2016-0668041E5 TCP and Article 13(5) of Canada-UK Treaty

Principal Issues: In the scenario described, do shares derive their value indirectly from immovable property?

Position: Yes.

Reasons: The gross asset value method should be used in determining whether more than 50% of the value of the shares of a corporation is derived from immovable property and the proportionate value approach should be used to determine the value of the shares of a subsidiary that is derived from immovable property for the purpose of applying the gross asset value method at its parent level.

Author: Graham, Kanwal
Section: 248(1) "taxable Canadian property"; paragraph 5 of Article 13 of the Canada-UK Treaty

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                                                                                                                                     2016-066804
                                                                                                                                     K. Graham
September 22, 2017

Dear XXXXXXXXXX:

Re: Taxable Canadian property definition and Article 13 of the Canada-UK Treaty

This is in reply to your email of September 26, 2016, in which you asked what methodology is to be used to determine the portion of the value of a company’s shares that is derived from real or immovable property situated in Canada. You presented the following hypothetical scenario to illustrate your question:

* A corporation resident in the United Kingdom (“UKCo”) owns all of the shares of a corporation resident in the Netherlands (“BVCo”). BVCo is not listed on a stock exchange.

* BVCo owns all of the shares of a corporation resident in Canada (“TCPCo”), the shares of which are taxable Canadian property (“TCP”) pursuant to the definition thereof in subsection 248(1) of the Income Tax Act (“Act”).

* BVCo also owns all of the shares of a corporation resident in Australia (“AusCo”).

* The fair market value (“FMV”) of BVCo’s shares is $1.5 M, which is determined as follows:

o FMV of TCPCo shares  $1 M
o FMV of AusCo shares  $0.5 M
o Liabilities    $0

* The FMV of TCPCo’s shares is $1 M, which is determined as follows:

o Real property situated in Canada $2 M
o Liabilities     $1 M

The real property situated in Canada is not property in which the business of TCPCo is carried on.

* The FMV of AusCo’s shares is $0.5 M, which is determined as follows:

o Real property situated in Australia $10 M
o Liabilities      $9.5 M

Given this hypothetical scenario, you asked whether the relevant computation at the BVCo level would be $1 M / $1.5 M (i.e., 67%) or $2 M / $12 M (i.e., 17%).

It is our understanding that you are asking whether Canada may, pursuant to the Canada-United Kingdom Tax Convention (the “Treaty”), tax UKCo on a disposition of the shares it holds in BVCo. That is, would the shares of BVCo be TCP pursuant to the definition thereof in subsection 248(1) of the Act and, if so, would UKCo be disposing of property described in paragraph 5 of Article 13 of the Treaty?

This technical interpretation provides general comments about the provisions of the Act and related legislation (where referenced).  It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination.  The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R7, Advance Income Tax Rulings and Technical Interpretations.

Our Comments

The Act

Pursuant to paragraph (d) of the definition of TCP in subsection 248(1) of the Act, TCP includes a share of the capital stock of certain corporations if, at any particular time during the 60-month period that ends at that time, more than 50% of the FMV of the share was derived directly or indirectly (otherwise than through an entity whose ownership interests were not themselves TCP at the particular time) from specific types of property. Those specific types of property are described in subparagraphs (d)(i) to (d)(iv) of the definition of TCP in subsection 248(1) of the Act, include real or immovable property situated in Canada, and are referred to as “relevant Canadian property” for purposes of this letter.

As recently described in our internal interpretation 2015-0624511I7, it has been CRA’s longstanding position that the gross asset value method should be used in determining whether more than 50% of the FMV of the shares of a corporation was derived from relevant Canadian property for the purpose of the definition of TCP in the Act. More specifically, the FMV of a property is to be determined without taking into account a corporation’s debts or other liabilities. Furthermore, 2015-0624511I7 describes our view that the proportionate value approach should be used to determine the FMV of the shares of a subsidiary that is derived from relevant Canadian property for the purpose of applying the gross asset value method at the parent level.

The gross asset value method for a particular entity as described in 2015-0624511I7 can be summarized as follows:

FMV of relevant Canadian property x 100 = percentage of relevant Canadian
       FMV of all assets                                                      property

In the scenario you presented, the gross asset value method should be applied first at the TCPCo and AusCo level. The percentage of relevant Canadian property for TCPCo is 100% (equal to $2 M / $2 M x 100). Whereas, the percentage of relevant Canadian property for AusCo is 0% (equal to $0 / $10 M x 100).

Next, the gross asset value method should be applied at BVCo’s level making use of the proportionate value approach. The proportionate value approach as described in 2015-0624511I7 can be summarized as follows:

* the percentage of relevant Canadian property of a particular subsidiary entity should be multiplied by the FMV of the shares of that entity; and

* the product resulting from above is the prorated FMV of the shares of the particular subsidiary entity which represents the FMV of a relevant Canadian property asset indirectly held by the parent. The remaining FMV of the shares of the particular subsidiary entity is attributable to property other than relevant Canadian property indirectly held by the parent.

In the scenario you presented, this would result in BVCo having a percentage of relevant Canadian property of 67% = $1 M / $1.5 M.

Since more than 50% of the FMV of BVCo’s shares is derived from real or immovable property situated in Canada, the shares of BVCo are TCP in the scenario presented. As such, UKCo would, pursuant to subparagraph 115(1)(a)(iii) and paragraph 115(1)(b) of the Act, be taxable in Canada on a disposition of the shares it holds in BVCo. This would be the case unless relief were provided by the Treaty.

The Treaty

Paragraph 5 of Article 13 of the Treaty provides that gains from the alienation of certain shares which derive their value or the greater part of their value directly or indirectly from immovable property situated in a Contracting State may be taxed in that state. As none of the exceptions to the application of paragraph 5 of Article 13 of the Treaty apply to the scenario you presented, Canada would retain its right to tax UKCo on the disposition of the shares it holds in BVCo if the shares of BVCo derive their value or the greater part of their value directly or indirectly from immovable property (which includes real property) situated in Canada.

In our view, the methodology to determine the portion of the value of a company’s shares that is derived directly or indirectly from immovable property situated in Canada for the purpose of the Treaty is the same as it is for the purpose of the definition of TCP in the Act. That is, the gross asset value method at the entity level with the proportionate value approach being used to determine the FMV of the shares of a subsidiary derived from relevant Canadian property for the purpose of applying the gross asset value method at the parent level.

As such, in the scenario you presented, 67% (i.e., the greater part) of the value of the shares of BVCo is derived indirectly from immovable property situated in Canada. Therefore, Canada would retain the right to tax UKCo on a disposition of the shares it holds in BVCo because those shares would be TCP pursuant to the definition thereof in subsection 248(1) of the Act and UKCo would be disposing of property described in paragraph 5 of Article 13 of the Treaty.

We trust our comments are of assistance.

Yours truly,

Lori Michele Carruthers, CPA, CA
Section Manager
for Division Director
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

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