lose the benefits of the Article for the first year.
Relationship to other Articles
The saving clause of paragraph 2 of Article XXIX (Miscellaneous Rules) does not
apply to Article XX with respect to an individual who neither is a citizen of the host State
nor has been admitted for permanent residence there. The saving clause, however, does
apply with respect to citizens and permanent residents of the host State. Thus, a U.S.
citizen who is a resident of Canada and who visits the United States as a full-time student
at an accredited university will not be exempt from U.S. tax on remittances from abroad
that otherwise constitute U.S. taxable income. However, an individual who is not a U.S.
citizen, and who visits the United States as a student and remains long enough to become
a resident under U.S. law, but does not become a permanent resident (i.e., does not
acquire a green card), will be entitled to the full benefits of the Article.
Article 16
Article 16 of the Protocol revises Article XXI (Exempt Organizations) of the
existing Convention.
39

Paragraph 1
Paragraph 1 amends Article XXI by renumbering paragraphs 4, 5, and 6 as 5, 6,
and 7, respectively.
Paragraph 2
Paragraph 2 replaces paragraphs 1 through 3 of Article XXI with four new
paragraphs. In general, the provisions of former paragraphs 1 through 3 have been
retained.
New paragraph 1 provides that a religious, scientific, literary, educational, or
charitable organization resident in a Contracting State shall be exempt from tax on
income arising in the other Contracting State but only to the extent that such income is
exempt from taxation in the Contracting State in which the organization is resident.
New paragraph 2 retains the provisions of former subparagraph 2(a), and provides
that a trust, company, organization, or other arrangement that is resident in a Contracting
State and operated exclusively to administer or provide pension, retirement or employee
benefits or benefits for the self-employed under one or more funds or plans established to
provide pension or retirement benefits or other employee benefits is exempt from taxation
on dividend and interest income arising in the other Contracting State in a taxable year, if
the income of such organization or other arrangement is generally exempt from taxation
for that year in the Contracting State in which it is resident.
New paragraph 3 replaces and expands the scope of former subparagraph 2(b)
Former subparagraph 2(b) provided that, subject to the provisions of paragraph 3 (new
paragraph 4), a trust, company, organization or other arrangement that was a resident of a
Contracting State, generally exempt from income taxation in that State and operated
exclusively to earn income for the benefit of one or more organizations described in
subparagraph 2(a) (new paragraph 2) was exempt from taxation on dividend and interest
income arising in the other Contracting State in a taxable year. The Internal Revenue
Service concluded in private letter rulings (PLR 200111027 and PLR 200111037) that a
pooled investment fund that included as investors one or more organizations described in
paragraph 1 could not qualify for benefits under former subparagraph 2(b). New
paragraph 3 now allows organizations described in paragraph 1 to invest in pooled funds
with trusts, companies, organizations, or other arrangements described in new paragraph
2.
Former subparagraph 2(b) did not exempt income earned by a trust, company or
other arrangement for the benefit of religious, scientific, literary, educational or charitable
organizations exempt from tax under paragraph 1. Therefore, the Protocol expands the
scope of paragraph 3 to include such income.
As noted above with respect to Article X (Dividends), paragraph 3 of the General
Note explains that distributions from Canadian income trusts and royalty trusts that are
treated as dividends as a result of changes to Canada’s law regarding taxation of income
and royalty trusts shall be treated as dividends for the purposes of Article X.
Accordingly, such distributions will also be entitled to the benefits of Article XXI.
New paragraph 4 replaces paragraph 3 and provides that the exemptions provided
by paragraphs 1, 2, 3 do not apply with respect to the income of a trust, company,
organization or other arrangement from carrying on a trade or business or from a related
40

person, other than a person referred to in paragraph 1, 2 or 3. The term “related person”
is not necessarily defined by paragraph 2 of Article IX (Related Person).
Article 17
Article 17 of the Protocol amends Article XXII (Other Income) of the Convention
by adding a new paragraph 4. Article XXII generally assigns taxing jurisdiction over
income not dealt with in the other articles (Articles VI through XXI) of the Convention.
New paragraph 4 provides a specific rule for residence State taxation of
compensation derived in respect of a guarantee of indebtedness. New paragraph 4
provides that compensation derived by a resident of a Contracting State in respect of the
provision of a guarantee of indebtedness shall be taxable only in that State, unless the
compensation is business profits attributable to a permanent establishment situated in the
other Contracting State, in which case the provisions of Article VII (Business Profits)
shall apply. The clarification that Article VII shall apply when the compensation is
considered business profits was included at the request of the United States.
Compensation paid to a financial services entity to provide a guarantee in the ordinary
course of its business of providing such guarantees to customers constitutes business
profits dealt with under the provisions of Article VII. However, provision of guarantees
with respect to debt of related parties is ordinarily not an independent economic
undertaking that would generate business profits, and thus compensation in respect of
such related-party guarantees is, in most cases, covered by Article XXII.
Article 18
Article 18 of the Protocol amends paragraph 2 of Article XXIII (Capital) of the
Convention by deleting language contained in that paragraph consistent with the changes
made by Article 9 of the Protocol.
Article 19
Article 19 of the Protocol deletes subparagraph 2(b) of Article XXIV (Elimination
of Double Taxation) of the Convention and replaces it with a new subparagraph.
New subparagraph 2(b) allows a Canadian company receiving a dividend from a
U.S. resident company of which it owns at least 10 percent of the voting stock, a credit
against Canadian income tax of the appropriate amount of income tax paid or accrued to
the United States by the dividend paying company with respect to the profits out of which
the dividends are paid. The third Protocol to the Convention, signed March 17, 1995, had
amended subparagraph (b) to allow a Canadian company to deduct in computing its
Canadian taxable income any dividend received by it out of the exempt surplus of a
foreign affiliate which is a resident of the United States. This change is consistent with
current Canadian tax treaty practice: it does not indicate any present intention to change
Canada’s “exempt surplus” rules, and those rules remain in effect.
Article 20
Article 20 of the Protocol revises Article XXV (Non-Discrimination) of the
existing Convention to bring that Article into closer conformity to U.S. tax treaty policy.
41

Paragraphs 1 and 2
Paragraph 1 replaces paragraph 1 of Article XXV of the existing Convention.
New paragraph 1 provides that a national of one Contracting State may not be subject to
taxation or connected requirements in the other Contracting State that are more
burdensome than the taxes and connected requirements imposed upon a national of that
other State in the same circumstances. The OECD Model would prohibit taxation that is
"other than or more burdensome" than that imposed on U.S. persons. Paragraph 1 omits
the words "other than or" because the only relevant question under this provision should
be whether the requirement imposed on a national of the other Contracting State is more
burdensome. A requirement may be different from the requirements imposed on U.S.
nationals without being more burdensome.
The term "national" in relation to a Contracting State is defined in subparagraph
1(k) of Article III (General Definitions). The term includes both individuals and juridical
persons. A national of a Contracting State is afforded protection under this paragraph
even if the national is not a resident of either Contracting State. Thus, a U.S. citizen who
is resident in a third country is entitled, under this paragraph, to the same treatment in
Canada as a national of Canada in the same or similar circumstances (i.e., one who is
resident in a third State).
Whether or not the two persons are both taxable on worldwide income is a
significant circumstance for this purpose. For this reason, paragraph 1 specifically refers
to taxation or any requirement connected therewith, particularly with respect to taxation
on worldwide income, as relevant circumstances. This language means that the United
States is not obliged to apply the same taxing regime to a national of Canada who is not
resident in the United States as it applies to a U.S. national who is not resident in the
United States. U.S. citizens who are not resident in the United States but who are,
nevertheless, subject to U.S. tax on their worldwide income are not in the same
circumstances with respect to U.S. taxation as citizens of Canada who are not U.S.
residents. Thus, for example, Article XXV would not entitle a national of Canada
residing in a third country to taxation at graduated rates on U.S.-source dividends or other
investment income that applies to a U.S. citizen residing in the same third country.
Because of the increased coverage of paragraph 1 with respect to the treatment of
nationals wherever they are resident, paragraph 2 of this Article no longer has
application, and therefore has been omitted.
Paragraph 3
Paragraph 3 makes changes to renumbered paragraph 3 of Article XXV in order
to conform with Article 10 of the Protocol by deleting the reference to “Article XV
(Dependent Personal Services)” and replacing it with a reference to “Article XV (Income
from Employment).”
Article 21
Paragraph 1 of Article 21 of the Protocol replaces paragraph 6 of Article XXVI
(Mutual Agreement Procedure) of the Convention with new paragraphs 6 and 7. New
paragraphs 6 and 7 provide a mandatory binding arbitration proceeding (Arbitration
Proceeding). The Arbitration Note details additional rules and procedures that apply to a
case considered under the arbitration provisions.
42

New paragraph 6 provides that a case shall be resolved through arbitration when
the competent authorities have endeavored but are unable through negotiation to reach a
complete agreement regarding a case and the following three conditions are satisfied.
First, tax returns have been filed with at least one of the Contracting States with respect
to the taxable years at issue in the case. Second, the case (i) involves the application of
one or more Articles that the competent authorities have agreed in an exchange of notes
shall be the subject of arbitration and is not a case that the competent authorities agree
before the date on which an Arbitration Proceeding would otherwise have begun, is not
suitable for determination by arbitration; or (ii) is a case that the competent authorities
agree is suitable for determination by arbitration. Third, all concerned persons and their
authorized representatives agree, according to the provisions of subparagraph 7(d), not to
disclose to any other person any information received during the course of the Arbitration
Proceeding from either Contracting State or the arbitration board, other than the
determination of the board (confidentiality agreement). The confidentiality agreement
may also be executed by any concerned person that has the legal authority to bind any
other concerned person on the matter. For example, a parent corporation with the legal
authority to bind its subsidiary with respect to confidentiality may execute a
comprehensive confidentiality agreement on its own behalf and that of its subsidiary.
