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Canada, United States Sign Tax Treaty

Related documents:

• Backgrounder.
• Protocol.
• FAQ: Taxation of Social Security Benefits.
• Treaty: Convention between Canada and the United States of America With Respect to Taxes on Income and on Capital - Adobe Acrobat Version (126,525 bytes).

Finance Minister Paul Martin today announced that a fourth Protocol to the Convention between Canada and the United States of America with Respect to Taxes on Income and on Capital (commonly known as the Canada-U.S. tax treaty) was signed today at Ottawa.

The Protocol, a draft version of which was initialed by officials this past April, addresses the taxation of social security benefits paid by one country to residents of the other, and the taxation of certain capital gains. The Protocol will become law when it is approved by the legislatures of both countries and instruments of ratification are exchanged.

"The Protocol will deliver significant tax relief to thousands of lower-income Canadians who receive U.S. social security benefits," Mr. Martin said. "Upon ratification, they will pay Canadian tax instead of the flat, non-refundable U.S. withholding tax they now pay."

The Protocol will also exempt from tax in Canada 15 per cent of any United States benefit paid to Canadian residents. Accordingly, a Canadian resident who receives $100 in U.S. benefits will include only $85 in their taxable income. As well, the United States will not tax its residents who receive Canadian benefits that are tax-free in Canada.

The new rules for social security benefits will apply retroactively to January 1, 1996, the date the current rule took effect. Refunds of excess tax paid will be distributed when the Protocol has been approved by the Parliament of Canada and the United States Senate. Revenue Canada will administer refunds for residents of Canada. Most refunds to Canadian residents should be automatic, without need for special application.

With respect to capital gains, the treaty proposes to limit the capital gains that each country can tax. Currently, neither country taxes non-residents' gains on shares of non-resident corporations. However, in 1995 Canada announced income tax amendments that would tax non-residents' gains on shares of some non-resident companies. The Protocol will preserve each country's exclusive right to tax its residents in these circumstances.

The Protocol was signed on behalf of Canada by Michael Leir, Director General, U.S. Relations, Department of Foreign Affairs and International Trade; and on behalf of the United States by Vladimir Sambaiew, Minister-Counselor for Economic Affairs, Embassy of the United States of America.

The text of the Protocol and additional background material are attached.

___________________ 
For further information:

Lawrence Purdy
Tax Legislation Division
(613) 996-0602

Protocol to Canada-U.S. Tax Treaty:
Backgrounder

1. Social Security benefits

How benefits are now taxed

Both Canada and the United States pay social security benefits to large numbers of people in the other country. Most of these are people who worked in one country and retired to the other. Others are persons with disabilities, or the surviving spouses or children of cross-border workers.

The Canada-United States tax treaty sets out which country can tax these benefits. Before 1996, the country that paid a benefit to a resident of the other country could not tax the benefit at all. The country where the recipient lived could include half the benefit in the recipient's taxable income. The other half was entirely tax-free.

In 1996 the tax treaty was changed. Under this rule, the country that pays a benefit can tax all of it. The country where the recipient lives cannot tax it at all.

Canada ordinarily taxes outbound Canada (and Quebec) Pension Plan and Old Age Security benefits at a 25 per cent rate. Canada also applies the OAS recovery tax to non-residents. However, any non-resident pensioner can choose to file a Canadian tax return and pay tax at ordinary Canadian rates, rather than the flat 25 per cent. Many low-income U.S. recipients thus pay little or no Canadian tax on their Canadian benefits.

The United States taxes outbound social security benefits at a rate of 25.5 per cent. But unlike Canada, the U.S. does not allow non-resident pensioners (other than U.S. citizens and resident aliens) to file tax returns. The 25.5 per cent tax is fixed and final.

The proposed new rule

The proposed new rule, included in the latest Protocol to the tax treaty, will give the country of residence the exclusive right to tax social security benefits. This means that only Canada will be able to tax U.S. benefits paid to residents of Canada, and vice versa.

