Principal Issues: 1. Does subsection 402(4.1) of the Income Tax Regulations apply to shipments of non-manufactured goods?
2. If so, how would gross revenue from such shipments be attributed to the permanent establishment(s)?
Position: 1. Yes, subsection 402(4.1) does apply to non-manufactured goods.
2. The taxpayer would return to the general rule found in subsection 402(3) and reasonably allocate the gross revenue to a permanent establishment.
Reasons: 1. Paragraph 402(4.1)(a) applies to "shipments of merchandise" and does not specify that the merchandise must be manufactured or produced by the corporation.
2. Based on operation of the provisions.
January 31, 2013
Canada Revenue Agency
International, Provincial and HEADQUARTERS
Strategic Policy Division Income Tax Rulings
Provincial Legislative Affairs Section Directorate
320 Queen Street, M. Gauthier
Place de Ville, Tower A, 20th floor (613) 957-2130
Ottawa, ON, K1A 0L5
2012-047036
Attention: Jane Stalker
Subsection 402(4.1) of the Income Tax Regulations
We are replying to your email of November 16, 2012, in which you asked whether subsection 402(4.1) of the Income Tax Regulations applies to shipments of goods that were not manufactured or produced by the taxpayer ("non-manufactured goods") and, if so, how would gross revenue from such shipments be attributed to the permanent establishments.
Unless otherwise noted, all references herein to sections or components thereof are references to the Income Tax Regulations (the "Regulations").
Background
Subsection 124(1) of the Income Tax Act (the "Act") provides for an abatement of federal income tax payable by corporations. It takes the form of a deduction from the tax otherwise payable by the corporation equal to 10 per cent of all of a corporation's taxable income earned in a taxation year in a province. Subsection 124(4) of the Act states that the "taxable income earned in the year in a province" is the amount determined in accordance with prescribed rules found in Part IV of the Regulations.
In general, the provincial income allocation provisions for most corporations are found in section 402. Subsection 402(3) applies where a corporation has a permanent establishment in a province and a permanent establishment outside that province. In such a case, the formula for determining the taxable income that is deemed to have been earned in the province is calculated with reference to the terms "gross revenue" and "salaries and wages". More specifically, the formula may require a determination of the "gross revenue for the year reasonably attributable to the permanent establishment in the province".
Subsection 402(4) has specific rules for "determining the gross revenue for the year reasonably attributable to a permanent establishment in a province or country other than Canada". This provision is generally applicable to the sale of merchandise and the provision of services. However, subsections 402(3) and 402(4) may be affected by subsection 402(4.1).
Subsection 402(4.1) contains three tests that must be met in order for it to apply. The conditions for the application of subsection 402(4.1) are as follows:
(a) the destination of a shipment of merchandise to a customer to whom the merchandise is sold by a corporation is in a country other than Canada or the customer to whom merchandise is sold by a corporation instructs that the shipment of merchandise be made by the corporation to another person and the customer's office with which the sale was negotiated is located in a country other than Canada,
(b) the corporation has a permanent establishment in the other country, and
(c) the corporation is not subject to taxation on its income under the laws of the other country, or its gross revenue derived from the sale is not included in computing the income or profit or other base for income or profits taxation by the other country, because of
(i) the provisions of any taxing statute of the other country, or
(ii) the operation of any tax treaty or convention between Canada and the other country,
If these conditions are met, paragraph 402(4.1)(d) modifies the rules found in subsection 402(4). These modified rules are included as "Appendix A" at the end of this memorandum.
The current position of the Legislative Policy Directorate ("LPD") is that when a corporation is determining the permanent establishment to which a specific amount should be allocated, the corporation first turns to subsection 402(3). The corporation then checks to see if another provision, such as 402(4) and/or 402(4.1), contains specific rules for allocating the gross revenue. If this is the case, the specific rules override the general rule in subsection 402(3).
As an example, LPD has addressed a situation involving a taxpayer with permanent establishments in a province and in a country other than Canada, who sells non-manufactured goods to a customer in the other country, where the sale is not taxed in that other country. LPD stated that because of the application of subsection 402(4.1), there are no longer any specific rules that apply to this sale to determine where the gross revenue shall be allocated. As such, LPD concluded that the taxpayer would then allocate the gross revenue on this sale on the basis of where it is reasonably attributable as required by subparagraph 402(3)(a)(i).
The Compliance Programs Branch has asked you whether subsection 402(4.1) should only be applied to shipments of merchandise that was manufactured or produced by the corporation so that subsection 402(4) could still be applied in situations such as the one described above. You have asked us for our views.
Our Comments
Subsection 402(4.1) consists of two parts, which must be applied in order. The first, paragraphs 402(4.1)(a) to (c), contains conditions that must be met in order for the subsection to apply. If these conditions are met, then the rules in paragraphs 402(4.1)(d) and (e) are applied. There is no rule of statutory interpretation that would operate such that the subsection would not apply where the conditions in paragraphs 402(4.1)(a) to (c) are met.
