The purpose of this article is to provide an update on current developments at the Canadian Competent Authority regarding Article XIII(8) of the Canada-United States Tax Convention (1980)1 ("Convention") and similar provisions found in other Canadian tax treaties.2 It is generally well understood that the primary purpose of an income tax treaty is to avoid double taxation. One common cause of juridical double taxation is where there are timing differences between the income recognition tax laws of two Contracting States. The OECD Model Tax Convention on Income and on Capital3 (the "OECD Model") addresses these timing mismatches by attempting to put some obligation on Resident States to rectify the double tax by providing relief regardless of when the tax is levied by the Source State.4 The OECD Model does not, however, require either a Resident State or a Source State to defer the recognition of that income at the first incidence of taxation in an attempt to coordinate both States' rules as a means of avoiding double tax. Deferral of a Contracting State's immediate right to tax would generally require a clear provision in a tax treaty empowering that State to defer recognition of the profit, income or gain otherwise taxable immediately under its domestic laws. The Convention has incorporated several of these special deferral provisions5 allowing the competent authority of each state, at its sole discretion, to defer income in order to avoid potential double tax.
Article XIII(8) Agreements
Paragraph 8 of Article XIII of the Convention attempts to address the potential for double taxation in the context of a tax-free corporate (or other organization) reorganization in one State ("Resident State") when the assets, that are the subject of the corporate restructuring, are not all located within that State and the State of situs of the non-domestically located assets considers those assets to have been alienated as a result of the reorganization and taxes the profit, gain or income there from. In the context of where Canada is the State of situs of the non-domestically located assets, upon a request received by the acquirer of such assets, the Canadian Competent Authority may enter into an agreement with the acquirer to defer the recognition of the profit, gain or income in accordance with Article XIII(8) of the Convention and section 115.1 of the Income Tax Act6 ("Act"). Relief from double taxation would then be achieved through a deferral of taxation in Canada. As mentioned above, the deferral, however, is not automatic and the deferral provisions leave its granting to the "sole" discretion of the Competent Authority of that State.
Paragraphs 72 to 85 of Information Circular 71-17R5, Guidance on Competent Authority Assistance Under Canada's Tax Conventions7 ("Circular"), summarize the Canadian Competent Authority's policies regarding agreements made pursuant to Article XIII(8) of the Convention. However, since the publication of the latest version of the Circular in 2005, the Canadian Competent Authority has undertaken a major policy review regarding the administration of Article XIII(8). This review was completed in 20068 and focused largely on the manner in which these agreements should be drafted (e.g. rollover versus suspended gain approach) and the types of subsequent transactions (i.e. transactions subsequent to the transaction that was the subject of the Article XIII(8) agreement) that are offensive in policy terms and should cause the Canadian Competent Authority to cease to defer the income, profit or gain. Even though there has been no official announcement by the Canadian Competent Authority, another major policy review began in 2010 and is still ongoing.9 However, the 2010 Policy Review is more focused on cross border divestitures and public company spin-offs and whether it is appropriate to enter into Article XIII(8) agreements in such circumstances.
2006 Policy Review of Article XIII(8)
The results of the 2006 Policy Review were summarized by the Canadian Competent Authority in its written response to Question 16 of the 2006 TEI Conference.10 The Canadian Competent Authority's policy with respect to agreements under Article XIII(8) of the Convention was broadened at that time to include individuals residing in the United States who enter into transactions described therein where the circumstances warrant relief. The Canadian Competent Authority also announced at that time that Article XIII(8) agreements would continue to follow a rollover approach where the vendor's cost base in the Taxable Canadian Property ("TCP") at the time of the reorganization will become the acquirer's cost base of the TCP. However, agreements concluded by the Canadian Competent Authority would be subject to a number of terms and conditions (generally referred to in such agreements as "triggering events") that require the immediate recognition of the deferred profit, gain or income in Canada if certain events occur during the deferral period that are considered offensive to Canada in policy terms. The following are some examples of the key triggering events that might cause the immediate recognition of the deferred profit, gain or income:
- where the TCP alienated consists of shares of a corporation resident in Canada, the payment of dividends in contemplation of a subsequent sale of the shares of that corporation may cause a triggering event. Consideration should therefore always be given by taxpayers to tax planning strategies which may alleviate these effects;
- any other transactions whereby the TCP initially alienated is no longer subject to tax in Canada, such as a change in the asset-mix of a corporation so that its shares no longer derive their value principally from real property situated in Canada11 ;
- transactions involving an arm's length sale, whether directly or indirectly, of the consideration (e.g. shares) issued to the vendor at the time of the Article XIII(8) transaction. The rationale for this is that a fundamental principle underlying the negotiation of terms and conditions for a deferral is that the Canadian Competent Authority will only agree to defer a gain up to the point in time when tax in the Resident State becomes payable in connection with the deferred gain, whether directly or indirectly; and
- with respect to individuals, date of death will be a triggering event since the Canadian Competent Authority is concerned that individuals could utilize Article XIII(8) agreements to reorganize their Canadian holdings to avoid future "date of death" tax consequences in Canada.
