Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA. Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.
Principal Issues: Whether an IC-DISC is resident in the U.S. for purposes of Part LIX of the Income Tax Regulations.
Reasons: The IC-DISC is liable to tax in the U.S. by reason of its place of incorporation.
Author: Eroff, Ina
Section: Reg. 5907(1), (11) and (11.2)(a)
Ina Eroff, B.C.L./LL.B.
May 24, 2018
Re: Interest Charge Domestic International Sales Corporation
We are writing in reply to your letter of June 21, 2017 and a follow up email of December 13, 2017 which provided additional information. You requested our views on the application of subsection 5907(1) and paragraph 5907(11.2)(a) of the Income Tax Regulations (“Regulations”) to an “Interest Charge Domestic International Sales Corporation” (“IC-DISC”). In particular you requested our view as to whether an IC-DISC would be considered a resident of the United States (“U.S.”) for purposes of the Canada-U.S. Convention with Respect to Taxes on Income and on Capital (the “Treaty”) and for Part LIX of the Regulations.
A Canadian resident public corporation (“Canco”) indirectly owns all of the issued and outstanding shares of a U.S. resident subchapter C corporation (“USco”). USco manufactures, sells, or licenses property produced in the U.S. for use both within and outside the U.S. USco is fully taxable in the U.S. You have advised that USco is earning active business income that is included in computing its exempt earnings for purposes of the Income Tax Act (the “Act”).
Canco would incorporate a wholly-owned subchapter C corporation (“Newco”) in the U.S. Newco’s sole place of central management and control would be in the U.S. at all relevant times, such that Newco would be a resident of the U.S. under Canadian common law principles.
Newco would elect to be treated as an IC-DISC under the Internal Revenue Code (the “Code”) and would meet all the statutory requirements related to minimum capital, holding qualified export assets, and earning qualified export income to qualify as such in the year it elects to be treated as an IC-DISC and in subsequent years.
Newco would operate either as a buy-sell IC-DISC or a commission IC-DISC, assisting USco in selling export property to customers for use outside the U.S. In a buy-sell structure, Newco would purchase export property from USco at a discount and would subsequently resell the merchandise to the ultimate customers. In a commission structure, Newco would act as a commissioned selling agent on behalf of USco for a commission determined based on specific pricing methodologies outlined by U.S. tax legislation. For U.S. tax purposes, you have advised that the commission paid would be deductible by USco in computing its taxable income. We understand that in the buy-sell structure the taxable income of USco would be reduced as a result of the property being sold at a discount.
You have advised that, by virtue of specific provisions of the Code and the election filed by Newco, the income earned by Newco as an IC-DISC would not be subject to Federal income tax in the U.S. provided the specified conditions to be treated as an IC-DISC continue to be met. Although an IC-DISC is generally not subject to U.S. Federal income tax, you have advised that IC-DISCs are still required to compute taxable income as determined under the Code. You have also advised that IC-DISCs are required to file income tax returns in the U.S. on a yearly basis. Income of an IC-DISC is generally taxed at the shareholder level when it is either distributed or deemed under the Code to be distributed to its shareholders as dividends.
We understand that the general purpose of the IC-DISC tax regime is to enable a corporate group to obtain a limited tax incentive that is available under the Code to manufacturers, producers, resellers, and exporters of goods that are produced within the U.S. with an ultimate destination outside the U.S.
This technical interpretation provides general comments about the provisions of the Act. 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.
You have indicated that Newco would be centrally managed and controlled in the U.S., and consequently it would be considered resident in the U.S. under common law principles. However, to be resident in the U.S. for purposes of Part LIX of the Regulations, Newco must also be resident in the U.S. for purposes of the Treaty, which would be the case if it is “liable to tax” in the U.S. by reason of its domicile, residence, place of management, place of incorporation or any other criterion of a similar nature, within the meaning of paragraph 1 of Article IV of the Treaty.
It has been our long-standing position, as stated in Income Tax Technical News 35, Treaty Residence—Resident of Convenience, dated February 26, 2007, that to be considered “liable to tax” for the purposes of the residence article of our treaties, a person must be subject to the most comprehensive form of taxation as exists in the relevant country.
As we further state in Income Tax Technical News 35, being subject to the most comprehensive form of taxation in a particular jurisdiction does not, in our view, necessarily mean that the person must pay tax to that jurisdiction. There may be situations where a person’s worldwide income is subject to a particular Contracting State’s full taxing jurisdiction but that Contracting State’s domestic law does not levy tax on the person’s taxable income or taxes it at a low rate. In such cases, we will generally accept that the person is a resident of that Contracting State unless the arrangement is abusive. We will view an arrangement as abusive where the person is in fact only a “resident of convenience” and is placed within the taxing jurisdiction of the particular Contracting State in order to gain treaty benefits in a manner that does not create any material economic nexus to that Contracting State. The determination of residence under a tax treaty remains a question of fact.
We have also previously stated (e.g., in 2007-0261551I7) that it is our view that in order for a person to be considered “liable to tax” in a Contracting State for the purposes of a treaty with the Contracting State, the following conditions have to be met:
1. The Contracting State asserts its jurisdiction to tax the person under its domestic law;
2. The assertion of jurisdiction is based on one of the connecting factors referenced in the residence article of the treaty (i.e., domicile, residence, place of management, place of incorporation, or any other criterion of a similar nature); and
3. By reason of conditions 1 and 2 being met, the person becomes liable to the most comprehensive form of taxation that exists in the Contracting State. (i.e., brought within its most comprehensive tax base pursuant to the domestic law of that State).
In applying conditions 1 to 3 above, the intention of the treaty drafters must be taken into account—in general, the treaty drafters will be understood not to have intended to include in the scope of the residence article an entity that is simply a “resident of convenience”. Based on our previous positions, the fact that the Code does not tax all U.S. corporations in the same manner is not relevant to the determination of whether Newco would be “liable to tax” in the U.S.
Newco would be a U.S. domestic corporation for the purposes of the Code which files an election to be treated as an IC-DISC for U.S. tax purposes. A U.S. domestic corporation is generally subject to U.S. tax on its income from both foreign and U.S. sources. We understand that under the Code, an IC-DISC is required to meet a number of requirements related to minimum capital, holding qualified export assets, and earning qualified export income on an annual basis in order to maintain its status as an IC-DISC. Failure to meet these ongoing requirements would result in Newco being subject to U.S. Federal income tax. Further, we understand that there is a maximum limit to the U.S. tax benefits that a corporate group may realize from the IC-DISC tax regime. Thus, it is our understanding that the U.S. asserts its jurisdiction to tax an IC-DISC on its worldwide income based on its place of incorporation. The U.S. then exercises its discretion to grant the benefits of the IC-DISC tax regime only up to certain limits, provided an IC-DISC continues to meet specified conditions for the tax exemption.
Therefore, based on the foregoing analysis and the hypothetical facts outlined, in our view Newco, an entity that is managed and controlled in the U.S., would be regarded as being “liable to tax” in the U.S. and thus a resident of the U.S. under the Treaty. Newco would therefore be considered a resident of a designated treaty country as defined in subsection 5907(11) of the Regulations and would not be considered not to be resident in a designated treaty country pursuant to paragraph 5907(11.2)(a) of the Regulations.
Our comments above are based on a hypothetical IC-DISC. If you have any concerns as to whether any particular IC-DISC is resident in the U.S. for the purposes of Part LIX of the Regulations, we would be prepared to address this issue in the context of an advance tax ruling.
We trust this information is of assistance to you and thank you for your enquiry.
Ann Kippen, CPA, CA
For Division Director
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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