Canada: Guidance relating to Canadian tax treaties and foreign limited partners
Although not legally binding, the Canada Revenue Agency (CRA) recently answered three questions about the entitlement of UK minority limited partners (Partners), under the Canada-UK income tax convention (Treaty), to a reduction of the Canadian 25% withholding rate on certain dividend and interest payments.
Jean Marc Gagnon
The context relates to a UK limited partnership (LP) that held all the shares of a Canadian corporation (Holdco) that in turn held all the shares of a Canadian operating corporation (Opco).
Subparagraph 10(2)(a) of the Treaty reduces the Canadian withholding tax rate on dividends paid by a Canadian corporation to a UK company if the recipient controlled directly or indirectly at least 10% of the voting power in the Canadian corporation. The CRA reiterated its position that it looks through a partnership to determine if its partners are entitled to treaty benefits in respect of the income of the partnership. The CRA stated that in this case, the LP's general partner controlled Holdco in such a way that the Partners would only be considered to indirectly control the voting power in Holdco if the partnership agreement specifically provided the Partners with the ability to vote on Holdco's shares.
The CRA also considered whether a Partner can own directly or indirectly shares of Holdco for purposes of subparagraph 10(3)(b) of the Treaty, which generally provides a withholding tax exemption on dividends paid to certain pensions or benefits organisations unless such an organisation owns directly or indirectly more than 10% of the capital or the voting power of the payor corporation. The CRA confirmed that each Partner would be considered to own indirectly Holdco shares (capital) in proportion to its partnership interests in LP. The CRA concluded that the words "directly or indirectly" in subparagraph (b) enabled it to attribute a particular percentage of LP's ownership of Holdco shares to each Partner, notwithstanding that under partnership law, partners are not generally considered to own partnership property.
The CRA was finally asked whether each Partner can be considered to be dealing at arm's length with Opco for purposes of subparagraph 11(3)(c) of the Treaty, which provides an exemption for interest paid to arm's length persons. Canadian law also provides an exemption from withholding tax for most interest paid to arm's length non-residents. For this purpose, a recipient partnership with at least one non-resident partner is deemed to be a non-resident person, and the CRA's view is presumably that for withholding purposes interest paid by Opco to LP is non-arm's length interest because LP controls Opco (through Holdco). However, as the CRA looks through a partnership to determine treaty benefits, the analysis under the Treaty is different.
The CRA confirmed that, unless the partnership agreement provides otherwise, the general partner is the sole partner controlling Holdco such that the general partner was not dealing at arm's length with Holdco or Opco. Accordingly, if each Partner dealt at arm's length with each other partner (including the general partner) and the partnership agreement did not remove control from the general partner, the CRA concluded that each Partner should be viewed as dealing at arm's length with Opco for the purposes of the Treaty. This position is in line with another administrative position of the CRA confirming that, if a partner has little or no say directing the partnership's operations, the partner is generally considered to be dealing at arm's length with the partnership. The CRA's position is also consistent with positions adopted by the CRA in situations involving partners and partnerships where a control position or exercise an influence over operations is key.
Several income tax conventions entered into by Canada include similar concepts as the Treaty, such that the recent CRA positions should have broader impact.
Blake, Cassels & Graydon
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