The principle message given by the Canadian Competent Authority in its written response to TEI on Question #16 was:
The main outcome of these consultations is a focus on the purpose of Article XIII(8) of the Convention, which is to avoid double taxation due to timing differences between the rules of both countries with respect to the recognition of gains, and not to facilitate tax planning.12 [Emphasis added]
It is evident that the Canadian Competent Authority is attempting to strike a delicate balance between safeguarding Canada's right to tax the deferred gain and achieving the desired objective of avoiding double taxation. The consequences, unfortunately, are that certain tax planning strategies that could have been accomplished had the non-resident taxpayer structured its Canadian holdings appropriately in the first place cannot achieve the new structure through the use of an Article XIII(8) agreement. Because of the Canadian Competent Authority's objective to protect their domestic right to tax the deferred gain, the fact that certain tax planning techniques would have been acceptable at the outset have been determined, in Article XIII(8) policy terms, not to be relevant.
2010 Policy Review (Public Company Spin-Offs and Internal Divisive Reorganizations)
With respect to the subject of public company spin-offs and internal divisive reorganizations, the Canadian Competent Authority has not been prepared to enter into Article XIII(8) agreements in certain scenarios. However, various tax practitioners have raised reasonable arguments against these existing policies and the Canadian Competent Authority has decided to revisit the matter. The project currently under review by the Canadian Competent Authority involves several scenarios fitting into the above category and the policy issues related thereto are quite complex. A full discussion of these structures and policy concerns is beyond the scope of this article. However, I will give a brief explanation of the two main contentious issues under review, as well as a third issue regarding whether it is appropriate for the Canadian Competent Authority to even enter into such agreements where the treaty partner (i.e. Resident State) does not tax the capital gain on the disposition of TCP.
Public Company Spin-Offs
To illustrate a simple scenario, consider a U.S. public corporation ("U.S. Vendor") who is proposing to spin-off the shares of its Canadian subsidiary ("Canco") to its shareholders. As a preliminary step, the U.S. Vendor transfers the shares of Canco to a wholly-owned U.S. subsidiary ("U.S. Newco") and then spins-off the shares of U.S. Newco to its shareholders. The series of transactions is done on a tax deferred basis for U.S. tax purposes. The first transaction in that series, that is, the transfer of the Canco shares to the U.S. Newco by U.S. Vendor, is the transaction that would be the subject of the Article XIII(8) agreement on the assumption, of course, that the shares of Canco are not treaty protected property as that term is defined in section 248 of the Act. At that stage there is nothing really offensive with the transaction in policy terms. However, the triggering event described above under the heading "2006 Policy Review of Article XIII(8)" regarding transactions involving an arm's length sale, whether directly or indirectly, of the consideration (e.g. shares of U.S. Newco) issued to the vendor (e.g. U.S. Vendor) at the time of the Article XIII(8) transaction will, for all intent and purpose, render the Article XIII(8) agreement pointless as the spin-off by U.S. Vendor of the shares of U.S. Newco to the public shareholders will cause the deferred gain to be brought immediately into income. Even if the Canadian Competent Authority was prepared not to apply that particular triggering event in its Article XIII(8) agreement to that particular transaction, because it does not find the spin-off transaction offensive13 , it would not matter. That is, even if the triggering event is not applied to the spin-off transaction, the same triggering event will apply when the public shareholders begin to sell the shares of U.S. Newco in the open market, the latter transaction being a taxable event in the U.S.
