13.3.2 U.S. Interpretation of the Treaty

13.3.2 [a] Article XIII(1) – Gains from Real Property

Paragraph 1 authorizes the U.S. to tax gains derived by a resident of Canada from the alienation of real property situated in the United States. This is an exception to the U.S. domestic law rule which generally exempts from U.S. taxation most gains realized by foreign persons.

The practical impact of this exception to the general rules is that careful planning is almost always desirable in connection with Canadian investment in U.S.real property. To illustrate, some of the many issues requiring consideration may include:

• Planning relating to the cross-border legal structuring of the real property and whether to hold the investment through a partnership, LLC, corporation or some combination thereof;
• Planning relating to repatriation of earnings;
• The combined Canadian and U.S. effective tax rate on repatriation of earnings;
• The merits of an election to have income treated as effectively connected with a U.S. trade or business under section 871(d).
• U.S withholding under sections 1441, 1442, 1445 and 1446;
• The impact of the branch profits tax under section 884 and availability of the $500,000 exe3mption;
• Planning relating to the alienation of U.S. real property;
• Financial modeling relating to the aforementioned; and
• Planning relating to reorganizations of real property holdings.

13.2.2[b] Article XIII(2) – Gains from personal property in Permanent Establishment Context

Paragraph 2 permits the taxation by the U.S. of gains by Canadian residents from the alternation of personal property constituting business property, if such gains are attributable to a permanent establishment or fixed base maintained by the Canadian resident in the United States.

13.2.2[c] Article XIII(3) – Definition of Real Property

Paragraph 3 expands the definition of real property to include the definition of a “United States real property interest” as defined under Code section 897[c]. Under section 897[c] of the Code, the term “United States real property interest” includes shares in a U.S. corporation that owns sufficient U.S. real property interests to satisfy an asset-ratio test on certain testing dates.

13.3.2[d] article XIII(4) – Residence – based Taxation of Other Gains

The general rule that limits the taxation of gains to the residence state is found in paragraph 4. Under this provision, only Canada has the right to tax gains of a resident of Canada, subject to paragraphs 1, 2, and 3, above.

13.3.2[e] Article XIII(5) – Gains Realized by Former Residents

Paragraph 5 provides yet a further exception to the U.S. domestic rul of not taxing gains derived by a non-resident alien, by preserving the right to tax a former U.S. citizen or resident individual under certain circumstances.

13.3.2[f] article XIII[6] – Special Rule for Principal Residence in Canada

Paragraph 6 provides a highly specialized rule applicable to a small number residents of Canada only contemplating immigration to the United States. The rule provides in principle relief from double taxation on the subsequent sale of the principal residence of a resident of Canada, where such sale occurs after the owner becomes a resident in the United States.

References: 

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

By:  Vitaly Timokhov, Raymond Montero, David Kerzner

Published by: Thomson Carswell