This taxation in the country of residence will be subject to some special rules. For residents of Canada, only 85 per cent of U.S. benefits will be included in taxable income. This means that 15 per cent of those benefits will be exempt from tax. For U.S. residents, any type of Canadian benefit that is exempt from tax in Canada will also be exempt in the United States.

In order to take effect, the Protocol must be formally adopted ("ratified") in both countries. In Canada, Parliament must pass a Bill that makes the Protocol part of Canadian law. In the United States, the Senate must approve the Protocol.

What the change means

Once the Protocol is ratified, several thousand low-income Canadians will no longer pay any income tax at all. Thousands more will pay less tax than they do currently. This new rule will apply as of January 1, 1996, the date the current rule came into effect. Excess tax collected under the current rule will therefore be refunded to social security recipients in both countries.

The change brings retroactive relief, but does not increase anybody's tax for the retroactive period. For example, Canada will ensure that the tax that applies to Canadian residents for 1996 and 1997 does not exceed the tax that the U.S. collected.

Canadian and U.S. authorities will work together to ensure that refunds can be paid out, after ratification, as quickly and efficiently as possible. For most residents of Canada, refunds will be handled automatically by Revenue Canada. In most cases, no special application or other forms will be required. Revenue Canada will have more information about the refund process as ratification approaches.

2. Capital gains on real estate

The Canada-U.S. tax treaty provides that Canada can tax capital gains realized by a resident of the U.S. on the shares of (or an interest in) any corporation, trust or partnership whose value is mostly made up of Canadian real estate. Similarly, the United States can tax gains realized by a resident of Canada on what is known in U.S. law as a "United States real property interest."

The definition of "United States real property interest" currently includes some Canadian partnerships and trusts, based on their holdings of U.S. property, but does not apply in the same way to shares of non-U.S. corporations. Canadian law currently taxes non-residents' gains on some non-Canadian partnerships, but not on non-resident trusts or corporations.

In 1995, Canada proposed to amend the Income Tax Act to tax non-residents' gains on shares of non-resident corporations, and interests in non-resident trusts, where most of the value of the shares or interests is attributable to Canadian real estate or resource property. Except where a tax treaty precludes such tax, the new rule would apply to gains that accrued (measured proportionally) after April 26, 1995.

The Protocol signed today will limit the application of this proposed Canadian tax change in the case of United States residents. Canada will agree not to tax U.S. residents' gains on shares of corporations that are not resident in Canada. Similarly, the United States will agree that "United States real property interests" will not include shares of corporations that are not resident in the U.S. The change applies as of April 26, 1995.

The change means that Canadians who invest in U.S. real estate through Canadian companies will continue to pay Canadian tax, rather than any possible future U.S. tax, when they sell their shares. And U.S. investors in U.S. companies that hold property in Canada will still pay U.S. tax when they sell their shares, rather than Canadian tax.

Protocol Amending the Convention Between Canada and the United States of America With Respect to Taxes on Income and on Capital Signed at Washington on September 26, 1980 As amended by the Protocols Signed on June 14, 1983, March 28, 1984 and March 17, 1995

Canada and the United States of America, desiring to conclude a Protocol to amend the Convention Between Canada and the United States of America with Respect to Taxes on Income and on Capital signed at Washington on September 26, 1980, as amended by the Protocols signed on June 14, 1983, March 28, 1984 and March 17, 1995 (hereinafter referred to as "the Convention"), have agreed as follows:

Article 1

1. Paragraph 3(a) of Article XIII (Gains) of the Convention shall be deleted and replaced by the following:

"(a) In the case of real property situated in the United States, means a United States real property interest and real property referred to in Article VI (Income from Real Property) situated in the United States, but does not include a share of the capital stock of a company that is not a resident of the United States; and"

2. Paragraph 3(b)(ii) of Article XIII (Gains) of the Convention shall be deleted and replaced by the following:

"(ii) A share of the capital stock of a company that is a resident of Canada, the value of whose shares is derived principally from real property situated in Canada; and"

Article 2

1. Paragraph 3 of Article XVIII (Pensions and Annuities) of the Convention shall be deleted and replaced by the following:

"3. For the purposes of this Convention, the term "pensions" includes any payment under a superannuation, pension or other retirement arrangement, Armed Forces retirement pay, war veterans pensions and allowances and amounts paid under a sickness, accident or disability plan, but does not include payments under an income-averaging annuity contract or, except for the purposes of Article XIX (Government Service), any benefit referred to in paragraph 5."

