2016-0672941E5 Par. 2 of Norway Other Income treaty Article

Principal Issues: Whether withholding tax on distributions from Canadian-resident trust to Norwegian XXXXXXXXXX entity will be reduced to 15% by operation of paragraph 2 of Article 22 of the Canada-Norway Income Tax Convention.

Position: Yes.

Reasons: The trust distribution is included in the income of the Norwegian XXXXXXXXXX entity, notwithstanding that the entity is exempt from tax on all of its income. Therefore paragraph 2 of Article 22 is satisfied.

Author: Johns, Jeffrey
Section: Paragraph 2, Article 22 of Canada- Norway Income Tax Convention

XXXXXXXXXX                                                                                                                2016-067294
                                                                                                                                        Jeffrey Johns
Attention: XXXXXXXXXX

March 28, 2018

Dear XXXXXXXXXX:

Re: Benefits Under paragraph 2 Article 22 - Canada Norway Tax Convention

This is in response to your correspondence in which you asked about the application of paragraph 2 of Article 22 of the Convention Between the Government of Canada and the Government of the Kingdom of Norway (the “Treaty”) to the facts outlined below.

Facts

1.    XXXXXXXXXX (the “Tax Exempt Entity”) maintains an investment fund (the “Fund”). The assets of the Fund are segregated from Tax Exempt Entity other assets but are owned directly by it.

2.    Under Article 4, paragraph 1, of the Treaty, Tax Exempt Entity, XXXXXXXXXX, is considered to be a resident of Norway for the purposes of the Treaty.

3.    Tax Exempt Entity (XXXXXXXXXX) is exempt from income tax liability under Norway income tax law.

4.    Tax Exempt Entity is a “non-resident” of Canada within the meaning of subsection 248(1) of the Income Tax Act (the “Act”), for the purposes of subsection 2(3), Division D – Part I, Part XIII and Part XIII.2 of the Act.

5.    Tax Exempt Entity, through the Fund, invests in a trust (the “REIT”).  For purposes of the Act, the REIT is resident in Canada and both a “mutual fund trust”, as defined in subsection 132(6) of the Act, and a “real estate investment trust”, as defined in subsection 122.1(1) of the Act.  The REIT units are publicly listed on a stock exchange in Canada.  Contributions to the REIT are not deductible from income under the Act.

6.    Units of the REIT held by the Tax Exempt Entity constitute a “Canadian property mutual fund investment” for purposes of Part XIII.2 of the Act.

7.    In the year, Tax Exempt Entity receives distributions from the REIT (the “Taxable Distributions”).  Subject to the application of the Treaty, paragraph 212(1)(c) of the Act applies to impose a 25% withholding tax on the Taxable Distributions.

8.    Under Norway tax law, distributions received by a resident of Norway from a trust not resident in Norway, such as the REIT, are included in the resident’s income for tax purposes as income from a foreign source.

Issue

Whether the statutory Canadian tax rate of 25% applicable to the Taxable Distributions will be reduced to 15% by operation of paragraph 2 of Article 22 of the Treaty.

Our Comments

This technical interpretation provides general comments about the provisions of the Act and the Treaty. 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 a particular transaction 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.

As you suggest, distributions made from a trust resident in Canada to a resident of Norway are dealt with in Article 22 of the Treaty, which deals with “Other Income”.  Paragraph 2 of Article 22 provides that where a resident of Norway derives income falling under the Article from a source in Canada, Canada may tax that amount.  The second sentence of the paragraph imposes a limitation on that right, as follows:

“Where such income is income from a trust, other than a trust to which contributions were deductible, the tax so charged shall, provided that the income is taxable in the Contracting State in which the beneficial owner is a resident, not exceed 15 per cent of the gross amount of the income.”

Contributions to the REIT are not deductible for Canadian income tax purposes.  Therefore, if the Taxable Distributions to Tax Exempt Entity are “income (that) is taxable” in Norway, the reduced withholding rate of 15% will apply.

Previous Rulings Views

The requirement that the distribution from the trust be taxable in the state of residence is contained in a number of Canada’s tax conventions.  This includes both the former (the “Former Israel Treaty”) and present income tax convention (the “Present Israel Treaty”) that Canada has entered into with Israel.  In External Technical Interpretation 9108375 (the “Charity Interpretation”), released in 1991, we stated our view that a distribution from a Canadian-resident trust to a tax-exempt charitable entity resident in Israel would qualify for the reduced withholding rate under the Former Israel Treaty’s Other Income article (Article XXI).

