Canadian Interpretation of the Treaty:

Article IV(1) provides the rules for determining residency of individuals and various entities, including corporations, trusts, and not-for-profit organizations.

For the purpose of treaty, the term “resident” means any person that, under the laws of that particular State, is liable to tax in that State by the reason of that person’s domicile, residence, citizenship, place of management, place of incorporation or any other criterion of similar nature.

According to a judgement by Canadian Supreme court, a particular person should be “subject to as comprehensive a tax liability as is imposed by a state”, and such liability for tax should arise by reason of one of the criteria listed in Article IV(1).

Article IV(1) deems the following entities to be resident in the U.S:

1 – The Government of the U.S or a political subdivision or local authority thereof, or any agency or instrumentality of such government, subdivision or authority.

2 – A trust, organization or other arrangement constituted in the U.S. that is operated exclusively to administer or provide pension, retirement or employee benefits, and a not-for-profit organization, provided that such entities have been constituted in the U.S. and generally exempt from income taxation in the United States.

Under Canadian law, in determining whether an entity would be entitled to the Treaty benefits with respect to U.S. source income, an entity would be considered an instrumentality of the State when it is an agent of the Crown under the terms of the enabling legislation or a Crown corporation. Further, an entity may be considered to be an instrumentality of the State when it is under the effective control of the Crown and performs the functions of a governmental nature.

It is important to that Article IV(1) deals only with the determination of residency for the purposes of the Treaty. Further consideration should be given to Article XXI, which deals with the treaty benefits available to such organizations in respect of the income derived from Canada or the U.S.

Article IV(1) provides a special rule for U.S citizens and permanent residents in the U.S., known as “green card” holders, who are subject to U.S. Tax on their worldwide income as tax residents of the U.S. regardless of their factual residence.

If a U.S citizen or “green card” holder is a tax resident of Canada for the purposes of the Act due to the “connecting factor” listed in the preamble to Article IV(1) (such as domicile or residency determined for the purposes of the Act), then the above deeming rule does not apply. In this case, the individual’s tax residence for purposes of the Treaty should be determined under the “tie-breaker” rules of Article IV(2), with additional relief granted under Article XXIV(4).

A permanent resident or “green card” holder who determines he is a resident of Canada under the treaty’s tie-breaker rules and claims a treaty benefit as a nonresident is treated as a nonresident for that part of the tax year during which he is a dual resident taxpayer when computing his US income tax liability.

A green card holder who is a dual resident taxpayer of both Canada and the U.S. may also elect in the U.S. not to claim treaty benefits and file a Form 1040 as a resident alien in the United States.

A “green card” holder who claims to be a tax resident of Canada under the tie-breaker rules of the Treaty on the individual’s tax return is still responsible for all reporting obligations of a U.S. resident and for Code purposes is still treated as a US resident other than for tax liability. Such an individual in so doing will trigger a termination of the residency status and may be subject to the exit tax rules.

A U.S. citizen may be a tax resident both in the U.S. and Canada for the purposes of respectively the U.S. Internal Revenue Code and the Income Tax Act (Canada), being as a result subject to taxation on income from worldwide sources both in Canada and the U.S. complex rules in Article XXIV (Elimination of Double Taxation) may apply to prove partial relief in these circumstances using the foreign tax credit system.

Residency of Certain Entities under the Treaty

Partnerships:

Article IV(1) does not address the residency of partnerships directly. Being a “body of persons” a partnership meets the definition of a person for the purposes of the Treaty. As the partnership distributes all its income to its partners in the proportion and amount determined under the applicable partnership law and partnership agreement, the CRA has traditionally held that the availability of treaty benefits should be treated as a corporation for the purposes of U.S. tax law and as such is liable to the most comprehensive form of taxation in the U.S., it may be viewed as a person resident in the U.S. and avail itself to the benefits of the Treaty.

U.S. Limited Liability Company:

Even though LLC’s are generally viewed as corporations for Canadian tax purposes, certain LLCs may not be entitled to the benefits of the Treaty.

The flow through entity character of an LLC does not allow it to be viewed as U.S. resident even if it would otherwise qualify as an instrumentality of the State under Article IV(5).

U.S. S-Corporations:

U.S. S-Corporations are viewed as resident in the U.S. for purposes of Article IV(1). The CRA has adopted this long-standing administrative position on the basis that, notwithstanding its treatment as a flow-through entity for the U.S. tax purposes, an S-Corporation is subject to tax in the U.S. on its worldwide income if certain conditions are not met.

References:

Advisor’s Guide to Canada – U.S. Tax Treaty

By:  Vitaly Timokhov, Raymond Montero, David Kerzner

Published by: Thomson Carswell