The United States and Canada have agreed in the Arbitration Note to submit cases
regarding the application of one or more of the following Articles to mandatory binding
arbitration under the provisions of paragraphs 6 and 7 of Article XXVI: IV (Residence),
but only insofar as it relates to the residence of a natural person, V (Permanent
Establishment), VII (Business Profits), IX (Related Persons), and XII (Royalties) (but
only (i) insofar as Article XII might apply in transactions involving related persons to
whom Article IX might apply, or (ii) to an allocation of amounts between royalties that
are taxable under paragraph 2 thereof and royalties that are exempt under paragraph 3
thereof). The competent authorities may, however, agree, before the date on which an
Arbitration Proceeding would otherwise have begun, that a particular case is not suitable
for arbitration.
New paragraph 7 provides six subparagraphs that detail the general rules and
definitions to be used in applying the arbitration provisions.
Subparagraph 7(a) provides that the term “concerned person” means the person
that brought the case to competent authority for consideration under Article XXVI
(Mutual Agreement Procedure) and includes all other persons, if any, whose tax liability
to either Contracting State may be directly affected by a mutual agreement arising from
that consideration. For example, a concerned person does not only include a U.S.
corporation that brings a transfer pricing case with respect to a transaction entered into
with its Canadian subsidiary for resolution to the U.S. competent authority, but also the
Canadian subsidiary, which may have a correlative adjustment as a result of the
resolution of the case.
Subparagraph 7(c) provides that an Arbitration Proceeding begins on the later of
two dates: two years from the “commencement date” of the case (unless the competent
authorities have previously agreed to a different date), or the earliest date upon which all
concerned persons have entered into a confidentiality agreement and the agreements have
been received by both competent authorities. The “commencement date” of the case is
defined by subparagraph 7(b) as the earliest date the information necessary to undertake
substantive consideration for a mutual agreement has been received by both competent
authorities.
43

Paragraph 16 of the Arbitration Note provides that each competent authority will
confirm in writing to the other competent authority and to the concerned persons the date
of its receipt of the information necessary to undertake substantive consideration for a
mutual agreement. In the case of the United States, this information is (i) the information
that must be submitted to the U.S. competent authority under Section 4.05 of Rev. Proc.
2006-54, 2006-49 I.R.B. 1035 (or any applicable successor publication), and (ii) for cases
initially submitted as a request for an Advance Pricing Agreement, the information that
must be submitted to the Internal Revenue Service under Rev. Proc. 2006-9, 2006-2
I.R.B. 278 (or any applicable successor publication). In the case of Canada, this
information is the information required to be submitted to the Canadian competent
authority under Information Circular 71-17 (or any applicable successor publication).
The information shall not be considered received until both competent authorities have
received copies of all materials submitted to either Contracting State by the concerned
person(s) in connection with the mutual agreement procedure. It is understood that
confirmation of the “information necessary to undertake substantive consideration for a
mutual agreement” is envisioned to ordinarily occur within 30 days after the necessary
information is provided to the competent authority.
The Arbitration Note also provides for several procedural rules once an
Arbitration Proceeding under paragraph 6 of Article XXVI (“Proceeding”) has
commenced, but the competent authorities may modify or supplement these rules as
necessary. In addition, the arbitration board may adopt any procedures necessary for the
conduct of its business, provided the procedures are not inconsistent with any provision
of Article XXVI of the Convention.
Paragraph 5 of the Arbitration Note provides that each Contracting State has 60
days from the date on which the Arbitration Proceeding begins to send a written
communication to the other Contracting State appointing one member of the arbitration
board. Within 60 days of the date the second of such communications is sent, these two
board members will appoint a third member to serve as the chair of the board. It is
agreed that this third member ordinarily should not be a citizen of either of the
Contracting States.
In the event that any members of the board are not appointed (including as a result
of the failure of the two members appointed by the Contracting States to agree on a third
member) by the requisite date, the remaining members are appointed by the highest
ranking member of the Secretariat at the Centre for Tax Policy and Administration of the
Organisation for Economic Co-operation and Development (OECD) who is not a citizen
of either Contracting State, by written notice to both Contracting States within 60 days of
the date of such failure.
Paragraph 7 of the Arbitration Note establishes deadlines for submission of
materials by the Contracting States to the arbitration board. Each competent authority
has 60 days from the date of appointment of the chair to submit a Proposed Resolution
describing the proposed disposition of the specific monetary amounts of income, expense
or taxation at issue in the case, and a supporting Position Paper. Copies of each State’s
submissions are to be provided by the board to the other Contracting State on the date the
later of the submissions is submitted to the board. Each of the Contracting States may
submit a Reply Submission to the board within 120 days of the appointment of the chair
to address points raised in the other State’s Proposed Resolution or Position Paper. If one
Contracting State fails to submit a Proposed Resolution within the requisite time, the
Proposed Resolution of the other Contracting State is deemed to be the determination of
the arbitration board. Additional information may be supplied to the arbitration board by
a Contracting State only at the request of the arbitration board. The board will provide
44

copies of any such requested information, along with the board’s request, to the other
Contracting State on the date the request is made or the response is received.
All communication with the board is to be in writing between the chair of the
board and the designated competent authorities with the exception of communication
regarding logistical matters.
In making its determination, the arbitration board will apply the following
authorities as necessary: (i) the provisions of the Convention, (ii) any agreed
commentaries or explanation of the Contracting States concerning the Convention as
amended, (iii) the laws of the Contracting States to the extent they are not inconsistent
with each other, and (iv) any OECD Commentary, Guidelines or Reports regarding
relevant analogous portions of the OECD Model Tax Convention.
The arbitration board must deliver a determination in writing to the Contracting
States within six months of the appointment of the chair. The determination must be one
of the two Proposed Resolutions submitted by the Contracting States. The determination
shall provide a determination regarding only the amount of income, expense or tax
reportable to the Contracting States. The determination has no precedential value and
consequently the rationale behind a board’s determination would not be beneficial and
shall not be provided by the board.
Paragraph 11 of the Arbitration Note provides that, unless any concerned person
does not accept the decision of the arbitration board, the determination of the board
constitutes a resolution by mutual agreement under Article XXVI and, consequently, is
binding on both Contracting States. Each concerned person must, within 30 days of
receiving the determination from the competent authority to which the case was first
presented, advise that competent authority whether the person accepts the determination.
The failure to advise the competent authority within the requisite time is considered a
rejection of the determination. If a determination is rejected, the case cannot be the
subject of a subsequent MAP procedure on the same issue(s) determined by the panel,
including a subsequent Arbitration Proceeding. After the commencement of an
Arbitration Proceeding but before a decision of the board has been accepted by all
concerned persons, the competent authorities may reach a mutual agreement to resolve
the case and terminate the Proceeding.
For purposes of the Arbitration Proceeding, the members of the arbitration board
and their staffs shall be considered “persons or authorities” to whom information may be
disclosed under Article XXVII (Exchange of Information). The Arbitration Note
provides that all materials prepared in the course of, or relating to, the Arbitration
Proceeding are considered information exchanged between the Contracting States. No
information relating to the Arbitration Proceeding or the board’s determination may be
disclosed by members of the arbitration board or their staffs or by either competent
authority, except as permitted by the Convention and the domestic laws of the
Contracting States. Members of the arbitration board and their staffs must agree in
statements sent to each of the Contracting States in confirmation of their appointment to
the arbitration board to abide by and be subject to the confidentiality and nondisclosure
provisions of Article XXVII of the Convention and the applicable domestic laws of the
Contracting States, with the most restrictive of the provisions applying.
The applicable domestic law of the Contracting States determines the treatment of
any interest or penalties associated with a competent authority agreement achieved
through arbitration.
45

In general, fees and expenses are borne equally by the Contracting States,
including the cost of translation services. However, meeting facilities, related resources,
financial management, other logistical support, and general and administrative
coordination of the Arbitration Proceeding will be provided, at its own cost, by the
Contracting State that initiated the Mutual Agreement Procedure. The fees and expenses
of members of the board will be set in accordance with the International Centre for
Settlement of Investment Disputes (ICSID) Schedule of Fees for arbitrators (in effect on
the date on which the arbitration board proceedings begin). All other costs are to be
borne by the Contracting State that incurs them. Since arbitration of MAP cases is
intended to assist taxpayers in resolving a governmental difference of opinion regarding
the taxation of their income, and is merely an extension of the competent authority
process, no fees will be chargeable to a taxpayer in connection with arbitration.
Article 22
Article 22 of the Protocol amends Article XXVI A (Assistance in Collection) of
the existing Convention. Article XXVI A sets forth provisions under which the United
States and Canada have agreed to assist each other in the collection of taxes.
Paragraph 1
Paragraph 1 replaces subparagraph 8(a) of Article XXVI A. In general, new
subparagraph 8(a) provides the circumstances under which no assistance is to be given
under the Article for a claim in respect of an individual taxpayer. New subparagraph 8(a)
contains language that is in substance the same as subparagraph 8(a) of Article XXVI A
of the existing Convention. However, the revised subparagraph also provides that no
assistance in collection is to be given for a revenue claim from a taxable period that
ended before November 9, 1995 in respect of an individual taxpayer, if the taxpayer
became a citizen of the requested State at any time before November 9, 1995 and is such
a citizen at the time the applicant State applies for collection of the claim.
The additional language is intended to avoid the potentially discriminating
application of former subparagraph 8(a) as applied to persons who were not citizens of
the requested State in the taxable period to which a particular collection request related,
but who became citizens of the requested State at a time prior to the entry into force of
Article XXVI A as set forth in the third protocol signed March 17, 1995. New
subparagraph 8(a) addresses this situation by treating the citizenship of a person in the
requested State at anytime prior to November 9, 1995 as comparable to citizenship in the
requested State during the period for which the claim for assistance relates if 1) the
person is a citizen of the requested state at the time of the request for assistance in
collection, and 2) the request relates to a taxable period ending prior to November 9,
1995. As is provided in subparagraph 3(g) of Article 27, this change will have effect for
revenue claims finally determined after November 9, 1985, the effective date of the
adoption of collection assistance in the third protocol signed March 17, 1995.