As you point out, in 2010 we released External Technical Interpretation 2008-0302321E5 (the “Tax Preference Interpretation”), which again looked at the Other Income Article of the Former Israel Treaty.  At issue in this Interpretation was whether the reduced withholding rate would apply to a distribution from a Canadian-resident trust to an individual resident in Israel.  The individual receiving the distribution was subject to special provisions of Israel income tax law applicable to individual immigrants of Israel in their first ten years of residence.  These provisions exclude income earned outside of Israel from such individual’s taxable income calculation.  Pursuant to these provisions, the individual described in the Tax Preference Interpretation was entitled to exclude the trust distribution received by the individual from his/her taxable income for Israel purposes.

In the Tax Preference Interpretation, it was concluded that only income which was included in the computation of taxable income for Israeli tax purposes would be considered “income (that) is taxable” in Israel.  As the distribution from the Canadian-resident trust was specifically excluded from the individual’s income for Israel income tax purposes, it was not part of the “income (that) is taxable” in Israel and the individual would not be entitled to the reduced withholding rate.

The Tax Preference Interpretation went on to state that the application of the Other Income Article to an individual discussed in that interpretation was distinguishable from that of the entity described in the Charity Interpretation and that the previous interpretation remained valid for tax-exempt entities described therein.

Application of the Treaty to the Taxable Distributions

The phrase “income is taxable” is not defined in the Treaty.  Paragraph 2 of Article 3 of the Treaty provides that, when the Treaty is being applied by Canada, any term that is undefined in the Treaty has the meaning that the term has under the Canadian laws that are applicable to the taxes to which the treaty applies, unless the context otherwise requires.

In this regard, we note that subsection 2(2) of the Act states that a taxpayer’s “taxable income” for a taxation year is the taxpayer’s income for the year (as computed under the Act), plus the additions and minus the deductions permitted by Division C.

We also note that under the Act, a distinction is made between entities that are fully exempt from income tax and entities that do not pay tax in respect of certain sources of income.  Section 149 of the Act provides for a full exemption from income taxation for certain entities, such as charities and crown corporations.  It does not affect or alter the entity’s income or taxable income under the Act.  In contrast, where the Act intends for a taxpayer not to pay tax in respect of certain sources, amounts from those sources are excluded from the computation of the taxpayer’s income under the Act (e.g. amounts excluded from income under section 81 of the Act) and thus are relevant to the computation of the taxpayer’s taxable income.  In other words, a distinction is made under the Act between entities that are exempt from tax and income that is exempt from tax.

In our view, the Treaty and the phrase “income is taxable” should be interpreted taking into account these concepts. Consequently, in our view, if a distribution from a Canadian-resident trust would otherwise be included in the Norwegian resident’s taxable income, but the recipient itself is, under Norwegian tax law, exempt from the imposition of income taxation, we would consider that the “income is taxable” for the purpose of paragraph 2 of Article 22.  In contrast, if the distribution were made to a Norwegian resident that was otherwise taxable under Norwegian tax law but entitled under Norwegian tax law to exclude the distribution from income, the requirements of paragraph 2 would not be met.

Based on our understanding of the facts, the Taxable Distributions are recognized under Norwegian income tax law and generally included in a resident’s income for tax purposes.

The reason no Norwegian income tax is imposed on Tax Exempt Entity in respect of the Taxable Distributions is because Tax Exempt Entity is exempt from the imposition of income tax under Norwegian tax law, and not the result of a specific exclusion from income.  As a result, paragraph 2 of Article 22 of the Treaty would apply to lower the withholding rate on the Taxable Distributions to 15%.

This interpretation is consistent with our views expressed in respect of the application of the “Other Income” Article in the Charity Interpretation and the Tax Preference Interpretation.

Finally, we note that the Tax Preference Interpretation considered the application of the Former Israel Treaty.  As a result, in that interpretation, the determination of whether the individual was “resident” under that treaty did not take into account the updated definition of “resident”, in paragraph 1 of Article 4 of the Present Israel Treaty, which excludes as a resident…“any person who is liable to tax in (a) State in respect only of income from sources in that State.”

We have not as of yet been asked to comment on the application of the Present Israel Treaty in similar circumstances.

We trust these comments will be of assistance to you.

Yves Moreno
Section Manager
for Director
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

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