Canada Revenue Agency comments on relief from double tax under Articles XIII(7) and XXIV(2) of the Canada-U.S. Tax Treaty on deemed disposition of U.S. real estate

In Canada Revenue Agency (“CRA”) Views document number 2021-0922301I7, the CRA considered a Canadian-resident trust deemed to dispose (for Canadian income tax purposes) of U.S. real property on its 21-year anniversary. The CRA was asked whether: (a) the trust could file an election under Article XIII(7) of the Convention Between Canada and the United States of America With Respect to Taxes on Income and Capital (the “Treaty”) to avoid double tax; or (b) if not, whether Article XXIV(2) of the Treaty could provide relief when the trust ultimately sold the real estate and became liable to U.S. tax.

As context, the trust sought to elect under Article XIII(7) of the Treaty to be deemed to dispose of the U.S. real property for U.S. income tax purposes in the same year as the deemed disposition. The intent was to permit the trust to claim the resultant U.S. taxes as a foreign tax credit (“FTC”) under subsection 126(1) of the Income Tax Act (Canada) (the “Tax Act”). Unfortunately for the trust, the CRA stated that such a question is in the sole jurisdiction of the Internal Revenue Service and it was thus unable to answer.

The CRA then considered the second question. In their view, relief from double taxation under Article XXIV(2) of the Treaty is subject to the limitations found in subsection 126(1) of the Tax Act. One such limitation provides that, in effect, if the trust pays tax in the United States on a capital gain arising from the actual disposition of U.S. real property but does not have sufficient U.S. source income for Canadian income tax purposes in that same year, an FTC may be unavailable. A further limitation is that foreign taxes paid on non-business income for a particular taxation year may not be carried back to a previous taxation year.

The CRA viewed both those circumstances as likely applying to the trust. Therefore, the CRA stated that the trust cannot rely on relief from double taxation provided under Article XXIV(2) of the Treaty. This notwithstanding the clear likelihood of tax being payable by the trust in both Canada and the U.S. – i.e., double tax. The CRA stated this approach is consistent with the commentary provided by the Organization for Economic Co-operation and Development (“OECD”) on Article 23B of the OECD Model Tax Convention on Income and Capital, 2017 (the “Model Tax Convention”). The Model Tax Convention provides, among other things, that it is preferable to leave each state free to apply its own legislation and technique in avoiding double-taxation, and that states may impose timing restrictions on claiming foreign tax credits.

Based on the CRA’s views, it is reasonable to conclude that double tax may arise even if an election under Article XIII(7) of the Treaty is available but the taxpayer fails to elect accordingly in respect of the year of the deemed disposition. Thus, Canadian residents holding U.S. real property at the time of a deemed disposition event (such as a personal trust reaching its 21-year anniversary) should consider whether to file an Article XIII(7) election. Based on the CRA’s above-noted views, however, it appears that only the IRS could confirm whether such an election is available.

Prepared by: Nicholas McIsaac , Brendan Forrest

Nicholas is a partner at the Toronto office of Thorsteinssons. Nicholas’ practice focuses on corporate and international tax planning, regularly advising Canadian and foreign-based multi-national groups on a variety of matters, including financing, mergers and acquisitions, restructurings and natural resource… more »

Brendan Forrest is an associate working out of the Toronto office of Thorsteinssons LLP. Brendan’s practice focuses on corporate tax advisory and planning services. Brendan earned his Bachelor of Arts (Honours) from St. Michael’s College at the University of Toronto… more »