Paragraph 2
Paragraph 2 replaces paragraph 9 of Article XXVI A of the Convention. Under
paragraph 1 of Article XXVI A, each Contracting State generally agrees to lend
assistance and support to the other in the collection of revenue claims. The term
"revenue claim" is defined in paragraph 1 to include all taxes referred to in paragraph 9 of
the Article, as well as interest, costs, additions to such taxes, and civil penalties. New
paragraph 9 provides that, notwithstanding the provisions of Article II (Taxes Covered)
of the Convention, Article XXVI A shall apply to all categories of taxes collected, and to
contributions to social security and employment insurance premiums levied, by or on
46

behalf of the Government of a Contracting State. Prior to the Protocol, paragraph 9 did
not contain a specific reference to contributions to social security and employment
insurance premiums. Although the prior language covered U.S. federal social security
and unemployment taxes, the language did not cover Canada’s social security (e.g.,
Canada Pension Plan) and employment insurance programs, contributions to which are
not considered taxes under Canadian law and therefore would not otherwise have come
within the scope of the paragraph.
Article 23
Article 23 of the Protocol replaces Article XXVII (Exchange of Information) of
the Convention.
Paragraph 1 of Article XXVII
New paragraph 1 of Article XXVII is substantially the same as paragraph 1 of
Article XXVII of the existing Convention. Paragraph 1 authorizes the competent
authorities to exchange information as may be relevant for carrying out the provisions of
the Convention or the domestic laws of Canada and the United States concerning taxes
covered by the Convention, insofar as the taxation under those domestic laws is not
contrary to the Convention. New paragraph 1 changes the phrase “is relevant” to “may
be relevant” to clarify that the language incorporates the standard in Code section 7602
which authorizes the Internal Revenue Service to examine "any books, papers, records, or
other data which may be relevant or material." (Emphasis added.) In United States v.
Arthur Young & Co., 465 U.S. 805, 814 (1984), the Supreme Court stated that “the
language ’may be’ reflects Congress's express intention to allow the Internal Revenue
Service to obtain ‘items of even potential relevance to an ongoing investigation, without
reference to its admissibility.’" (Emphasis in original.) However, the language "may be"
would not support a request in which a Contracting State simply asked for information
regarding all bank accounts maintained by residents of that Contracting State in the other
Contracting State, or even all accounts maintained by its residents with respect to a
particular bank.
The authority to exchange information granted by paragraph 1 is not restricted by
Article I (Personal Scope), and thus need not relate solely to persons otherwise covered
by the Convention. Under paragraph 1, information may be exchanged for use in all
phases of the taxation process including assessment, collection, enforcement or the
determination of appeals. Thus, the competent authorities may request and provide
information for cases under examination or criminal investigation, in collection, on
appeals, or under prosecution.
Any information received by a Contracting State pursuant to the Convention is to
be treated as secret in the same manner as information obtained under the tax laws of that
State. Such information shall be disclosed only to persons or authorities, including courts
and administrative bodies, involved in the assessment or collection of, the administration
and enforcement in respect of, or the determination of appeals in relation to, the taxes
covered by the Convention and the information may be used by such persons only for
such purposes. (In accordance with paragraph 4, for the purposes of this Article the
Convention applies to a broader range of taxes than those covered specifically by Article
II (Taxes Covered)). Although the information received by persons described in
paragraph 1 is to be treated as secret, it may be disclosed by such persons in public court
proceedings or in judicial decisions.
Paragraph 1 also permits, however, a Contracting State to provide information
received from the other Contracting State to its states, provinces, or local authorities, if it
47

relates to a tax imposed by that state, province, or local authority that is substantially
similar to a national-level tax covered under Article II (Taxes Covered). This provision
does not authorize a Contracting State to request information on behalf of a state,
province, or local authority. Paragraph 1 also authorizes the competent authorities to
release information to any arbitration panel that may be established under the provisions
of new paragraph 6 of Article XXVI (Mutual Agreement Procedure). Any information
provided to a state, province, or local authority or to an arbitration panel is subject to the
same use and disclosure provisions as is information received by the national
Governments and used for their purposes.
The provisions of paragraph 1 authorize the U.S. competent authority to continue
to allow legislative bodies, such as the tax-writing committees of Congress and the
Government Accountability Office to examine tax return information received from
Canada when such bodies or offices are engaged in overseeing the administration of U.S.
tax laws or a study of the administration of U.S. tax laws pursuant to a directive of
Congress. However, the secrecy requirements of paragraph 1 must be met.
It is contemplated that Article XXVII will be utilized by the competent authorities
to exchange information upon request, routinely, and spontaneously.
Paragraph 2 of Article XXVII
New paragraph 2 conforms with the corresponding U.S. and OECD Model
provisions. The substance of the second sentence of former paragraph 2 is found in new
paragraph 6 of the Article, discussed below.
Paragraph 2 provides that if a Contracting State requests information in
accordance with Article XXVII, the other Contracting State shall use its information
gathering measures to obtain the requested information. The instruction to the requested
State to “use its information gathering measures" to obtain the requested information
communicates the same instruction to the requested State as the language of former
paragraph 2 that stated that the requested State shall obtain the information “in the same
way as if its own taxation was involved.” Paragraph 2 makes clear that the obligation to
provide information is limited by the provisions of paragraph 3, but that such limitations
shall not be construed to permit a Contracting State to decline to obtain and supply
information because it has no domestic tax interest in such information.
In the absence of such a paragraph, some taxpayers have argued that
subparagraph 3(a) prevents a Contracting State from requesting information from a bank
or fiduciary that the Contracting State does not need for its own tax purposes. This
paragraph clarifies that paragraph 3 does not impose such a restriction and that a
Contracting State is not limited to providing only the information that it already has in its
own files.
Paragraph 3 of Article XXVII
New paragraph 3 is substantively the same as paragraph 3 of Article XXVII of the
existing Convention. Paragraph 3 provides that the provisions of paragraphs 1 and 2 do
not impose on Canada or the United States the obligation to carry out administrative
measures at variance with the laws and administrative practice of either State; to supply
information which is not obtainable under the laws or in the normal course of the
administration of either State; or to supply information which would disclose any trade,
business, industrial, commercial, or professional secret or trade process, or information
the disclosure of which would be contrary to public policy.
48

Thus, a requesting State may be denied information from the other State if the
information would be obtained pursuant to procedures or measures that are broader than
those available in the requesting State. However, the statute of limitations of the
Contracting State making the request for information should govern a request for
information. Thus, the Contracting State of which the request is made should attempt to
obtain the information even if its own statute of limitations has passed. In many cases,
relevant information will still exist in the business records of the taxpayer or a third party,
even though it is no longer required to be kept for domestic tax purposes.
While paragraph 3 states conditions under which a Contracting State is not
obligated to comply with a request from the other Contracting State for information, the
requested State is not precluded from providing such information, and may, at its
discretion, do so subject to the limitations of its internal law.
As discussed with respect to paragraph 2, in no case shall the limitations in
paragraph 3 be construed to permit a Contracting State to decline to obtain information
and supply information because it has no domestic tax interest in such information.
Paragraph 4 of Article XXVII
The language of new paragraph 4 is substantially similar to former paragraph 4.
New paragraph 4, however, consistent with new paragraph 1, discussed above, replaces
the words “is relevant” with “may be relevant” in subparagraph 4(b).
Paragraph 4 provides that, for the purposes of Article XXVII, the Convention
applies to all taxes imposed by a Contracting State, and to other taxes to which any other
provision of the Convention applies, but only to the extent that the information may be
relevant for the purposes of the application of that provision.
Article XXVII does not apply to taxes imposed by political subdivisions or local
authorities of the Contracting States. Paragraph 4 is designed to ensure that information
exchange will extend to taxes of every kind (including, for example, estate, gift, excise,
and value added taxes) at the national level in the United States and Canada.
Paragraph 5 of Article XXVII
New paragraph 5 conforms with the corresponding U.S. and OECD Model
provisions. Paragraph 5 provides that a Contracting State may not decline to provide
information because that information is held by a financial institution, nominee or person
acting in an agency or fiduciary capacity. Thus, paragraph 5 would effectively prevent a
Contracting State from relying on paragraph 3 to argue that its domestic bank secrecy
laws (or similar legislation relating to disclosure of financial information by financial
institutions or intermediaries) override its obligation to provide information under
paragraph 1. This paragraph also requires the disclosure of information regarding the
beneficial owner of an interest in a person.
Paragraph 6 of Article XXVII
The substance of new paragraph 6 is similar to the second sentence of paragraph 2
of Article XXVII of the existing Convention. New paragraph 6 adopts the language of
paragraph 6 of Article 26 (Exchange of Information and Administrative Assistance) of
the U.S. Model. New paragraph 6 provides that the requesting State may specify the
form in which information is to be provided (e.g., depositions of witnesses and
authenticated copies of original documents). The intention is to ensure that the informa-
tion may be introduced as evidence in the judicial proceedings of the requesting State.
49

The requested State should, if possible, provide the information in the form requested to
the same extent that it can obtain information in that form under its own laws and
administrative practices with respect to its own taxes.
Paragraph 7 of Article XXVII
New paragraph 7 is consistent with paragraph 8 of Article 26 (Exchange of
Information and Administrative Assistance) of the U.S. Model. Paragraph 7 provides
that the requested State shall allow representatives of the requesting State to enter the
requested State to interview individuals and examine books and records with the consent
of the persons subject to examination. Paragraph 7 was intended to reinforce that the
administrations can conduct consensual tax examinations abroad, and was not intended to
limit travel or supersede any arrangements or procedures the competent authorities may
have previously had in place regarding travel for tax administration purposes.
