Monthly Archives: September 2016


On September 23, 2016,treaty-150x150 I got an email from the Ministry of Finance announcing a new tax treaty between Canada and Israel.

The actual posting on the Ministry’s website contained the following statement:

“A new Convention between the Government of Canada and the Government of the State of Israel for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income was signed in New York on September 21, 2016.

The new Convention limits the rate of withholding tax to 5% for dividends paid to a company that holds directly or indirectly at least 25% of the capital of the company that pays the dividends, to 15% for dividends paid in all other cases, and to 10% for payments of interest and royalties. The new Convention also exempts from withholding tax certain payments of interest and royalties.

The new Convention includes provisions reflecting the standard developed by the Organisation for Economic Co-operation and Development for the exchange of information for tax purposes.

The new Convention will enter into force once Canada and the State of Israel have notified each other that the procedures required by their laws for the bringing into force of the Convention have been completed. The new Convention will have effect in accordance with Article 28 of the Convention.”

As soon as I read this, I said to myself “I bet that they closed ‘The Loophole’ too!”

What is “The Loophole”? First, some background discussion, and then I wilI explain.

Under Canada’s domestic tax law, at least as it has applied since 2010, shares of a corporation that derive more than 50% of their value, directly or indirectly, from Canadian real estate, are “taxable Canadian property” (“TCP”). This means that non-residents are subject to Canadian tax on gains derived from that property.

In a general sense, Canada’s tax treaties normally permit Canada to levy tax in such circumstances. The main departures from domestic tax law are that there is no 60 month “lookback” rule in tax treaties; some treaties limit Canada’s ability to levy tax to situations where the corporations is resident in Canada[1]; and some treaties exclude situations where the relevant real estate is used in a business of the owner[2].

In addition, both domestic law, and tax treaties, are generally drafted in such a way that the real estate does not have to be held directly by the relevant corporation-it could be held in a subsidiary, even several tiers below.

Envision a situation where a Canadian corporation (“Canco”) owns nothing but the shares of a subsidiary, and the sole asset of that subsidiary is Canadian real estate. For sure, the shares of Canco are TCP, and generally tax treaties would allow Canada to levy tax on any resulting gains.

Now here is “The Loophole”:

The relevant provision of Canada’s current tax treaty with Israel (Article 13(3)) says the following (bold-faced lettering added)

“Gains from the alienation of shares of a company, the property of which consists principally of immovable property situated in a Contracting State, may be taxed in that State. Gains from the alienation of an interest in a partnership or a trust, the property of which consists principally of immovable property situated in a Contracting State, may be taxed in that State.”

In the example note above, Canco owns no “immovable property” (i.e. real estate) and hence Canada would not have any right to tax the gain. In fact, Article 13(4) would preclude it, since it states:

“Gains from the alienation of any property, other than those mentioned in paragraphs 1, 2 and 3 shall be taxable only in the Contracting State of which the alienator is a resident.”

Based on the revised version of the treaty that was just released, it looks like the powers that be woke-up and found The Loophole! Article 13(3) will now read as follows:

“Gains derived by a resident of a Contracting State from the alienation of:

(a) shares, deriving more than 50 per cent of their value directly or indirectly from immovable property situated in the other State (at the time of the alienation or at any time during the twelve preceding months); or

(b) an interest in a partnership, trust or other entity, deriving more than 50 per cent of its value directly or indirectly from immovable property situated in that other State (at the time of the alienation or at any time during the twelve preceding months);

may be taxed in that other State.”

This, of course will catch the Canco shares as mentioned above.

Interestingly enough, some years back, several of Canada’s tax treaties, including those with Italy and Switzerland, also had The Loophole, until they were fixed. The same was true for the one with Barbados until a revision was released in 2011.

As far as I know, the treaty with Israel was the last one that still had The Loophole, although I cannot claim to have actually reviewed all of Canada’s tax treaties currently in force to be  certain about that (at the end of 2015, there were 94 of them!). If anybody out there knows of another, please send me an email!

However, The Loophole is not quite dead and buried yet. Under Article 28(1), the new treaty comes into force as indicated below

“Each of the Contracting States shall notify the other Contracting State in writing, through diplomatic channels, of the completion of the procedures required by its law for the bringing into force of this Convention. This Convention shall enter into force on the date of the later of these notifications and its provisions shall have effect:

(a) in respect of taxes withheld at source, on amounts paid or credited to non-residents, on or after the first day of January of the calendar year following that in which this Convention enters into force; and

(b) in respect of other taxes, for taxation years beginning on or after the first day of January of the calendar year following that in which this Convention enters into force.”

This means, that, at the very earliest, it would not come into effect until January 1, 2017, and that would only occur if both countries ratified by the end of 2016-highly unlikely!

Until then, The Loophole still applies.

Accordingly, it would theoretically be possible for an Israeli resident to take steps to lock-in tax-exempt gains that have accrued by taking steps to “crystallize” them before The Loophole is actually closed. For example, in connection with the Canco shares mentioned above, steps could be taken to create a capital gain and tax-exempt step-up in cost base by implementing what is often called a “dirty section 86”[3] reorganization.

[1] For example, the ones with the US, Germany and the Netherlands

[2] For example, the ones with the UK, France, Germany, Mexico and the Netherlands

[3] Under which the existing shares of Canco would be purchased for cancellation in return for shares of another class. By filing form T2057 with the CRA, the exchange would be within the realm of subsection 85(1) of the Act, and an “elected” gain could be created. No tax clearance and withholding issues need apply if form T2062C is sent to the CRA.


A Canadian corporation (“Canco”) which earns profits from carrying on business in the U.S. through a “permanent establishment” (“PE”) there will generally be subject to US federal taxes on its income derived from that PE. In addition to the normal federal income taxes on that income, as well as possibly state taxes, there is the… Continue Reading


Many types of businesses (including the ownership of real estate) are structured as partnership. The partners can be individuals, corporations or even other partnerships. If the interest in the partnership is sold, then normally a capital gain or loss will result from the disposition of the partnership. It is well established that an interest in… Continue Reading