To the Canada Revenue Agency (“BOW”) See Document Number 2021-0922301I7, the CRA deemed a Canadian resident trust deemed to dispose (for Canadian income tax purposes) of US real property on its 21st birthday. The CRA was asked whether: (a) the trust could file an election under subsection XIII(7) of the Convention Between Canada and the United States of America with Respect to Taxes on Income and on Capital (there “Treaty”) to avoid double taxation; or (b) if not, whether Article XXIV(2) of the Treaty could provide relief when the trust ultimately sold the real estate and became subject to US tax.
In this context, the trust sought to elect, under Article XIII(7) of the Treaty, to be deemed to dispose of the U.S. real property for U.S. income tax purposes in the same year. than the deemed disposition. The intention was to allow the trust to claim the resulting US taxes as a foreign tax credit (“FTC”) under subsection 126(1) of the income tax law (Canada) (the “tax law”). Unfortunately for the trust, the CRA said such a question falls within the exclusive jurisdiction of the Internal Revenue Service and therefore was unable to answer it.
The CRA then turned to the second question. In their view, the relief from double taxation provided for in paragraph 2 of Article XXIV of the treaty is subject to the restrictions provided for in subsection 126(1) of the Tax Act. One of these restrictions provides that, in fact, if the trust pays tax in the United States on a capital gain arising from the actual disposition of a United States property, but does not have income sufficient US source for Canadian income tax purposes in the same year, an FTC may be unavailable. Another limitation is that foreign tax paid on non-business income for a given tax year cannot be carried forward to a previous tax year.
The CRA considered both of these circumstances likely to apply to the trust. Therefore, the CRA has declared that the trust cannot claim relief from double taxation under Article XXIV(2) of the Treaty. This is notwithstanding the obvious likelihood that the trust will be subject to tax in both Canada and the United States – ie double taxation. ARC stated that this approach is consistent with the commentary provided by the Organization for Economic Co-operation and Development (“OECD”) on Article 23B of the OECD Model Tax Convention on Income and on Capital, 2017 (the “Model tax treaty”). The model tax convention provides, among other things, that it is preferable to leave each State free to apply its own legislation and its own technique to avoid double taxation, and that the States can impose temporal restrictions on the request for credits foreign tax.
In the opinion of the CRA, it is reasonable to conclude that double taxation may arise even if an election under Article XIII(7) of the Treaty is available, but the taxpayer fails to make an election accordingly in respect of the year of the deemed disposition. Thus, Canadian residents holding US real property at the time of a deemed disposition event (such as a personal trust reaching its 21st birthday) should consider filing an election under Article XIII(7). However, based on the aforementioned CRA opinions, it appears that only the IRS could confirm whether such a choice is available.