2. Paragraph 5 of Article XVIII (Pensions and Annuities) of the Convention shall be deleted and replaced by the following:

"5. Benefits under the social security legislation in a Contracting State (including tier 1 railroad retirement benefits but not including unemployment benefits) paid to a resident of the other Contracting State shall be taxable only in that other State, subject to the following conditions:

(a) a benefit under the social security legislation in the United States paid to a resident of Canada shall be taxable in Canada as though it were a benefit under the Canada Pension Plan, except that 15 per cent of the amount of the benefit shall be exempt from Canadian tax; and

(b) a benefit under the social security legislation in Canada paid to a resident of the United States shall be taxable in the United States as though it were a benefit under the Social Security Act, except that a type of benefit that is not subject to Canadian tax when paid to residents of Canada shall be exempt from United States tax."

Article 3

1. This Protocol shall be subject to ratification in accordance with the applicable procedures in Canada and the United States and instruments of ratification shall be exchanged as soon as possible.

2. This Protocol shall enter into force upon the exchange of instruments of ratification, and shall have effect as follows:

(a) Article 1 of this Protocol shall have effect as of April 26, 1995; and

(b) Article 2 of this Protocol shall have effect with respect to amounts paid or credited to a resident of the other Contracting State after 1995, except that where a Contracting State has, in accordance with the Convention read without reference to this Protocol, imposed a tax on benefits paid or credited under the social security legislation in that State, and those benefits are paid or credited after 1995 and

(i) before the calendar year in which this Protocol enters into force, if this Protocol enters into force before September 1 of that year, or

(ii) before the end of the calendar year in which this Protocol enters into force, if this Protocol enters into force after August 31 of that year,

Article 2 shall only have effect with respect to such benefits (referred to in this Article as "source-taxed benefits") as described in paragraphs 3, 4 and 5.

3. With respect to source-taxed benefits paid by a Contracting State to a resident of the other Contracting State, Article 2 applies only if the resident has, within three years after the date on which this Protocol enters into force, applied to the competent authority of the first-mentioned Contracting State for a refund of the tax imposed on the benefits. However, with respect to source-taxed benefits paid by the United States to a resident of Canada, the competent authority of Canada shall:

(a) apply for and receive such refund on behalf of the resident;

(b) remit to the resident, in accordance with the law of Canada governing refunds of income tax overpayments, such refund less any tax imposed in Canada on the benefits in accordance with Article 2 of this Protocol; and

(c) make the application referred to in subparagraph (a) only if the additional tax that would be imposed in Canada on the benefits, on the assumption that Article 2 of this Protocol applied, would be less than the tax imposed in the United States on the benefits as a result of paragraph 5 of Article XVIII (Pensions and Annuities) of the Convention read without reference to this Protocol.

4. All taxes refunded as a result of this Protocol shall be refunded without interest and interest on any taxes of a resident of a Contracting State assessed as a result of this Protocol shall be computed as though those taxes became payable no earlier than December 31 of the year following the year in which this Protocol enters into force.

5. The competent authorities of the Contracting States shall establish procedures for making or revoking the application referred to in paragraph 3 and shall agree on such additional procedures as are necessary to ensure the appropriate implementation of this Protocol.

IN WITNESS WHEREOF, the undersigned, being duly authorized thereto by their respective Governments, have signed this Protocol.

Done at Ottawa in duplicate, in the English and French languages, both texts being equally authentic, this 29th day of July, 1997.