6.1 Introduction

Article VI (Income from Real Property) affirms the jurisdictional powers of the source State to impose its income tax on income derived by the resident of the residence State real property situated in the source State.

The distinguishing feature of Article VI is that, unlike other provision to the Treaty, it does not provide withholding tax relief or tax reduction to the resident of the Residence State in respect of income from real property.

6.2 Explanation & Interpretation of Article VI under Canadian Domestic Law

6.2.1 (a) Income from Real Property

Income from real property may take different forms. The prevalent form of income from real property is rents or lease payments for the use of real or other immovable property. However, income from real property may also include other forms of income, such as royalty payments for the use of or production from natural resources and income from the disposition of real or immovable property, including natural resources, capital cost allowance recapture etc.

In determining the proper treatment of income from real property, the fundamental issue facing a non-resident is whether the particular income receipt should be characterized as income from property or from a business carried on by the non-resident in or outside Canada.

It is question of fact whether the particular income is from business or property. Rather, the determination is guided by common law principles and relies on multiple factors enunciated in Canadian jurisprudence and various CRA’s interpretation bulletins and rulings.

6.2.1 (b) Non – Resident’s Rental and Royalty Income from Real Property

Pursuant to the Act, a non-resident is subject to a withholding tax equal to 25 per cent of every amount that a person resident in Canada pays or credits to the non-resident as, on account or in lieu of payment of, or in satisfaction of, the payment of rent, royalty or similar payment.

The liability for the part XIII withholding tax is borne by a non-resident payee; however, a payer – a Canadian resident or a person deemed to be a Canadian resident for withholding tax purposes – is jointly liable with the non-resident payee for the amount of part XIII tax and is required to withhold and remit on such amount to the Receiver General.

6.2.1 (c) Income from Business

Where a non-resident receives income from real property (such as rents or royalties) in the course of carrying on business in Canada through a permanent establishment in Canada, the non-resident is subject to income tax computed under Par I of the Act on the net income basis.

Rental income derived by a non-resident in the course of carrying on business in Canada is generally presumed by Canadian tax authorities to be derived through a permanent establishment in Canada.

Where the rents and royalties are found not to be earned through a permanent establishment in Canada, a non-resident payee may be subject to 25 per cent withholding tax under Part XIII in respect of such payments.

In computing a non-resident’s taxable income earned in Canada, the non-resident shuld be allowed to claim deductions for certain expenses that relate to the income earned by the non-resident in Canada.

6.2.1 (d) Section 216 Election

Section 216 applies where a rent on real property in Canada or timber royalty received by a non-resident constitutes income from property. Where section 216 applies, a non-resident (including a non-resident individual, corporation or trust) may elect to pay Canadian tax in respect of the rent or timber royalty on a net income, rather than on a gross income, and claim certain deductions for expenses incurred by the non-resident to earn this income.

As result of a section 216 election, a non-resident will be subject to Canadian income tax computed at the regular applicable rates (which depend on the legal form of the non-resident) as if it carried on directly a separate rental business in Canada.

A section 216 election does not change the character of income and it remains for all purposes of the Act income from property.

6.2.1 (e) Meaning of the term “Real Property”

The term “real property” is not defined in the Act and derives its meaning, for the purposes of the Act, from applicable Canadian law. Generally, in Canadian law the term “real property” means “land, and generally whatever is erected or growing upon or affixed to land.”

Real property may also include various fixtures attached to land. Whether a particular tangible property is a fixture is a question of fact that requires consideration of the degree and the purpose of annexation.

A tangible property may become a fixture and, therefore, real property, where there exists some substantial connection with the land or building on which the tangible property is located, so that it has become a permanent part of the land or a building.

The general definition of the term “real property” also includes the “rights issuing out of, annexed to, and exercisable within or about land” and thus may be broad enough to include various rights and interest in land and other real property.

6.2.1 (f) Withholding and Compliance

Where the activities carried on by a non-resident constitute business carried on in Canada, a non-resident should file an annual tax return within the period prescribed in section 150 of the Act.

Where a particular income receipt constitutes income from property, a non-resident person is subject to the Part XIII withholding tax. Generally, the Part XIII tax should be collected and remitted to the Receiver General by a payer, who is jointly and severally liable with the on-resident recipient for the amount of the Pat XIII tax.

Generally, Canadian real property, interests and options therein, and certain instruments deriving their value from Canadian real property and natural resources constitute taxable Canadian property.

Where a non-resident disposes of a Canadian taxable property, there are additional withholding and reporting obligations, imposed by the Act both on a seller and a purchaser. In particular, where a seller fails to obtain from Canadian tax authorities and present to a purchaser a clearance certificate issued under section 116, the purchaser of taxable Canadian property may be required to withhold and remit to the Minister an amount equal up to 50 percent of the purchase price or other consideration paid for a particular property.

Specific withholding and compliance requirements apply to both a non-resident and a Canadian payer where the non-resident elects to file a tax return under section 216 of the Act.

A section 216 tax return should be filed separately from other income tax filing obligations, including income tax return filed under Part I of the Act. If a non-resident carries on business in Canada and receives income form property, in respect of which she intends to file a section 216 election, the non-resident has to file two tax returns in respect of the particular year.

Where a non-resident has filed or intends to file an annual election under section 216, an agent or any other person acting on behalf of the non-resident )such as a property manager) is still required to withhold tax, equal to 25 percent of the gross amount of a rental or royalty payment.

6.2.2 Explanation & Interpretation of the Treaty under Canadian Law

6.2.2 (a) Article VI(1) Source Based Taxation of Income from Real Property

Article VI (1) provides that income derived by a U.S. resident from real property situated in Canada may be taxed in Canada. Further, as Article VI (1) does not grant Canada an exclusive fiscal jurisdiction for the income from Canadian real property, such income derived by a U.S. resident may also be taxed in the U.S., with further relief from double-taxation provided pursuant to the U.S. Internal Revenue Code and Article XXIV (Elimination of Double Taxation).

There are several elements that should be considered in the course of the interpretation of Article VI (I):

1 – The income should be derived by a U.S. resident

2 – It should be from real property as this term is defined in Article VI (I) and (2)

3 – Such real property should be situated in Canada.

Article VI deals with the income from real property as this term is defined in Article VI (2).

Article VI (Income from Real Property) and Article XIII (Gains) both deal with the income derived by a U.S. resident from the disposition of Canadian real property.

The scope of Article VI is limited to the dispositions of real property, the gain from which is on account of income. Article VI also ensures that all income derived by a U.S. resident from the disposition of Canadian real property is subject to Canadian taxation.

The scope of Article VI (1) does not extend to the income derived by a U.S. resident from shares of companies holding Canadian property and other similar instruments.

References:

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

By:  Vitaly Timokhov, Raymond Montero, David Kerzner

Published by: Thomson Carswell