The obvious concern with this current Canadian Competent Authority policy is that the U.S. public shareholders had always been in a position to dispose of the shares of U.S. Vendor (and indirectly the shares of Canco) without generating any tax consequences in Canada. Therefore, since the treaty protection for the public shareholders already existed and was not being created as the result of the reorganization, the disposal of the shares of U.S. Newco should not result in any tax consequences in Canada. However, the Canadian Competent Authority has maintained this policy because they are of the view that it is not appropriate to allow a deferral in these cases because, among other factors, arm's length parties would be indirectly acquiring the Canco shares and U.S. Vendor would no longer have any interest in the property at the end of the series of transactions. They are of the view that Article XIII(8) was not intended to apply to a divestiture of TCP. Rather, the granting of a deferral was only intended to apply to reorganizations where the initial owner maintained its interest in the property, albeit through a different structure.
Internal Divisive Reorganizations
The other contentious issue currently under review by the Canadian Competent Authority relates to those reorganizations that involve the spin-off of various companies or assets in the corporate group but do not result in a disposition or divestiture of such property (TCP) by the existing owner to arm's length parties. Commonly this type of internal divisive reorganization within a corporate group of companies is intended to segregate certain assets of the group for commercial reasons such as streamlining business operations or creditor proofing. The problem that occurs is where the steps undertaken in the Resident State for the divisive reorganization cannot be generally accomplished on a tax-deferred basis in Canada. The concern here is that the Canadian Competent Authority does not want to give a more preferential treatment to a non-resident of Canada that it would to its own residents in similar circumstances. For example, where the divisive reorganization involves a direct distribution of the TCP by the U.S. Vendor to its shareholder(s), regardless that these transactions may be able to be accomplished on a tax free basis in the Resident State, they do not meet the condition outlined in subparagraph 76(c) of the Circular in that there is no similar rollover provision in Canadian law that would be applicable to the proposed reorganization if it involved only residents of Canada. In other words, had a Canadian resident corporation distributed its assets directly to a shareholder, subsections 69(4) or (5) of the Act would generally apply to deem there to be a disposition of such assets at fair market value. This type of reorganization (direct spin-off of corporate assets to its shareholders) cannot be done in Canada on a tax deferred basis. Canadian residents are required to structure these reorganizations in a manner that complies with the rules in the Act for divisive reorganizations (e.g. paragraphs 55(3)(a) and (b) of the Act). Therefore, the Canadian Competent Authority has requested taxpayers in the past to restructure their affairs in the Resident State in a way that simulates a paragraph 55(3)(a) or (b) type divisive reorganization.
If the vendor is a resident of the U.S., these requests to restructure in order to get an Article XIII(8) agreement may be possible in some cases but is sometimes not practical for the taxpayer. However, other countries that have a treaty with Canada and a similar provision to Article XIII(8) may not have tax laws that would allow for this type of restructuring and the only tax deferred transaction possible in that country is a direct spin-off of the corporate assets. The Canadian Competent Authority's current policy is to reject requests for Article XIII(8) agreements in those cases where a direct spin-off of corporate assets is undertaken.
The main argument against this policy is that it really restricts the application of Article XIII(8), and its equivalent in other treaties, in an unreasonable manner. For example, it is highly unlikely that the treaty negotiators would have expected the two treaty partners to have similar or identical corporate reorganization tax laws when it negotiated the inclusion of this provision into the treaty. The policy objective should simply be, after looking at the overall purpose and final result of the foreign reorganization, that as long as a deferral could have been obtained in Canada in an all Canadian context, regardless of the precise steps that would have been necessary under the Act (e.g. a paragraph 55(3)(a) reorganization), that should be sufficient.
As there are reasonable arguments that have been put forth by practitioners, the Canadian Competent Authority has agreed to re-examine its policy on this. However, as the policy issue described in subparagraph 76(c) of the Circular is fairly long standing, the Canadian Competent Authority intends to maintain its current policy until they have had an opportunity to consult with their policy advisors on this and other related issues.
Gains not Taxable in Resident State due to Territorial or Exclusionary Tax Systems
As mentioned above, the Canadian Competent Authority have stated that the main purpose of Article XIII(8) of the Convention is to "avoid double taxation due to timing differences between the rules of both countries". Historically, the Article XIII(8) type workload received by the Canadian Competent Authority has predominately involved U.S. residents disposing of TCP where the gain was not taxable in the U.S. due to a special deferral or non-recognition provision in its domestic tax laws. The scenarios have always involved TCP that will ultimately be taxable in the Resident State (i.e. the U.S.) upon a subsequent arm's length disposition of the TCP, hence the "timing" issue between the two Contracting States. However, recent cross border reorganizations involving residents of other countries in which Canada shares a tax treaty, and that has an Article XIII(8) type provision in the treaty, have raised an issue where the gain on the disposition of the TCP is permanently not taxable in the Resident State.
