Hugessen, J.A.:—We are all of the view that the learned trial judge reached the correct conclusion.
Briefly put, the appellant taxpayer's contention is based on an interpretation of the last sentence of paragraph 1 of Article III of the Canada-U.S. Tax Convention (S.C. 7 George VI c. 21 as amended by 14 George VI c. 27).
In the determination of the net industrial and Commercial profits of the permanent establishment there shall be allowed as deductions all expenses, wherever incurred, reasonably allocable to the permanent establishment, including executive and general administrative expenses so allocable.
By the terms of the implementing legislation the provisions of the Convention prevail over domestic legislation in the event of inconsistency. The appellant says that the quoted sentence allows it, in the calculation of the profits of its Canadian establishment, to deduct “all expenses" that is to say all those which are reasonably deductible in accordance with generally accepted accounting principles, even though such deductions may not be permitted under the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"). Specifically the appellant seeks to deduct as expenses, for the 1974 taxation year, royalty payments made to a provincial government; the deduction of such expenses after May 6, 1974, would be contrary to the terms of paragraph 18(1)(m) of the Act.
18. (1) In computing the income of a taxpayer from a business or property no deduction shall be made in respect of
(m) any amount (other than a prescribed amount) paid or payable by virtue of an obligation imposed by statute or a contractual obligation substituted for an obligation imposed by statute to
(i) Her Majesty in right of Canada or a province,
(ii) an agent of Her Majesty in right of Canada or a province, or
(iii) a Corporation, commission or association that is controlled by Her Majesty in right of Canada or a province or by an agent of Her Majesty in right of Canada or a province
as a royalty, tax (other than a tax or portion thereof that may reasonably be considered to be a municipal or school tax), lease rental or bonus or as an amount, however described, that may reasonably be regarded as being in lieu of any such amount, and that may reasonably be regarded as being in relation to
(iv) the acquisition, development or ownership of a Canadian resource property, or
(v) the production in Canada of
(A) petroleum, natural gas or related hydrocarbons from a natural accumulation of petroleum or natural gas in Canada (other than a mineral resource) or from an oil or gas well in Canada,
(B) metal or minerals (other than iron or petroleum or related hydrocarbons) from a mineral resource in Canada to any stage that is not beyond the prime metal stage or its equivalent,
(C) iron from a mineral resource in Canada to any stage that is not beyond the pellet stage or its equivalent, or
(D) petroleum or related hydrocarbons from tar sands from a mineral resource in Canada to any stage that is not beyond the crude oil stage or its equivalent;
We do not agree. The sentence of the Convention relied upon by the appellant was added in 1950 (see S.C. 14 George VI c. 27). It must be read in context and conformably to the purpose and intent of the Convention as a whole. Articles I and III in their entirety, and as amended, read:
An enterprise of one of the contracting States is not subject to taxation by the other contracting State in respect of its industrial and commercial profits except in respect of such profits allocable in accordance with the Articles of this Convention to its permanent establishment in the latter State.
No account shall be taken in determining the tax in one of the contracting States, of the mere purchase of merchandise effected therein by an enterprise of the other State.
1. If an enterprise of one of the contracting States has a permanent establishment in the other State, there shall be attributed to such permanent establishment the net industrial and commercial profit which it might be expected to derive if it were an independent enterprise engaged in the same or similar activities under the same or similar conditions. Such net profit will, in principle, be determined on the basis of the separate accounts pertaining to such establishment. In the determination of the net industrial and commercial profits of the permanent establishment there shall be allowed as deductions all expenses, wherever incurred, reasonably allocable to the permanent establishment, including executive and general administrative expenses so allocable.
2. The competent authority of the taxing State may, when necessary, in execution of paragraph 1 of this Article, rectify the accounts produced, notably to correct errors and omissions or to re-establish the prices or remunerations entered in the books at the value which would prevail between independent persons dealing at arm's length.
3. If (a) an establishment does not produce an accounting showing its own operations, or (b) the accounting produced does not correspond to the normal usages of the trade in the country where the establishment is situated, or (c) the rectifications provided for in paragraph 2 of this article cannot be effected the competent authority of the taxing State may determine the net industrial and commercial profit by applying such methods or formulae to the operations of the establishment as may be fair and reasonable.
4. To facilitate the determination of industrial and commercial profits allocable to the permanent establishment, the competent authorities of the contracting States may consult together with a view to the adoption of uniform rules of allocation of such profits.
In the determination of the net industrial and commercial profits of the permanent establishment there shall be allowed as deductions all expenses, wherever incurred, reasonably allocable to the permanent establishment, including executive and general administrative expenses so allocable.
It is quite clear that the purpose of the Convention is to avoid double taxation of enterprises doing business in the two countries and, to that end, to provide for the equitable allocation of the profits of such enterprises as between the two contracting powers. That purpose appears most clearly from the preambles both to the original Convention and to the amending Convention of 1950.
The Government of Canada and the Government of the United States of America, being desirous of further promoting the flow of commerce between the two countries, of avoiding double taxation and of preventing fiscal evasion in the case of income taxes, have decided to conclude a Convention. . . .
The Government of Canada and the Government of the United States of America, being desirous of modifying and supplementing in certain respects the Convention and accompanying Protocol for the avoidance of double taxation and the prevention of fiscal evasion in the case of income taxes, signed at Washington on March 4, 1942, have decided to conclude a supplementary Convention for that purpose.. . .
The purpose of the sentence added to paragraph 1 of article III by the amending Convention of 1950 is stated even more specifically, and the amendment itself is put in context, in the Presidential Message to the U.S. Senate seeking that body's ratification of the Convention.
Subparagraph (a) of article I would amend paragraph 1 of article III of the convention of 1942 by adding a new sentence relating to the determination of the net industrial and commercial profits of the permanent establishment. Article III of the existing convention lays down certain fundamental principles affecting the allocation of business income. During the years of administering that convention numerous adjustments have been made under the provisions of article III, with settlements satisfactory to the Governments and to the taxpayers. In practice, during all this time, reasonable deductions have been allowed by Canada, in determining business income, for head office expenses incurred in the United States for or on behalf of a Canadian subsidiary or a Canadian branch. The new sentence gives formal recognition to that practice.
[Emphasis added.] Clearly that purpose was not, as the appellant would have us believe, to create for enterprises doing business and having permanent establishments in both countries a separate and different system of taxation from that prevailing for taxpayers doing business in only one or other of them.
The interpretation adopted by the learned trial judge gives effect to the purpose of the parties to the Convention and does no violence to the language used by them. The interpretation proposed by the appellant, on the other hand, would have the effect of giving a U.S. taxpayer with a permanent establishment in Canada a more favourable tax treatment than its Canadian competitor engaged in the same business in this country. Such a result would not be in accordance with the policy expressed in the preamble to the Convention and indeed would be contrary to it. It would take much clearer language than a simple reference to“ all expenses" to bring it about.
The appeal will be dismissed with costs.