26 July 1994 Internal T.I. 9404997 - SPLIT COMMISSIONS ON ADVERTISING-PART XIII

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

		July 26, 1994

	INTERNATIONAL TAX 	Rulings DirectoratePROGRAMS DIRECTORATEP. Diguer
	Development of Audit Programs Section	(613) 957-8953

O. Hageraats-Massicotte

		7-940499

Split commissions on Advertising
Part XIII tax implications in respect of
certain payments to a U.S. parent corporation

This is in reply to your memorandum of February 25, 1994. You requested our opinion on the application of Part XIII of the Income Tax Act (Canada) (the "Act") in respect of payments made by Canadian subsidiaries to their non-resident parents, where both operate in the advertising sector. You describe your understanding of the facts as follows and included a copy of the

December 17, 1993, memorandum from Paul Redvers of the Non-Resident Audit Section of the Toronto District Office. We apologize for the delay in responding to your request.

Situation

1.The non-resident parent of a multinational firm ("Foreign Co") contracts with the parent of a multinational advertising agency ("Ad Co") to handle their advertising.

2.The Canadian subsidiary ("Can Ad Co") of the multinational advertising agency (Ad Co) is then assigned to handle the advertising of the Canadian subsidiary ("Canco") of the multinational firm (Foreign Co).

3.The written contract between Foreign Co and Ad Co detail the work allocation by Ad Co to its Canadian subsidiary, Can Ad Co.

4.Where Can Ad Co uses Ad Co's advertising material, Can Ad Co pays a portion of its income to its parent, Ad Co, as a commission. This may be a set fee or based on earnings by Can Ad Co.

5.In cases where there is no creative input by the parent, Ad Co, but rather direction of business for the Canadian subsidiary, Can Ad Co, Ad Co charges a fee (non-taxable in Canada) for negotiating the contract.

6.You have encountered several situations in the past involving corporations in the advertising sector and have found the treatment of these payments by the Canadian subsidiaries to be inconsistent for purposes of the Act in that in certain cases the Canadian subsidiaries are withholding tax whereas in other similar cases the Canadian subsidiaries are not withholding tax.

We also understand from the Toronto D.O.'s memorandum that there are many variations to theses arrangements. The involvement of Can Ad Co in providing advertising services and the pricing structure, the extent of the use by the subsidiary of the advertising material of the parent, and the amount of the fee/commission paid by the subsidiary to the parent depend on the agreements between the parties.

Opinion requested

Specifically, you ask the following:

1.Is the fee/commission from the subsidiary to the parent taxable under 212(1)(d)(iii) when there is shared industrial, commercial or other material involved?

2.If the fee/commission is not taxable under 212(1)(d)(iii), is it taxable under another section of the Act and on what basis?

3.Is the amount taxable where there is the opportunity to share such material, whether the Canadian subsidiary actually uses it or not?

Our Comments

Given the wide variety of arrangements possible, it does not appear possible to offer a firm opinion on whether the fee/commission from the subsidiary to the parent is taxable pursuant to paragraph 212(1)(d) of the Act, nor can we offer any interpretative statements of general application since we do not have any previous experience with split commission type payments. Each situation must be dealt with on a case by case basis, depending on its own particular facts. Nevertheless, we would like to make the following general observations.

Fees based on the billing of the advertising subsidiaries

We assume that the U.S. parent does not have a permanent establishment in Canada and that the only issue is the taxation of the payments pursuant to Part XIII.

At the outset, it seems imperative to acquire a clear understanding of the exact nature of the payments to the non-residents and the contractual obligations of the parties to the agreements since the onus is on the Minister to establish whether the payments are caught by the charging provisions of paragraph 212(1)(d) of the Act. This may require an examination of the agreements between the non-resident parents as well as any relevant agreements between the advertising subsidiary and its parent. The nature of the payments may also be determined by reference to the payment calculations and by asking the taxpayers to explain the nature of the payments and the reasons for not withholding. It is expected that taxpayers will have no difficulty explaining the nature of the payments since they must be able to justify the deductibility of the payments pursuant to paragraph 18(1)(a) of the Act in the computation of their income. It appears quite conceivable, on the basis of the facts cited above, that the payments could be caught pursuant to subparagraphs (i) to (iii) since they appear to be either for the use or the right to use property of the parent or for information or services of the type described in subparagraph (ii) or (iii), the consideration being presumably dependent upon one or more of the items described in division (A), (B), or (C) of these provisions. As stated earlier however, this determination will depend on the facts of each case. The exceptions provided for in 212(1)(d)(vi) to (xi) do not appear applicable here. Finally, consideration should be given to the application of the tax treaty between Canada and the country of residence of the parent corporations.

With respect to your second question, if the fee/commission is not taxable pursuant to paragraph 212(1)(d) of the Act, we fail to see any other Part XIII provision which could be applicable to tax the payments in the hands of the non-resident. It does not appear that the payments are management fees for the purposes of paragraph 212(1)(a) of the Act, but you may consider the application of this provision in some circumstances, particularly if the payments are for a fixed amount.

With respect to your third question, we would generally consider that a payment for information can fall within the purview of subparagraph 212(1)(d)(ii) of the Act regardless of whether the Canadian subsidiary uses the information or not if the payment is dependent on sales as provided for in division (B).

Set fee

Generally, a fixed payment by the subsidiary to the parent as described in paragraph 4 above, would not fall within the ambit of subparagraph 212(1)(d) (ii) or (iii) to the extent that the fee would not depend in whole or in part upon any of the factors described in the said provisions, although we cannot rule out the possibility of a subparagraph 212(1)(d)(i) payment. Indeed, a payment for the use or the right to use property could include a lump sum payment. A set fee could also represent a reimbursement of expenses, the purchase price for property or a management fee. Clarification on the nature of the payment would be required before we could offer an opinion on this type of payment. Where the payment by the Canadian subsidiary relates to the direction of its business and it pays a fee to its parent in respect of the contract negotiation services provided by the parent, such payments would not appear to be subject to withholding tax pursuant to paragraph 212(1)(d), although they may be management fees subject to a withholding tax pursuant to paragraph 212(1)(a). In this regard, we refer you to IT-468R.

We regret that we are unable to offer any further assistance concerning this matter at this time. We would be pleased to consider any request for assistance relating to a specific case that you may wish to submit. In order to assist in any such review we would ask that you provide us with all the relevant information including copies of any agreements and details of all payments. If you have any question, please feel free to call us.

Director
Reorganizations and Foreign Division
Rulings Directorate
Policy and Legislation Branch

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