Paragraph 13 of General Note
As is explained in paragraph 13 of the General Note, the United States and
Canada understand and agree that the standards and practices described in Article XXVII
of the Convention are to be in no respect less effective than those described in the Model
Agreement on Exchange of Information on Tax Matters developed by the OECD Global
Forum Working Group on Effective Exchange of Information.
Article 24
Article 24 amends Article XXIX (Miscellaneous Rules) of the Convention.
Paragraph 1
Paragraph 1 replaces paragraph 2 of Article XXIX of the existing Convention.
New paragraph 2 is divided into two subparagraphs. In general, subparagraph 2(a)
provides a “saving clause” pursuant to which the United States and Canada may each tax
its residents, as determined under Article IV (Residence), and the United States may tax
its citizens and companies, including those electing to be treated as domestic corporations
(e.g. under Code section 1504(d)), as if there were no convention between the United
States and Canada with respect to taxes on income and capital. Subparagraph 2(a)
contains language that generally corresponds to former paragraph 2, but omits certain
language pertaining to former citizens, which are addressed in new subparagraph 2(b).
New subparagraph 2(b) generally corresponds to the provisions of former
paragraph 2 addressing former citizens of the United States. However, new subparagraph
2(b) also includes a reference to former long-term residents of the United States. This
addition, as well as other changes in subparagraph 2(b), brings the Convention in
conformity with the U.S. taxation of former citizens and long-term residents under Code
section 877.
Similar to subparagraph 2(a), new subparagraph 2(b) operates as a “saving
clause” and provides that notwithstanding the other provisions of the Convention, a
former citizen or former long-term resident of the United States, may, for a period of ten
years following the loss of such status, be taxed in accordance with the laws of the United
States with respect to income from sources within the United States (including income
deemed under the domestic law of the United States to arise from such sources).
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Paragraphs 11 and 12 of the General Note provide definitions based on Code
section 877 that are relevant to the application of paragraph 2 of Article XXIX.
Paragraph 11 of the General Note provides that the term “long-term resident” means any
individual who is a lawful permanent resident of the United States in eight or more
taxable years during the preceding 15 taxable years. In determining whether the eight-
year threshold is met, one does not count any year in which the individual is treated as a
resident of Canada under this Convention (or as a resident of any country other than the
United States under the provisions of any other U.S. tax treaty), and the individual does
not waive the benefits of such treaty applicable to residents of the other country. This
understanding is consistent with how this provision is generally interpreted in U.S. tax
treaties.
Paragraph 12 of the General Note provides that the phrase “income deemed under
the domestic law of the United States to arise from such sources” as used in new
subparagraph 2(b) includes gains from the sale or exchange of stock of a U.S. company
or debt obligations of a U.S. person, the United States, a State, or a political subdivision
thereof, or the District of Columbia, gains from property (other than stock or debt
obligations) located in the United States, and, in certain cases, income or gain derived
from the sale of stock of a non-U.S. company or a disposition of property contributed to
such non-U.S. company where such company would be a controlled foreign corporation
with respect to the individual if such person had continued to be a U.S. person. In
addition, an individual who exchanges property that gives rise or would give rise to U.S.-
source income for property that gives rise to foreign-source income will be treated as if
he had sold the property that would give rise to U.S.-source income for its fair market
value, and any consequent gain shall be deemed to be income from sources within the
United States.
Paragraph 2
Paragraph 2 replaces subparagraph 3(a) of Article XXIX of the existing
Convention. Paragraph 3 provides that, notwithstanding paragraph 2 of Article XXIX,
the United States and Canada must respect specified provisions of the Convention in
regard to certain persons, including residents and citizens. Therefore, subparagraph 3(a)
lists certain paragraphs and Articles of the Convention that represent exceptions to the
"saving clause" in all situations. New subparagraph 3(a) is substantially similar to former
subparagraph 3(a), but now contains a reference to paragraphs 8, 10, and 13 of Article
XVIII (Pensions and Annuities) to reflect the changes made to that article in paragraph 3
of Article 13 of the Protocol.
Article 25
Article 25 of the Protocol replaces Article XXIX A (Limitation on Benefits) of
the existing Convention, which was added to the Convention by the Protocol done on
March 17, 1995. Article XXIX A addresses the problem of “treaty shopping” by
residents of third States by requiring, in most cases, that the person seeking benefits not
only be a U.S. resident or Canadian resident but also satisfy other tests. For example, a
resident of a third State might establish an entity resident in Canada for the purpose of
deriving income from the United States and claiming U.S. treaty benefits with respect to
that income. Article XXIX A limits the benefits granted by the United States or Canada
under the Convention to those persons whose residence in the other Contracting State is
not considered to have been motivated by the existence of the Convention. As replaced
by the Protocol, new Article XXIX A is reciprocal, and many of the changes to the
former paragraphs of Article XXIX A are made to effectuate this reciprocal application.
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Absent Article XXIX A, an entity resident in one of the Contracting States would
be entitled to benefits under the Convention, unless it were denied such benefits as a
result of limitations under domestic law (e.g., business purpose, substance-over-form,
step transaction, or conduit principles or other anti-avoidance rules) applicable to a
particular transaction or arrangement. As noted below in the explanation of paragraph 7,
general anti-abuse provisions of this sort apply in conjunction with the Convention in
both the United States and Canada. In the case of the United States, such anti-abuse
provisions complement the explicit anti-treaty-shopping rules of Article XXIX A. While
the anti-treaty-shopping rules determine whether a person has a sufficient nexus to
Canada to be entitled to benefits under the Convention, the anti-abuse provisions under
U.S. domestic law determine whether a particular transaction should be recast in
accordance with the substance of the transaction.
Paragraph 1 of Article XXIX A
New paragraph 1 of Article XXIX A provides that, for the purposes of the
application of the Convention, a “qualifying person” shall be entitled to all of the benefits
of the Convention and, except as provided in paragraphs 3, 4, and 6, a person that is not a
qualifying person shall not be entitled to any benefits of the Convention.
Paragraph 2 of Article XXIX A
New paragraph 2 lists a number of characteristics any one of which will make a
United States or Canadian resident a qualifying person. The “look-through” principles
introduced by the Protocol (e.g. paragraph 6 of Article IV (Residence)) are to be applied
in conjunction with Article XXIX A. Accordingly, the provisions of Article IV shall
determine the person who derives an item of income, and the objective tests of Article
XXIX A shall be applied to that person to determine whether benefits shall be granted.
The rules are essentially mechanical tests and are discussed below.
Individuals and governmental entities
Under new paragraph 2, the first two categories of qualifying persons are (1)
natural persons resident in the United States or Canada (as listed in subparagraph 2(a)),
and (2) the Contracting States, political subdivisions or local authorities thereof, and any
agency or instrumentality of such Government, political subdivision or local authority (as
listed in subparagraph 2(b)). Persons falling into these two categories are unlikely to be
used, as the beneficial owner of income, to derive benefits under the Convention on
behalf of a third-country person. If such a person receives income as a nominee on
behalf of a third-country resident, benefits will be denied with respect to those items of
income under the articles of the Convention that would otherwise grant the benefit,
because of the requirements in those articles that the beneficial owner of the income be a
resident of a Contracting State.
Publicly traded entities
Under new subparagraph 2(c), a company or trust resident in a Contracting State
is a qualifying person if the company's principal class of shares, and any disproportionate
class of shares, or the trust's units, or disproportionate interest in a trust, are primarily and
regularly traded on one or more recognized stock exchanges. The term "recognized stock
exchange" is defined in subparagraph 5(f) of the Article to mean, in the United States, the
NASDAQ System and any stock exchange registered as a national securities exchange
with the Securities and Exchange Commission, and, in Canada, any Canadian stock
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exchanges that are "prescribed stock exchanges" or “designated stock exchanges” under
the Income Tax Act. These are, at the time of signature of the Protocol, the Montreal
Stock Exchange, the Toronto Stock Exchange, and Tiers 1 and 2 of the TSX Venture
Exchange. Additional exchanges may be added to the list of recognized exchanges by
exchange of notes between the Contracting States or by agreement between the
competent authorities.
If a company has only one class of shares, it is only necessary to consider whether
the shares of that class meet the relevant trading requirements. If the company has more
than one class of shares, it is necessary as an initial matter to determine which class or
classes constitute the "principal class of shares." The term "principal class of shares" is
defined in subparagraph 5(e) of the Article to mean the ordinary or common shares of the
company representing the majority of the aggregate voting power and value of the
company. If the company does not have a class of ordinary or common shares
representing the majority of the aggregate voting power and value of the company, then
the "principal class of shares" is that class or any combination of classes of shares that
represents, in the aggregate, a majority of the voting power and value of the company.
Although in a particular case involving a company with several classes of shares it is
conceivable that more than one group of classes could be identified that account for more
than 50% of the voting power and value of the shares of the company, it is only necessary
for one such group to satisfy the requirements of this subparagraph in order for the
company to be entitled to benefits. Benefits would not be denied to the company even if
a second, non-qualifying, group of shares with more than half of the company's voting
power and value could be identified.
A company whose principal class of shares is regularly traded on a recognized
stock exchange will nevertheless not qualify for benefits under subparagraph 2(c) if it has
a disproportionate class of shares that is not regularly traded on a recognized stock
exchange. The term "disproportionate class of shares" is defined in subparagraph 5(b) of
the Article. A company has a disproportionate class of shares if it has outstanding a class
of shares which is subject to terms or other arrangements that entitle the holder to a larger
portion of the company's income, profit, or gain in the other Contracting State than that to
which the holder would be entitled in the absence of such terms or arrangements. Thus,
for example, a company has a disproportionate class of shares if it has outstanding a class
of "tracking stock" that pays dividends based upon a formula that approximates the
company's return on its assets employed in the United States. Similar principles apply to
determine whether or not there are disproportionate interests in a trust.
