Article 12.2.2 Canadian Interpretation of the Treaty
12.2.2[a] Article XII(1) – Residence – Based Jurisdiction to Tax
Article XII(1) plays an important jurisdictional function by confirming the right of the residency State to tax royalties arising from sources in the source State and paid to a resident of the residence State. The jurisdictional aspect of Article XII(1) is supplemented by Article XII(8) that deals with royalty payments to persons not resident in the residency State.
Article XII(1) defines the scope of payments that may be eligible for Treaty relief under Article XII(2).
Article XII(1) differs from Articles X and XI by not requiring a payment of income to be made by a person resident in Canada. Rather, the scope of Article XII is expanded to encompass the payment of royalties made by residents or non-residents, provided that such royalties arise in Canada, as this term is described, for the purposes of Article XII, in Article XII(6).
12.2.2[b] Article XII(2) – Source based jurisdiction to Tax at Reduced Rates
Article XII(2) serves three main functions in the framework of Article XII.
First, it complements the jurisdictional division established in Article XII(1) by providing that, subject to Article XIII(3), the royalties that arise in Canada may also be taxed in Canada accordance with Canadian law.
Secondly, Article XII(2) reduces the rate of withholding tax that Canada may impose on such royalties to 10 percent of the gross amount of royalties.
Finally, subject to the anti-avoidance provisions in the Treaty and the GAAR, Article XII(2) serves as a limited anti-avoidance rule by stipulating that a U.S. resident may avail herself to a reduced rate under Article XII(2) if and only if she is a beneficial owner of such royalty payment.
12.2.2[c] Article XII(3) – Exceptions to Source-based Jurisdiction
Article XII(3) provides a list of royalties that are exempt from a withholding tax. As a condition precedent for the application of Article XII(3), the particular royalties should (1) arise in Canada as determined under Article XII(6), and (2) be beneficially owned by a U.S resident.
12.2.2[d] Article XII(4) – Definition of Royalties
Article XII(4) provides a definition of the term “royalties” for the purposes of Article XII. As the term “royalties” as defined for the purposes of Article XII encompasses not only royalties but also rents and other similar payments and therefore, differs from its meaning under Canadian law, particular attention should be given to the technical meaning of this term in the course of applicable Treaty analysis.
12.2.2[e] Article XII(5) – Royalty Income Associated with a Permanent Establishment
Article XII(5) generally provides that where a U.S. resident carries on business in Canada through a permanent establishment or performs in Canada independent personal services from a fixed base, the royalties paid to the U.S. resident are not subject to Canadian withholding tax, provided that the royalties have arisen in Canada and the right or property (in respect of which the royalties are paid) is effectively connected with the permanent establishment.
12.2.2[f] Article XII(6) – Source Rules for Royalties
The function of Article XII(6) is to determine whether a particular royalty paid to a U.S. resident arises in Canada for the purposes of Article XII and Article XXII (Other Income).
Canadian law does not have source rules and the source of royalty, rent and other similar payments is determined by the payer’s residence.
12.2.2[g] Article XII(7) – Excessive Royalties
Article XII(7) generally limits the amount of royalties eligible for treaty relief to the commercially reasonable arm’s length amount. In particular, this provision stipulates that where, by reason of a special relationship between the payer and the beneficial owner, the amount of royalties exceeds the amount that would be agreed by arm’s length parties, the amount of such excess should be taxable under the laws of each Contracting State, with due regard to other provisions of the Treaty.
12.2.2[h] Article XII(8) – Triangular Royalty Payments
Article XII(8) provides that where a Canadian resident pays royalties to a resident of a third State, the U.S. cannot impose tax in respect of these payments, except and to that extent that such royalties either (1) arise in the U.S. under the rules in Article XI(6), or (2) the property in respect of which the royalties is paid is effectively connected with a permanent establishment or a fixed base situated in the United States.
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References:
Advisor’s Guide to Canada – U.S. Tax Treaty
By: Vitaly Timokhov, Raymond Montero, David Kerzner
Published by: Thomson Carswell