With respect to the meaning of merchandise, there is nothing in the general meaning of the word to take the view that merchandise only applies to manufactured goods. Further, the scheme of subsection 402 contemplates that merchandise would include both goods manufactured by the taxpayer and goods that the taxpayer purchased from a third party. For example, subparagraphs 402(4)(c)(i) and (ii) state, "if the merchandise was produced or manufactured or produced and manufactured, partly in the particular province and partly in another place by the taxpayer,
" . Paragraph 402(4.1)(a) applies to "shipments of merchandise" and does not specify that the merchandise must be manufactured or produced by the corporation. As such, subsection 402(4.1) would apply to shipments of merchandise regardless of whether that merchandise is manufactured or produced by the corporation.
You also asked for guidance where, because of the application of paragraph 402(4.1)(d), there is no specific rule in paragraphs 402(4)(a) through (f) applicable for sales of non-manufactured goods. Specifically, you asked whether the normal rules in paragraphs 402(4)(a) and (d) for non-manufactured goods could be applied notwithstanding the modifications in subsection 402(4.1) or whether the gross revenue from the shipments of non-manufactured goods could be allocated using some other reasonable basis.
We agree with the position taken by LPD that, where there is no specific rule provided by 402(4) after the modifications required by 402(4.1), the taxpayer would have to allocate the gross revenue on this sale on the basis of where it is reasonably attributable as required by subparagraph 402(3)(a)(i). Where the taxpayer has chosen to allocate the gross revenue in accordance with the normal rules found in paragraphs 402(4)(a) and (d), this would appear to be a reasonable approach; however the taxpayer would not be required to do so. The taxpayer could allocate gross revenue using any method that leads to a reasonable allocation.
If you have any questions regarding the above, please do not hesitate to contact Michel Gauthier at (613) 957-2130.
Terry Young, CPA, CA
Manager, Administrative Law Section
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
Appendix A:
Subsection 402(4) of the Income Tax Regulations where the conditions of
subsection 402(4.1) of the Income Tax Regulations have been met
402(4) [Revenue attributable to a permanent establishment] - For the purpose of determining the gross revenue for the year reasonably attributable to a permanent establishment in a province or country other than Canada, within the meaning of subsection (3), the following rules shall apply:
(b) except as provided in paragraph (c), where the destination of a shipment of merchandise to a customer to whom the merchandise is sold is in a province or country other than Canada in which the taxpayer has no permanent establishment, if the person negotiating the sale may reasonably be regarded as being attached to the permanent establishment in the particular province or country, the gross revenue derived therefrom shall be attributable to that permanent establishment;
(c) where the destination of a shipment of merchandise to a customer to whom the merchandise is sold is in a country other than Canada," and
(i) if the merchandise was produced or manufactured or produced and manufactured, entirely in the particular province by the taxpayer, the gross revenue derived therefrom shall be attributable to the permanent establishment in the province, or
(ii)if the merchandise was produced or manufactured, or produced and manufactured, partly in the particular province and partly in another place by the taxpayer, the gross revenue derived therefrom attributable to the permanent establishment in the province shall be that proportion thereof that the salaries and wages paid in the year to employees of the permanent establishment in the province where the merchandise was partly produced or manufactured (or partly produced and manufactured) is of the aggregate of the salaries and wages paid in the year to employees of the permanent establishments where the merchandise was produced or manufactured (or produced and manufactured);
(e) except as provided in paragraph (f), where a customer to whom merchandise is sold instructs that shipment be made to some other person and the customer's office with which the sale was negotiated is located in a province or country other than Canada in which the taxpayer has no permanent establishment, if the person negotiating the sale may reasonably be regarded as being attached to the permanent establishment in the particular province or country, the gross revenue derived therefrom shall be attributable to that permanent establishment;
(f) where a customer to whom the merchandise is sold instructs that shipment be made to some other person and the customer's office with which the sale was negotiated is located in a country other than Canada,
(i) if the merchandise was produced or manufactured, or produced and manufactured, entirely in the particular province by the taxpayer, the gross revenue derived therefrom shall be attributable to the permanent establishment in the province, or
(ii)if the merchandise was produced or manufactured, or produced and manufactured, partly in the particular province and partly in another place by the taxpayer, the gross revenue derived therefrom attributable to the permanent establishment in the province shall be that proportion thereof that the salaries and wages paid in the year to employees of the permanent establishment in the province where the merchandise was partly produced or manufactured (or partly produced and manufactured) is of the aggregate of the salaries and wages paid in the year to employees of the permanent establishments where the merchandise was produced or manufactured (or produced and manufactured);
(g) where gross revenue is derived from services rendered in the particular province or country, the gross revenue shall be attributable to the permanent establishment in the province or country;
(h) where gross revenue is derived from services rendered in a province or country other than Canada in which the taxpayer has no permanent establishment, if the person negotiating the contract may reasonably be regarded as being attached to the permanent establishment of the taxpayer in the particular province or country, the gross revenue shall be attributable to that permanent establishment;
(i) where standing timber or the right to cut standing timber is sold and the timber limit on which the timber is standing is in the particular province or country, the gross revenue from such sale shall be attributable to the permanent establishment of the taxpayer in the province or country; and
(j) gross revenue which arises from leasing land owned by the taxpayer in a province and which is included in computing its income under Part I of the Act shall be attributable to the permanent establishment, if any, of the taxpayer in the province where the land is situated.