As a simple example, consider a treaty partner of Canada that has an exclusionary tax system which provides an exemption method of relief with respect to certain foreign source income (including the gain on the disposition of the Canadian TCP). In light of the Canadian Competent Authority's stated purpose of Article XIII(8) of the Convention, this certainly raises an interesting policy issue with respect to whether the Canadian Competent Authority should even entertain a request for deferral. It also begs the question as to why an Article XIII(8) type provision was included in the treaty in the first place. One would only have to look at the Canadian Competent Authority's current Article XIII(8) template agreement, which is available to taxpayers upon request, to see that the majority of the triggering events described therein are based on the policy objective that the Canadian deferral should not continue past a point in time where there is no longer a double tax exposure. In the case of a permanent deferral or exemption in the Resident State, there will never be double tax exposure.
If the Canadian Competent Authority were to enter into Article XIII(8) type agreements where the capital gain on the disposition of the TCP is permanently exempt from tax in the Resident State, then it is possible that they would have to go back to square one to completely revise, and simplify, their approach to Article XIII(8) in general. For example, it will be difficult for the Canadian Competent Authority to maintain the position that the purpose of these treaty provisions is to avoid double tax. Entering into a XIII(8) type agreement where the capital gain is not taxable in the other state due to a territorial or exclusionary tax system would seem to suggest an admission that the true purpose of these treaty provisions is strictly to facilitate cross border reorganizations where no actual economic realization of proceeds of disposition have occurred. This would be a significant change in direction for the Canadian Competent Authority and their previous policy advice. This would also seem inconsistent with the primary purpose of a tax treaty which is to avoid double tax.
On the other hand, should it be relevant whether Canada's treaty partner has a territorial or exclusionary tax system versus a residency based tax system, where, for example, foreign tax credit relief is provided to alleviate double tax on foreign source income? In the latter case, the Resident State has only residual taxing rights anyhow. But if the Canadian Competent Authority was prepared to give Article XIII(8) type agreements to taxpayers residing in a Contracting State with a territorial or exclusionary tax system, would that not be akin to treating Article XIII(8) like a tax sparing provision? This is an extremely difficult treaty policy issue that could have ramifications on the entire current competent authority process.
New U.S. Tax Legislation Regarding "Foreign Tax Splitters"
A new section of the Internal Revenue Code (the "Code") will likely need to be considered by the Canadian Competent Authority to determine the potential impact of the new legislation on the Canadian Competent Authority's Article XIII(8) program. Section 909 was added to the Code in 2010 (generally applicable after December 31, 2010) and deals with "foreign tax splitters". It contains new rules that "suspend" a foreign tax credit for US tax purposes when the item of income that gave rise to the foreign tax is not immediately recognized for US tax purposes. Under the new section, the foreign tax credit is allowed in the year the item of income is recognized for US tax purposes. These rules would appear to remove any double tax exposure to U.S. taxpayers eligible for the domestic relief. Although these rules seem to be intended to apply mostly to hybrid entities, they may be applicable in certain Article XIII(8) scenarios. If so, this will raise similar policy issues to those discussed above where the gain on the disposition of the TCP is permanently not taxable in the Resident State due to territorial or exclusionary tax systems. Again, the Canadian Competent Authority will have to seriously reconsider its policy that the main purpose of Article XIII(8) is to "avoid double taxation due to timing differences between the rules of both countries".
As can be seen from above, Article XIII(8) is not being administered by the Canadian Competent Authority as a simple automatic rollover provision. In reality, the XIII(8) agreements are more of a quasi rollover-suspended gain approach and are quite complex. Taxpayers and their advisors should not assume that the provision will apply in all cross border reorganizations where there is a timing mismatch. Early discussions with the Canadian Competent Authority should be done before significant hours and resources are invested preparing Article XIII(8) submissions. This will ensure that if there are policy impediments that would otherwise prevent the Canadian Competent Authority from entering into an agreement, it is at least brought to the attention of the taxpayer and their advisor at a very early stage. Also, some specialized tax planning may be a good idea before the Article XIII(8) transactions are actually carried out to avoid unfavourable tax treatment.