The following example illustrates the application of subparagraph 5(b).
Example. OCo is a corporation resident in Canada. OCo has two classes of
shares: Common and Preferred. The Common shares are listed and regularly traded on a
designated stock exchange in Canada. The Preferred shares have no voting rights and are
entitled to receive dividends equal in amount to interest payments that OCo receives from
unrelated borrowers in the United States. The Preferred shares are owned entirely by a
single investor that is a resident of a country with which the United States does not have a
tax treaty. The Common shares account for more than 50 percent of the value of OCo
and for 100 percent of the voting power. Because the owner of the Preferred shares is
entitled to receive payments corresponding to the U.S.-source interest income earned by
OCo, the Preferred shares are a disproportionate class of shares. Because the Preferred
shares are not primarily and regularly traded on a recognized stock exchange, OCo will
not qualify for benefits under subparagraph 2(c).
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The term "regularly traded" is not defined in the Convention. In accordance with
paragraph 2 of Article III (General Definitions) and paragraph 1 of the General Note, this
term will be defined by reference to the domestic tax laws of the State from which
benefits of the Convention are sought, generally the source State. In the case of the
United States, this term is understood to have the meaning it has under Treas. Reg.
section 1.884-5(d)(4)(i)(B), relating to the branch tax provisions of the Code, as may be
amended from time to time. Under these regulations, a class of shares is considered to be
"regularly traded" if two requirements are met: trades in the class of shares are made in
more than de minimis quantities on at least 60 days during the taxable year, and the
aggregate number of shares in the class traded during the year is at least 10 percent of the
average number of shares outstanding during the year. Sections 1.884-5(d)(4)(i)(A), (ii)
and (iii) will not be taken into account for purposes of defining the term "regularly
traded" under the Convention.
The regularly-traded requirement can be met by trading on one or more
recognized stock exchanges. Therefore, trading may be aggregated for purposes of this
requirement. Thus, a U.S. company could satisfy the regularly traded requirement
through trading, in whole or in part, on a recognized stock exchange located in Canada.
Authorized but unissued shares are not considered for purposes of this test.
The term “primarily traded” is not defined in the Convention. In accordance with
paragraph 2 of Article III (General Definitions) and paragraph 1 of the General Note, this
term will have the meaning it has under the laws of the State concerning the taxes to
which the Convention applies, generally the source State. In the case of the United
States, this term is understood to have the meaning it has under Treas. Reg. section
1.884-5(d)(3), as may be amended from time to time, relating to the branch tax provisions
of the Code. Accordingly, stock of a corporation is “primarily traded” if the number of
shares in the company’s principal class of shares that are traded during the taxable year
on all recognized stock exchanges exceeds the number of shares in the company’s
principal class of shares that are traded during that year on all other established securities
markets.
Subject to the adoption by Canada of other definitions, the U.S. interpretation of
“regularly traded” and “primarily traded” will be considered to apply, with such
modifications as circumstances require, under the Convention for purposes of Canadian
taxation.
Subsidiaries of publicly traded entities
Certain companies owned by publicly traded corporations also may be qualifying
persons. Under subparagraph 2(d), a company resident in the United States or Canada
will be a qualifying person, even if not publicly traded, if more than 50 percent of the
vote and value of its shares, and more than 50 percent of the vote and value of each
disproportionate class of shares, is owned (directly or indirectly) by five or fewer persons
that are qualifying persons under subparagraph 2(c). In addition, each company in the
chain of ownership must be a qualifying person. Thus, for example, a company that is a
resident of Canada, all the shares of which are owned by another company that is a
resident of Canada, would qualify for benefits of the Convention if the principal class of
shares (and any disproportionate classes of shares) of the parent company are regularly
and primarily traded on a recognized stock exchange. However, such a subsidiary would
not qualify for benefits under subparagraph 2(d) if the publicly traded parent company
were a resident of a third state, for example, and not a resident of the United States or
Canada. Furthermore, if a parent company qualifying for benefits under subparagraph
2(c) indirectly owned the bottom-tier company through a chain of subsidiaries, each
54

subsidiary in the chain, as an intermediate owner, must be a qualifying person in order for
the bottom-tier subsidiary to meet the test in subparagraph 2(d).
Subparagraph 2(d) provides that a subsidiary can take into account ownership by
as many as five companies, each of which qualifies for benefits under subparagraph 2(c)
to determine if the subsidiary qualifies for benefits under subparagraph 2(d). For
example, a Canadian company that is not publicly traded but that is owned, one-third
each, by three companies, two of which are Canadian resident corporations whose
principal classes of shares are primarily and regularly traded on a recognized stock
exchange, will qualify under subparagraph 2(d).
By applying the principles introduced by the Protocol (e.g. paragraph 6 of Article
IV) in the context of this rule, one “looks through” entities in the chain of ownership that
are viewed as fiscally transparent under the domestic laws of the State of residence (other
than entities that are resident in the State of source).
The 50-percent test under subparagraph 2(d) applies only to shares other than
"debt substitute shares." The term "debt substitute shares" is defined in subparagraph
5(a) to mean shares defined in paragraph (e) of the definition in the Canadian Income Tax
Act of "term preferred shares" (see subsection 248(1) of the Income Tax Act), which
relates to certain shares received in debt-restructuring arrangements undertaken by reason
of financial difficulty or insolvency. Subparagraph 5(a) also provides that the competent
authorities may agree to treat other types of shares as debt substitute shares.
Ownership/base erosion test
Subparagraph 2(e) provides a two-part test under which certain other entities may
be qualifying persons, based on ownership and lack of "base erosion." A company
resident in the United States or Canada will satisfy the first of these tests if 50 percent or
more of the vote and value of its shares and 50 percent or more of the vote and value of
each disproportionate class of shares, in both cases not including debt substitute shares, is
not owned, directly or indirectly, by persons other than qualifying persons. Similarly, a
trust resident in the United States or Canada will satisfy this first test if 50 percent or
more of its beneficial interests, and 50 percent or more of each disproportionate interest,
is not owned, directly or indirectly, by persons other than qualifying persons. The
wording of these tests is intended to make clear that, for example, if a Canadian company
is more than 50 percent owned, either directly or indirectly (including cumulative indirect
ownership through a chain of entities), by a U.S. resident corporation that is, itself,
wholly owned by a third-country resident other than a qualifying person, the Canadian
company would not pass the ownership test. This is because more than 50 percent of its
shares is owned indirectly by a person (the third-country resident) that is not a qualifying
person.
It is understood by the Contracting States that in determining whether a company
satisfies the ownership test described in subparagraph 2(e)(i), a company, 50 percent of
more of the aggregate vote and value of the shares of which and 50 percent or more of the
vote and value of each disproportionate class of shares (in neither case including debt
substitute shares) of which is owned, directly or indirectly, by a company described in
subparagraph 2(c) will satisfy the ownership test of subparagraph 2(e)(i). In such case,
no further analysis of the ownership of the company described in subparagraph 2(c) is
required. Similarly, in determining whether a trust satisfies the ownership test described
in subparagraph 2(e)(ii), a trust, 50 percent or more of the beneficial interest in which and
50 percent or more of each disproportionate interest in which, is owned, directly or
indirectly, by a trust described in subparagraph (2)(c) will satisfy the ownership test of
55

subparagraph (2)(e)(ii), and no further analysis of the ownership of the trust described in
subparagraph 2(c) is required.
The second test of subparagraph 2(e) is the so-called "base erosion" test. A
company or trust that passes the ownership test must also pass this test to be a qualifying
person under this subparagraph. This test requires that the amount of expenses that are
paid or payable by the entity in question, directly or indirectly, to persons that are not
qualifying persons, and that are deductible from gross income (with both deductibility
and gross income as determined under the tax laws of the State of residence of the
company or trust), be less than 50 percent of the gross income of the company or trust.
This test is applied for the fiscal period immediately preceding the period for which the
qualifying person test is being applied. If it is the first fiscal period of the person, the test
is applied for the current period.
The ownership/base erosion test recognizes that the benefits of the Convention
can be enjoyed indirectly not only by equity holders of an entity, but also by that entity's
obligees, such as lenders, licensors, service providers, insurers and reinsurers, and others.
For example, a third-country resident could license technology to a Canadian-owned
Canadian corporation to be sub-licensed to a U.S. resident. The U.S.-source royalty
income of the Canadian corporation would be exempt from U.S. withholding tax under
Article XII (Royalties) of the Convention. While the Canadian corporation would be
subject to Canadian corporation income tax, its taxable income could be reduced to near
zero as a result of the deductible royalties paid to the third-country resident. If, under a
convention between Canada and the third country, those royalties were either exempt
from Canadian tax or subject to tax at a low rate, the U.S. treaty benefit with respect to
the U.S.-source royalty income would have flowed to the third-country resident at little or
no tax cost, with no reciprocal benefit to the United States from the third country. The
ownership/base erosion test therefore requires both that qualifying persons substantially
own the entity and that the entity's tax base is not substantially eroded by payments
(directly or indirectly) to nonqualifying persons.
For purposes of this subparagraph 2(e) and other provisions of this Article, the
term "shares" includes, in the case of a mutual insurance company, any certificate or
contract entitling the holder to voting power in the corporation. This is consistent with
the interpretation of similar limitation on benefits provisions in other U.S. treaties. In
Canada, the principles that are reflected in subsection 256(8.1) of the Income Tax Act
will be applied, in effect treating memberships, policies or other interests in a corporation
incorporated without share capital as representing an appropriate number of shares.
