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Mergers and Acquisitions in Canada


The Treaty contains relief provisions for income tax, withholding tax, branch tax on business profits, as well as various types of investment income. However, as noted below under the section “Limitation on Benefits Provision,” it contains a limitation on benefits provision which may restrict the ability of certain U.S. resident entities from benefiting from its provisions.

Business Profits

Article VII of the Treaty limits Canada’s jurisdiction to tax the business profits of a U.S. corporation that are attributable to a permanent establishment (as defined in the Treaty) situated in Canada. Accordingly, business profits that are not attributable to a permanent establishment situated in Canada are not subject to Canadian income taxes. In this regard, business profits include income from a business, as well as other types of income that do not fall within other categories of income recognized by the Treaty. For instance, as noted above under the section “Withholding Taxes,” the payment of certain management and administration fees is subject to withholding tax at the domestic withholding tax rate of 25%. However, Article VII of the Treaty will normally permit a full exemption for such fees paid to a resident of the U.S. who can benefit from the Treaty, provided that the fees are not business profits attributable to a permanent establishment situated in Canada and that the fees are reasonable.

The definition of “permanent establishment” under Article V of the Treaty includes branches, offices, agencies and other fixed places of business of a U.S. corporation. However, a place of business used solely for the purpose of storage, display or delivery of goods belonging to the U.S. resident, or used solely for the purchase of goods, the collection of certain information and advertising, is excluded from the definition of “permanent establishment.”

A “permanent establishment” of a U.S. resident also includes an agent (other than an agent of an independent status), if such person has, and habitually exercises in Canada, an authority to conclude contracts in the name of the U.S. resident. A U.S. resident will not be deemed to have a permanent establishment in Canada merely because such resident has a broker, general commission agent or any other agent of an independent status in Canada.

In addition, a permanent establishment will be deemed to exist in Canada for: (a) an individual who performs services in Canada, is present for more than 182 days in Canada in any 12-month period, and more than 50% of the gross active business revenue of the enterprise consists of income derived from the services performed in Canada by the individual; and (b) any person providing services, if the services are provided in Canada for an aggregate of more than 182 days in any 12-month period with respect to the same or a connected project for customers who are either residents of Canada or who maintain a permanent establishment in Canada, and whose services are provided in respect of that permanent establishment.

Dividends

Article X of the Treaty limits the rate of withholding tax that can be imposed on payments of dividends to a resident of the U.S. which qualifies for Treaty benefits to 15%. In addition, paragraph 2 of this Article provides that if a U.S. corporation beneficially owns at least 10% of the voting stock of a Canadian corporation, dividends paid by the Canadian corporation to the U.S. corporation will be subject to a 5% withholding tax rate.

Interest

The rate of withholding tax that can be imposed on payments of interest to a resident of the U.S. is governed by Article XI of the Treaty. However, as noted above, effective January 1, 2008, the Act was amended to eliminate withholding tax on interest paid by a Canadian resident to an arm’s length person of any country, so long as such interest is not “participating debt interest.” In addition, the Treaty eliminates withholding tax on most interest paid to non-related U.S. residents, including interest paid to a non-arm’s length U.S. person) so long as such interest is not a form of participating interest, as defined in the Treaty. It should be noted that the definition of “participating interest” in the Act is different than that found in the Treaty. Interestingly, no other Canadian tax treaty has a similar provision relating to non-arm’s length interest payments.

Branch Tax Relief

The Treaty also reduces the rate of branch tax on non-resident corporations carrying on business in Canada to 5 percent, (which is comparable with the rate reduction that would apply to dividend payments by a Canadian corporation to its US parent). It also provides for an exemption from branch tax in respect of the first CDN$500,000 of branch profits, net of prior years’ losses, which must be shared among related or non-arm’s length corporations. This “lifetime” exemption can result in tax savings of up to CDN$25,000
(i.e. $500,000 x 5%) and the repatriation of such exempt branch profits will not be subject to Canadian withholding taxes.

Capital Gains

Article XIII of the Treaty limits Canada’s jurisdiction to tax gains from the disposition of property by a US resident. Paragraphs 1 and 2 of this Article provide that Canada may impose income tax on gains of a US resident from the disposition of real property situated in Canada, and personal property forming part of the business property of a permanent establishment in Canada. For the purpose of this Article, real property situated in Canada includes a share of the capital stock of a company that is resident in Canada, if the value of the shares is derived principally from real property situated in Canada, and an interest in a partnership, trust or estate, the value of which is derived principally from real property situated in Canada. Real property is defined in Article VI of the Treaty to include rights to explore for or to exploit mineral deposits, sources and other natural resources such as oil and gas. Interestingly, under the Treaty, shares of non-Canadian resident corporations cannot be “real property situated in Canada,” even if such corporation’s value is derived from Canadian real estate. Paragraph 4 of Article XIII provides that gains of a US resident from the disposition of any property that is not specifically subject to Canadian tax under the Treaty is taxable only in the US. Accordingly, a US resident’s gain from the disposition of shares of a corporation resident in Canada will generally be exempt from Canadian income tax if the value of the shares is not derived principally from real property situated in Canada at the time of the disposition of the shares, even if the shares are taxable Canadian property, as discussed above under the heading “Federal Income Taxes.”

Similar provisions, as the ones discussed above, are found in most of Canada’s tax treaties. However, several treaties including those entered into with Japan and Australia, do not exclude Canadian tax on capital gains in respect of taxable Canadian property by non-residents.

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