On the flip side, the 2010 policy review may eventually broaden the eligibility for Article XIII(8) relief and taxpayers and their advisors should be aware of that possibility, especially with respect to U.S. public company spin-offs and internal divisive reorganizations. As a further possibility, Canada's Department of Finance may ultimately amend the Act to allow for a deferral of the gain in certain transactions involving non-residents disposing of TCP to non-Canadian entities. They have already introduced provisions to accommodate Canadian shareholders of foreign entities that are involved in spin-offs 14. Also, the need for such amendments to the Act is clearly evident in cases involving U.S. absorptive mergers where the U.S. entity that legally ceases to exist, as a consequence of the merger, held TCP. Even though the latter scenario is a typical transaction that is granted Article XIII(8) relief by the Canadian Competent Authority, the complexity of those agreements and the potential adverse tax consequences where a subsequent triggering event occurs make Article XIII(8) agreements an option of last resort for taxpayers.
Finally, where a tax-free corporate (or other organization) reorganization takes place in a country with which Canada has entered into a tax treaty, but that particular tax treaty does not have an Article XIII(8) type provision, and the reorganization results in a taxable event in Canada (e.g. a disposition of TCP by a non-resident of Canada), then no deferral of the gain, for Canadian tax purposes, will likely be possible. As alluded to in the opening paragraph above, in the absence of a specific deferral provision in the treaty, the Canadian Competent Authority, to date, has refused to defer the recognition of any such gain as a means of avoiding potential or future double tax. It would generally be expected, as a means of resolving double taxation, that the resident state will provide a foreign tax credit for the Canadian taxes payable, ideally in the year it taxes the gain. It is evident that the Canadian Competent Authority is of the view that, in the absence of a special deferral provision in the treaty, and where a timing issue has arisen regarding the income recognition laws of both states, deferral of tax at the first incidence of taxation is a benefit that goes beyond its mandate of relieving double tax.
 Convention between Canada and the United States of America with Respect to Taxes on Income and on Capital, 26 September 1980, SC 1984, c 20, Part I (entered into force 16 August 1984) as amended by the protocols done in 1983, 1984, 1995, 1997 and 2007 (Fifth Protocol, SC 2007, c 32 (entered into force 15 December 2008)) [Convention].
 Estonia, (art 13, para 5), Finland (art 13, para 6), Germany (art 13, para 5), Hungary (art 13, para 5), Iceland (art 13, para 5), Korea (art 13, para 9), Latvia (art 13, para 5), Lithuania (art 13, para 5), Luxembourg (art 13, para 6), Mongolia (art 13, para 5), Netherlands (art 13, para 6), Norway (art 13, para 9), Peru (art 13, para 5), Switzerland (art 13, para 5), Tanzania (art 13, para 6), Venezuela (art 13, para 8) and Zimbabwe (art 14, para 6).
 OECD, Model Tax Convention on Income and on Capital, Condensed Version (OECD Publishing, 2010) [OECD Model].
 See OECD Model, ibid at para 32.8 of the commentary to articles 23A and 23B.
 See Convention, supra note 1 at articles XIII(8), XXIXB(5) (Death) and XVIII(7)(Pensions and Annuities).
 Income Tax Act, RSC 1985 (5th Supp), c 1 [ITA].
 Canada Revenue Agency, Information Circular 71-17R5, "Guidance on Competent Authority Assistance Under Canada's Tax Conventions" (1 January 2005).
 Tax Executives Institute Inc, "Income Tax Questions Submitted to Canada Revenue Agency [with Responses from CRA]" (December 5, 2006), (2010) Thomson Reuters Canada Ltd TaxPartner [TEI Questions].
 The Canadian Competent Authority has been informing tax practitioners who have current files with them, or who have simply made enquiries, that another policy review is ongoing.
 See Convention, supra note 1 at article XIII, para 4 (Denies Canada the right to tax the gain arising on the disposition of the TCP in that scenario).
 TEI Questions, supra note 8.
 For example, since the spin-off did not result in a taxable event in the U.S., it should not be considered offensive in Canadian article XIII(8) policy terms and thus it should not be necessary to cause the deferred gain to be brought back into income)
 ITA, supra note 6 at s 86.1.