Canada and U.S. sign new tax protocol
by Carey Singer

Following a decade of negotiation, a Fifth Protocol (the Protocol) amending the Canada-U.S. Income Tax Convention was signed on September 21, 2007, by Canadian and U.S. representatives. The Protocol must still be ratified by the Canadian Parliament and U.S. Senate. Many of the proposed changes will be effective on either the ratification date or January 1, 2008 — whichever is later.

The Protocol contains several significant changes, including:

• The elimination of the withholding tax on cross-border interest payments. Currently, when a person in one country borrows money from a lender in the other country, any interest payments made are subject to a 10-per-cent withholding tax. The Protocol eliminates this tax for loans between non-related persons, effective on the second month after the Protocol goes into force. For related-party loans, the Protocol eliminates the tax over a three-year phase-in period.

• New rules that allow (or deny) treaty benefits (of the Canada-U.S. tax treaty) for income received through hybrid entities. These entities include limited liability companies that are currently treated as fiscally transparent in the United States, but not in Canada.

• A comprehensive "limitation on benefits" provision, which helps ensure that the treaty benefits are only available to residents of Canada or the United States.

• A process requiring the tax authorities of Canada and the United States to resolve certain issues through binding arbitration. This will provide personal and corporate taxpayers with increased certainty that cases involving double taxation will be resolved.

• Rules to address pension contributions and accrued pension benefits in cross-border employment situations. Canadian residents who are employed across the border, and who participate in their American employer's 401(k) pension plan, will be able to deduct their contributions for both Canadian and U.S. tax purposes.

• Rules clarifying how to tax stock options in cross-border situations. Currently, no rule governs how Canada and the United States would divide up the taxation in a situation where a stock option granted to an employee in one country is exercised by the employee after moving to the other country to work for the same or a related employer.

Our U.S. tax team can help you take advantage of the Protocol.

Carey is a U.S. Tax Partner and the leader of the U.S. Tax Team. He can be reached at (416) 644-4354 or by e-mail at carey_singer@mintzca.com.

Tax Alert is an e-newsletter written by the Tax Team of Mintz & Partners LLP. Please go to http://www.mintzca.com/index.php?section=taxdirectory to learn more about our Tax Team. The issues raised are for information purposes only. Readers are urged to contact their professional advisors before acting on the basis of the material contained herein.

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