The look-through principles introduced by the Protocol (e.g. new paragraph 6 of
Article IV) are to be taken into account when applying the ownership and base erosion
provisions of Article XXIX A. Therefore, one “looks through” an entity that is viewed as
fiscally transparent under the domestic laws of the residence State (other than entities that
are resident in the source State) when applying the ownership/base erosion test. Assume,
for example, that USCo, a company incorporated in the United States, wishes to obtain
treaty benefits by virtue of the ownership and base erosion rule. USCo is owned by
USLLC, an entity that is treated as fiscally transparent in the United States. USLLC in
turn is wholly owned in equal shares by 10 individuals who are residents of the United
States. Because the United States views USLLC as fiscally transparent, the 10 U.S.
individuals shall be regarded as the owners of USCo for purposes of the ownership test.
Accordingly, USCo would satisfy the ownership requirement of the ownership/base
erosion test. However, if USLLC were instead owned in equal shares by four U.S.
individuals and six individuals who are not residents of either the United States or
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Canada, USCo would not satisfy the ownership requirement. Similarly, for purposes of
the base erosion test, deductible payments made to USLLC will be treated as made to
USLLC’s owners.
Other qualifying persons
Under new subparagraph 2(f), an estate resident in the United States or Canada is
a qualifying person entitled to the benefits of the Convention.
New subparagraphs 2(g) and 2(h) specify the circumstances under which certain
types of not-for-profit organizations will be qualifying persons. Subparagraph 2(g)
provides that a not-for-profit organization that is resident in the United States or Canada
is a qualifying person, and thus entitled to benefits, if more than half of the beneficiaries,
members, or participants in the organization are qualifying persons. The term "not-for-
profit organization" of a Contracting State is defined in subparagraph 5(d) of the Article
to mean an entity created or established in that State that is generally exempt from
income taxation in that State by reason of its not-for-profit status. The term includes
charities, private foundations, trade unions, trade associations, and similar organizations.
New subparagraph 2(h) specifies that certain trusts, companies, organizations, or
other arrangements described in paragraph 2 of Article XXI (Exempt Organizations) are
qualifying persons. To be a qualifying person, the trust, company, organization or other
arrangement must be established for the purpose of providing pension, retirement, or
employee benefits primarily to individuals who are (or were, within any of the five
preceding years) qualifying persons. A trust, company, organization, or other
arrangement will be considered to be established for the purpose of providing benefits
primarily to such persons if more than 50 percent of its beneficiaries, members, or
participants are such persons. Thus, for example, a Canadian Registered Retirement
Savings Plan ("RRSP") of a former resident of Canada who is working temporarily
outside of Canada would continue to be a qualifying person during the period of the
individual's absence from Canada or for five years, whichever is shorter. A Canadian
pension fund established to provide benefits to persons employed by a company would be
a qualifying person only if most of the beneficiaries of the fund are (or were within the
five preceding years) individual residents of Canada or residents or citizens of the United
States.
New subparagraph 2(i) specifies that certain trusts, companies, organizations, or
other arrangements described in paragraph 3 of Article XXI (Exempt Organizations) are
qualifying persons. To be a qualifying person, the beneficiaries of a trust, company,
organization or other arrangement must be described in subparagraph 2(g) or 2(h).
The provisions of paragraph 2 are self-executing, unlike the provisions of
paragraph 6, discussed below. The tax authorities may, of course, on review, determine
that the taxpayer has improperly interpreted the paragraph and is not entitled to the
benefits claimed.
Paragraph 3 of Article XXIX A
Paragraph 3 provides an alternative rule, under which a United States or Canadian
resident that is not a qualifying person under paragraph 2 may claim benefits with respect
to those items of income that are connected with the active conduct of a trade or business
in its State of residence.
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This is the so-called "active trade or business" test. Unlike the tests of paragraph
2, the active trade or business test looks not solely at the characteristics of the person
deriving the income, but also at the nature of the person’s activity and the connection
between the income and that activity. Under the active trade or business test, a resident
of a Contracting State deriving an item of income from the other Contracting State is
entitled to benefits with respect to that income if that person (or a person related to that
person under the principles of Code section 482, or in the case of Canada, section 251 of
the Income Tax Act) is engaged in an active trade or business in the State where it is
resident, the income in question is derived in connection with, or is incidental to, that
trade or business, and the size of the active trade or business in the residence State is
substantial relative to the activity in the other State that gives rise to the income for which
benefits are sought. Further details on the application of the substantiality requirement
are provided below.
Income that is derived in connection with, or is incidental to, the business of
making or managing investments will not qualify for benefits under this provision, unless
those investment activities are carried on with customers in the ordinary course of the
business of a bank, insurance company, registered securities dealer, or deposit-taking
financial institution.
Income is considered derived "in connection" with an active trade or business if,
for example, the income-generating activity in the State is "upstream," "downstream," or
parallel to that conducted in the other Contracting State. Thus, for example, if the U.S.
activity of a Canadian resident company consisted of selling the output of a Canadian
manufacturer or providing inputs to the manufacturing process, or of manufacturing or
selling in the United States the same sorts of products that were being sold by the
Canadian trade or business in Canada, the income generated by that activity would be
treated as earned in connection with the Canadian trade or business. Income is
considered "incidental" to a trade or business if, for example, it arises from the short-term
investment of working capital of the resident in securities issued by persons in the State
of source.
An item of income may be considered to be earned in connection with or to be
incidental to an active trade or business in the United States or Canada even though the
resident claiming the benefits derives the income directly or indirectly through one or
more other persons that are residents of the other Contracting State. Thus, for example, a
Canadian resident could claim benefits with respect to an item of income earned by a
U.S. operating subsidiary but derived by the Canadian resident indirectly through a
wholly-owned U.S. holding company interposed between it and the operating subsidiary.
This language would also permit a resident to derive income from the other Contracting
State through one or more residents of that other State that it does not wholly own. For
example, a Canadian partnership in which three unrelated Canadian companies each hold
a one-third interest could form a wholly-owned U.S. holding company with a U.S.
operating subsidiary. The "directly or indirectly" language would allow otherwise
unavailable treaty benefits to be claimed with respect to income derived by the three
Canadian partners through the U.S. holding company, even if the partners were not
considered to be related to the U.S. holding company under the principles of Code section
482.
As described above, income that is derived in connection with, or is incidental to,
an active trade or business in a Contracting State, must pass the substantiality
requirement to qualify for benefits under the Convention. The trade or business must be
substantial in relation to the activity in the other Contracting State that gave rise to the
income in respect of which benefits under the Convention are being claimed. To be
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considered substantial, it is not necessary that the trade or business be as large as the
income-generating activity. The trade or business cannot, however, in terms of income,
assets, or other similar measures, represent only a very small percentage of the size of the
activity in the other State.
The substantiality requirement is intended to prevent treaty shopping. For
example, a third-country resident may want to acquire a U.S. company that manufactures
television sets for worldwide markets; however, since its country of residence has no tax
treaty with the United States, any dividends generated by the investment would be subject
to a U.S. withholding tax of 30 percent. Absent a substantiality test, the investor could
establish a Canadian corporation that would operate a small outlet in Canada to sell a few
of the television sets manufactured by the U.S. company and earn a very small amount of
income. That Canadian corporation could then acquire the U.S. manufacturer with
capital provided by the third-country resident and produce a very large number of sets for
sale in several countries, generating a much larger amount of income. It might attempt to
argue that the U.S.-source income is generated from business activities in the United
States related to the television sales activity of the Canadian parent and that the dividend
income should be subject to U.S. tax at the 5 percent rate provided by Article X
(Dividends) of the Convention. However, the substantiality test would not be met in this
example, so the dividends would remain subject to withholding in the United States at a
rate of 30 percent.
It is expected that if a person qualifies for benefits under one of the tests of
paragraph 2, no inquiry will be made into qualification for benefits under paragraph 3.
Upon satisfaction of any of the tests of paragraph 2, any income derived by the beneficial
owner from the other Contracting State is entitled to treaty benefits. Under paragraph 3,
however, the test is applied separately to each item of income.
Paragraph 4 of Article XXIX A
Paragraph 4 provides a limited "derivative benefits" test that entitles a company
that is a resident of the United States or Canada to the benefits of Articles X (Dividends),
XI (Interest), and XII (Royalties), even if the company is not a qualifying person and
does not satisfy the active trade or business test of paragraph 3. In general, a derivative
benefits test entitles the resident of a Contracting State to treaty benefits if the owner of
the resident would have been entitled to the same benefit had the income in question been
earned directly by that owner. To qualify under this paragraph, the company must satisfy
both the ownership test in subparagraph 4(a) and the base erosion test of subparagraph
4(b).
Under subparagraph 4(a), the derivative benefits ownership test requires that the
company’s shares representing more than 90 percent of the aggregate vote and value of
all of the shares of the company, and at least 50 percent of the vote and value of any
disproportionate class of shares, in neither case including debt substitute shares, be
owned directly or indirectly by persons each of whom is either (i) a qualifying person or
(ii) another person that satisfies each of three tests. The three tests of subparagraph 4(a)
that must be satisfied by these other persons are as follows:
First, the other person must be a resident of a third State with which the
Contracting State that is granting benefits has a comprehensive income tax convention.
The other person must be entitled to all of the benefits under that convention. Thus, if the
person fails to satisfy the limitation on benefits tests, if any, of that convention, no
benefits would be granted under this paragraph. Qualification for benefits under an
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active trade or business test does not suffice for these purposes, because that test grants
benefits only for certain items of income, not for all purposes of the convention.
Second, the other person must be a person that would qualify for benefits with
respect to the item of income for which benefits are sought under one or more of the tests
of paragraph 2 or 3 of Article XXIX A, if the person were a resident of the Contracting
State that is not providing benefits for the item of income and, for purposes of paragraph
3, the business were carried on in that State. For example, a person resident in a third
country would be deemed to be a person that would qualify under the publicly-traded test
of paragraph 2 of Article XXIX A if the principal class of its shares were primarily and
regularly traded on a stock exchange recognized either under the Convention between the
United States and Canada or under the treaty between the Contracting State granting
benefits and the third country. Similarly, a company resident in a third country would be
deemed to satisfy the ownership/base erosion test of paragraph 2 under this hypothetical
analysis if, for example, it were wholly owned by an individual resident in that third
country and the company's tax base were not substantially eroded by payments (directly
or indirectly) to nonqualifying persons.
The third requirement is that the rate of tax on the item of income in respect of
which benefits are sought must be at least as low under the convention between the
person's country of residence and the Contracting State granting benefits as it is under the
Convention.
Subparagraph 4(b) sets forth the base erosion test. This test requires that the
amount of expenses that are paid or payable by the company in question, directly or
indirectly, to persons that are not qualifying persons under the Convention, and that are
deductible from gross income (with both deductibility and gross income as determined
under the tax laws of the State of residence of the company), be less than 50 percent of
the gross income of the company. This test is applied for the fiscal period immediately
preceding the period for which the test is being applied. If it is the first fiscal period of
the person, the test is applied for the current period. This test is qualitatively the same as
the base erosion test of subparagraph 2(e).
Paragraph 5 of Article XXIX A
Paragraph 5 defines certain terms used in the Article. These terms were identified
and discussed in connection with new paragraph 2, above.
Paragraph 6 of Article XXIX A
Paragraph 6 provides that when a resident of a Contracting State derives income
from the other Contracting State and is not entitled to the benefits of the Convention
under other provisions of the Article, benefits may, nevertheless be granted at the
discretion of the competent authority of the other Contracting State. This determination
can be made with respect to all benefits under the Convention or on an item by item
basis. In making a determination under this paragraph, the competent authority will take
into account all relevant facts and circumstances relating to the person requesting the
benefits. In particular, the competent authority will consider the history, structure,
ownership (including ultimate beneficial ownership), and operations of the person. In
addition, the competent authority is to consider (1) whether the creation and existence of
the person did not have as a principal purpose obtaining treaty benefits that would not
otherwise be available to the person, and (2) whether it would not be appropriate, in view
of the purpose of the Article, to deny benefits. If the competent authority of the other
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Contracting State determines that either of these two standards is satisfied, benefits shall
be granted.
For purposes of implementing new paragraph 6, a taxpayer will be permitted to
present his case to the competent authority for an advance determination based on a full
disclosure of all pertinent information. The taxpayer will not be required to wait until it
has been determined that benefits are denied under one of the other provisions of the
Article. It also is expected that, if and when the competent authority determines that
benefits are to be allowed, they will be allowed retroactively to the time of entry into
force of the relevant provision of the Convention or the establishment of the structure in
question, whichever is later (assuming that the taxpayer also qualifies under the relevant
facts for the earlier period).
Paragraph 7 of Article XXIX A
New paragraph 7 is in substance similar to paragraph 7 of Article XXIX A of the
existing Convention and clarifies the application of general anti-abuse provisions. New
paragraph 7 provides that paragraphs 1 through 6 of Article XXIX A shall not be
construed as limiting in any manner the right of a Contracting State to deny benefits
under the Convention where it can reasonably be concluded that to do otherwise would
result in an abuse of the provisions of the Convention. This provision permits a
Contracting State to rely on general anti-avoidance rules to counter arrangements
involving treaty shopping through the other Contracting State.
Thus, Canada may apply its domestic law rules to counter abusive arrangements
involving "treaty shopping" through the United States, and the United States may apply
its substance-over-form and anti-conduit rules, for example, in relation to Canadian
residents. This principle is recognized by the OECD in the Commentaries to its Model
Tax Convention on Income and on Capital, and the United States and Canada agree that it
is inherent in the Convention. The statement of this principle explicitly in the Protocol is
not intended to suggest that the principle is not also inherent in other tax conventions
concluded by the United States or Canada.
Article 26
Article 26 of the Protocol replaces paragraphs 1 and 5 of Article XXIX B (Taxes
Imposed by Reason of Death) of the Convention. In addition, paragraph 7 of the General
Note provides certain clarifications for purposes of paragraphs 6 and 7 of Article XXIX
B.
Paragraph 1
Paragraph 1 of Article XXIX B of the existing Convention generally addresses the
situation where a resident of a Contracting State passes property by reason of the
individual’s death to an organization referred to in paragraph 1 of Article XXI (Exempt
Organizations) of the Convention. The paragraph provided that the tax consequences in a
Contracting State arising out of the passing of the property shall apply as if the
organization were a resident of that State.
The Protocol replaces paragraph 1, and the changes set forth in new paragraph 1
are intended to specifically address questions that have arisen about the application of
former paragraph 1 where property of an individual who is a resident of Canada passes
by reason of the individual’s death to a charitable organization in the United States that is
not a “registered charity” under Canadian law. Under one view, paragraph 1 of Article
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XXIX B requires Canada to treat the passing of the property as a contribution to a
“registered charity” and thus to allow all of the same deductions for Canadian tax
purposes as if the U.S. charity had been a “registered charity” under Canadian law.
Under another view, paragraph 6 of Article XXI (Exempt Organizations) of the
Convention continues to limit the amount of the income tax charitable deduction in
Canada to the individual’s income arising in the United States. The changes set forth in
new paragraph 1 are intended to provide relief from the Canadian tax on gain deemed
recognized by reason of death that would otherwise give rise to Canadian tax when the
individual passes the property to a charitable organization in the United States, but, for
purposes of the separate Canadian income tax, do not eliminate the limitation under
paragraph 6 of Article XXI on the amount of the deduction in Canada for the charitable
donation to the individual’s income arising in the United States.
As revised, paragraph 1 is divided into two subparagraphs. New subparagraph
1(a) applies where property of an individual who is a resident of the United States passes
by reason of the individual’s death to a qualifying exempt organization that is a resident
of Canada. In such case, the tax consequences in the United States arising from the
passing of such property apply as if the organization were a resident of the United States.
A bequest by a U.S. citizen or U.S. resident (as defined for estate tax purposes under the
Code) to an exempt organization generally is deductible for U.S. federal estate tax
purposes under Code section 2055, without regard to whether the organization is a U.S.
corporation. Thus, generally, the individual’s estate will be entitled to a charitable
deduction for Federal estate tax purposes equal to the value of the property transferred to
the organization. Generally, the effect is that no Federal estate tax will be imposed on the
value of the property.
New subparagraph 1(b) applies where property of an individual who is a resident
of Canada passes by reason of the individual’s death to a qualifying exempt organization
that is a resident of the United States. In such case, for purposes of the Canadian capital
gains tax imposed at death, the tax consequences arising out of the passing of the
property shall apply as if the individual disposed of the property for proceeds equal to an
amount elected on behalf of the individual. For this purpose, the amount elected shall be
no less than the individual’s cost of the property as determined for purposes of Canadian
tax, and no greater than the fair market value of the property. The manner in which the
individual’s representative shall make this election shall be specified by the competent
authority of Canada. Generally, in the event of a full exercise of the election under new
subparagraph 1(b), no capital gains tax will be imposed in Canada by reason of the death
with regard to that property.
New paragraph 1 does not address the situation in which a resident of one
Contracting State bequeaths property with a situs in the other Contracting State to a
qualifying exempt organization in the Contracting State of the decedent's residence. In
such a situation, the other Contracting State may impose tax by reason of death, for
example, if the property is real property situated in that State.
Paragraph 2
Paragraph 2 of Article 26 of the Protocol replaces paragraph 5 of Article XXIX B
of the existing Convention. The provisions of new paragraph 5 relate to the operation of
Canadian law. Because Canadian law requires both spouses to have been Canadian
residents in order to be eligible for the rollover, these provisions are intended to provide
deferral ("rollover") of the Canadian tax at death for certain transfers to a surviving
spouse and to permit the Canadian competent authority to allow such deferral for certain
transfers to a trust. For example, they would enable the competent authority to treat a
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trust that is a qualified domestic trust for U.S. estate tax purposes as a Canadian spousal
trust as well for purposes of certain provisions of Canadian tax law and of the
Convention. These provisions do not affect U.S. domestic law regarding qualified
domestic trusts. Nor do they affect the status of U.S. resident individuals for any other
purpose.
New paragraph 5 adds a reference to subsection 70(5.2) of the Canadian Income
Tax Act. This change is needed because the rollover in respect of certain kinds of
property is provided in that subsection. Further, new paragraph 5 adds a clause “and with
respect to such property” near the end of the second sentence to make it clear that the
trust is treated as a resident of Canada only with respect to its Canadian property.
For example, assume that a U.S. decedent with a Canadian spouse sets up a
qualified domestic trust holding U.S. and Canadian real property, and that the decedent's
executor elects, for Federal estate tax purposes, to treat the entire trust as qualifying for
the Federal estate tax marital deduction. Under Canadian law, because the decedent is
not a Canadian resident, Canada would impose capital gains tax on the deemed
disposition of the Canadian real property immediately before death. In order to defer the
Canadian tax that might otherwise be imposed by reason of the decedent’s death, under
new paragraph 5 of Article XXIX B, the competent authority of Canada shall, at the
request of the trustee, treat the trust as a Canadian spousal trust with respect to the
Canadian real property. The effect of such treatment is to defer the tax on the deemed
distribution of the Canadian real property until an appropriate triggering event such as the
death of the surviving spouse.
Paragraph 7 of the General Note
In addition to the foregoing, paragraph 7 of the General Note provides certain
clarifications for purposes of paragraphs 6 and 7 of Article XXIX B. These clarifications
ensure that tax credits will be available in cases where there are inconsistencies in the
way the two Contracting States view the income and the property.
Subparagraph 7(a) of the General Note applies where an individual who
immediately before death was a resident of Canada held at the time of death a share or
option in respect of a share that constitutes property situated in the United States for the
purposes of Article XXIX B and that Canada views as giving rise to employment income
(for example, a share or option granted by an employer). The United States imposes
estate tax on the share or option in respect of a share, while Canada imposes income tax
on income from employment. Subparagraph 7(a) provides that for purposes of clause
6(a)(ii) of Article XXIX B, any employment income in respect of the share or option
constitutes income from property situated in the United States. This provision ensures
that the estate tax paid on the share or option in the United States will be allowable as a
deduction from the Canadian income tax.
Subparagraph 7(b) of the General Note applies where an individual who
immediately before death was a resident of Canada held at the time of death a registered
retirement savings plan (RRSP) or other entity that is a resident of Canada and that is
described in subparagraph 1(b) of Article IV (Residence) and such RRSP or other entity
held property situated in the United States for the purposes of Article XXIX B. The
United States would impose estate tax on the value of the property held by the RRSP or
other entity (to the extent such property is subject to Federal estate tax), while Canada
would impose income tax on a deemed distribution of the property in the RRSP or other
entity. Subparagraph 7(b) provides that any income out of or under the entity in respect
of the property is, for the purpose of subparagraph 6(a)(ii) of Article XXIX B, income
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from property situated in the United States. This provision ensures that the estate tax
paid on the underlying property in the United States (if any) will be allowable as a
deduction from the Canadian income tax.
Subparagraph 7(c) of the General Note applies where an individual who
immediately before death was a resident or citizen of the United States held at the time of
death an RRSP or other entity that is a resident of Canada and that is described in
subparagraph 1(b) of Article IV (Residence). The United States would impose estate tax
on the value of the property held by the RRSP or other entity, while Canada would
impose income tax on a deemed distribution of the property in the RRSP or other entity.
Subparagraph 7(c) provides that for the purpose of paragraph 7 of Article XXIX B, the
tax imposed in Canada is imposed in respect of property situated in Canada. This
provision ensures that the Canadian income tax will be allowable as a credit against the
U.S. estate tax.
Article 27
Article 27 of the Protocol provides the entry into force and effective date of the
provisions of the Protocol.
Paragraph 1
Paragraph 1 provides generally that the Protocol is subject to ratification in
accordance with the applicable procedures in the United States and Canada. Further, the
Contracting States shall notify each other by written notification, through diplomatic
channels, when their respective applicable procedures have been satisfied.
Paragraph 2
The first sentence of paragraph 2 generally provides that the Protocol shall enter
into force on the date of the later of the notifications referred to in paragraph 1, or
January 1, 2008, whichever is later. The relevant date is the date on the second of these
notification documents, and not the date on which the second notification is provided to
the other Contracting State. The January 1, 2008 date is intended to ensure that the
provisions of the Protocol will generally not be effective before that date.
Subparagraph 2(a) provides that the provisions of the Protocol shall have effect in
respect of taxes withheld at source, for amounts paid or credited on or after the first day
of the second month that begins after the date on which the Protocol enters into force.
Further, subparagraph 2(b) provides that the Protocol shall have effect in respect of other
taxes, for taxable years that begin after (or, if the later of the notifications referred to in
paragraph 1 is dated in 2007, taxable years that begin in and after) the calendar year in
which the Protocol enters into force. These provisions are generally consistent with the
formulation in the U.S. Model treaty, with the exception that a parenthetical was added in
subparagraph 2(b) to address the contingency that the written notifications provided
pursuant to paragraph 1 may occur in the 2007 calendar year. Further, subparagraph 3(d)
of Article 27 of the Protocol contains special provisions with respect to the taxation of
cross-border interest payments that have effect for the first two calendar years that end
after the date the Protocol enters into force. Therefore, during this period, cross-border
interest payments are not subject to the effective date provisions of subparagraph 2(a).
Paragraph 3
Paragraph 3 sets forth exceptions to the general effective date rules set forth in
paragraph 2 of Article 27 of the Protocol.
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Dual corporate residence tie-breaker
Subparagraph 3(a) of Article 27 of the Protocol provides that paragraph 1 of
Article 2 of the Protocol relating to Article IV (Residence) shall have effect with respect
to corporate continuations effected after September 17, 2000. This date corresponds to a
press release issued on September 18, 2000 in which the United States and Canada
identified certain issues with respect to these transactions and stated their intention to
negotiate a protocol that, if approved, would address the issues effective as of the date of
the press release.
Certain payments through fiscally transparent entities
Subparagraph 3(b) of Article 27 of the Protocol provides that new paragraph 7 of
Article IV (Residence) set forth in paragraph 2 of Article 2 of the Protocol shall have
effect as of the first day of the third calendar year that ends after the Protocol enters into
force.
Permanent establishment from the provision of services
Subparagraph 3(c) of Article 27 of the Protocol sets forth the effective date for the
provisions of Article 3 of the Protocol, pertaining to Article V (Permanent Establishment)
of the Convention. The provisions pertaining to Article V shall have effect as of the third
taxable year that ends after the Protocol enters into force, but in no event shall it apply to
include, in the determination of whether an enterprise is deemed to provide services
through a permanent establishment under paragraph 9 of Article V of the Convention,
any days of presence, services rendered, or gross active business revenues that occur or
arise prior to January 1, 2010. Therefore, the provision will apply beginning no earlier
than January 1, 2010 and shall not apply with regard to any presence, services or related
revenues that occur or arise prior to that date.
Withholding rates on cross-border interest payments
Subparagraph 3(d) of Article 27 of the Protocol sets forth special effective date
rules pertaining to Article 6 of the Protocol relating to Article XI (Interest) of the
Convention. Article 6 of the Protocol sets forth a new Article XI of the Convention that
provides for exclusive residence State taxation regardless of the relationship between the
payer and the beneficial owner of the interest. Subparagraph 3(d), however, phases in the
application of paragraph 1 of Article XI during the first two calendar years that end after
the date the Protocol enters into force. During that period, paragraph 1 of Article XI of
the Convention permits source State taxation of interest if the payer and the beneficial
owner are related or deemed to be related by reason of paragraph 2 of Article IX (Related
Persons) of the Convention (“related party interest”), and the interest would not otherwise
be exempt under the provisions of paragraph 3 of Article XI as it read prior to the
Protocol. However, subparagraph 3(d) also provides that the source State taxation on
such related party interest is limited to 7 percent in the first calendar year that ends after
entry into force of the Protocol and 4 percent in the second calendar year that ends after
entry into force of the Protocol.
Subparagraph 3(d) makes clear that the provisions of the Protocol with respect to
exclusive residence based taxation of interest when the payer and the beneficial owner
are not related or deemed related (“unrelated party interest”) applies for interest paid or
credited during the first two calendar years that end after entry into force of the Protocol.
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The withholding rate reductions for related party interest and exemptions for
unrelated party interest will likely apply retroactively. For example, if the Protocol enters
into force on June 30, 2008, paragraph 1 of Article XI, as it reads under subparagraph
3(d) of Article 27, will have the following effect during the first two calendar years.
First, unrelated party interest that is paid or credited on or after January 1, 2008 will be
exempt from taxation in the source State. Second, related party interest paid or credited
on or after January 1, 2008 and before January 1, 2009, will be subject to source State
taxation but at a rate not to exceed 7 percent of the gross amount of the interest. Third,
related party interest paid or credited on or after January 1, 2009 and before January 1,
2010, will be subject to source State taxation but at a rate not to exceed 4 percent of the
gross amount of the interest. Finally, all interest paid or credited after January 1, 2010,
will be subject to the regular rules of Article XI without regard to subparagraph 3(d) of
Article 27.
Further, the provisions of subparagraph 3(d) ensure that even with respect to
circumstances where the payer and the beneficial owner are related or deemed related
under the provisions of paragraph 2 of Article IX, the source State taxation of such cross-
border interest shall be no greater than the taxation of such interest prior to the Protocol.
Gains
Subparagraph 3(e) of Article 27 of the Protocol provides the effective date for
paragraphs 2 and 3 of Article 8 of this Protocol, which relate to the changes made to
paragraphs 5 and 7 of Article XIII (Gains) of the Convention. The changes set forth in
those paragraphs shall have effect with respect to alienations of property that occur
(including, for greater certainty, those that are deemed under the law of a Contracting
State to occur) after September 17, 2000. This date corresponds to the press release
issued on September 18, 2000 which announced the intention of the United States and
Canada to negotiate a protocol that, if approved, would incorporate the changes set forth
in these paragraphs to coordinate the tax treatment of an emigrant’s gains in the United
States and Canada.
Arbitration
Subparagraph 3(f) of Article 27 of the Protocol pertains to Article 21 of the
Protocol which implements the new arbitration provisions. An arbitration proceeding
will generally begin two years after the date on which the competent authorities of the
Contracting States began consideration of a case. Subparagraph 3(f), however, makes
clear that the arbitration provisions shall apply to cases that are already under
consideration by the competent authorities when the Protocol enters into force, and in
such cases, for purposes of applying the arbitration provisions, the commencement date
shall be the date the Protocol enters into force. Further, the provisions of Article 21 of
the Protocol shall be effective for cases that come into consideration by the competent
authorities after the date that the Protocol enters into force. In order to avoid the potential
for a large number of MAP cases becoming subject to arbitration immediately upon the
expiration of two years from entry into force, the competent authorities are encouraged to
develop and implement procedures for arbitration by January 1, 2009, and begin
scheduling arbitration of otherwise unresolvable MAP cases in inventory (and meeting
the agreed criteria) prior to two years from entry into force.
Assistance in collection
Subparagraph 3(g) of Article 27 of the Protocol pertains to the date when the
changes set forth in Article 22 of the Protocol, relating to assistance in collection of taxes,
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shall have effect. Consistent with the third protocol that entered into force on November
9, 1995, and which had effect for requests for assistance on claims finally determined
after November 9, 1985, the provisions of Article 22 of the Protocol shall have effect for
revenue claims finally determined by an applicant State after November 9, 1985.
67