Sumner v. The Queen, docket 98-1222-IT-G

Date: 19991207

Docket: 98-1222-IT-G; 98-1410-IT-G

BETWEEN:

GORDON M. SUMNER, ROXANNE MUSIC INC.,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Reasons for Judgment

Bowman, J.T.C.C.

[1] These appeals were heard together. They both involve the consequences under the Canadian Income Tax Act of six concerts put on by Mr. Sumner in 1991 in Canada.

[2] Gordon M. Sumner is a well-known rock star who performed under the name "Sting". In the taxation year in question, 1991, he resided in the United Kingdom. In that year he had an extensive North American tour in which he performed in Canada, the United States and Mexico. Six of the concerts took place in Canada.

[3] The North American tour took place under the aegis of Roxanne Music Inc. ("Roxanne") which was contractually obliged to pay Mr. Sumner 95% of its net profit before any deduction for amounts paid to him.

[4] The difference between the parties' respective positions can most easily be demonstrated by comparing the numbers.

[5] It is not disputed that Roxanne reported total revenues of $5,965,599 U.S. in respect of North American revenues earned from the appellant's North American tour in its 1991 U.S. return. Of this, it attributed $543,494 U.S. to concerts held in Canada. This represents 9.11% of the total North American revenues.

[6] Mr. Sumner's salary in 1991 from Roxanne was $1,488,000 U.S. In his U.S. return of income, Mr. Sumner declared $1,511,850 U.S. This included a prior year's benefit with which we are not concerned. From the figure of $1,511,860 U.S., he excluded, for U.S. tax purposes $127,543 U.S. as attributable to the Canadian tour. After certain minor adjustments he declared $1,385,499 U.S. in his U.S. return.

[7] In his Canadian income tax return for 1991, Mr. Sumner declared $42,780 Cdn.

[8] The Minister assessed Mr. Sumner on $155,890 Cdn. The difference between the two figures is attributable to two methods of calculation.

[9] Mr. Sumner, for Canadian tax purposes, used the following formula:

6 (the no. of days worked in Canada)

240 the no. of days it was assumed he worked X $1,488,000 (total

for Roxanne in 1991 salary from Roxanne)

= $37,200 U.S. X 1.15 (U.S. Exchange rates)

= $42,780

[10] The Minister followed the same method as Roxanne had:

$1,488,000 U.S. X $543,494 U.S.

(total salary) (revenue from Canadian concerts)

$5,965,599 U.S. (total revenue from

North American tour)

= $135,557 U.S. X 1.15 (U.S. exchange rate)

= $155,890 Cdn.

[11] Roxanne is incorporated under the laws of Delaware. It is a taxable entity of the United States and is a U.S. resident with no permanent establishment in Canada as that expression is used in the Canada-U.S. Income Tax Convention.

[12] It filed a Canadian income tax return for 1991 in which it declared gross revenue from the Canadian tour of $625,018. Against this it deducted salaries and employee benefits of $230,083 (which the Minister assumed related only to Mr. Sumner) which, together with other expenses, resulted in a claimed loss of $104,530 from the Canadian tour.

[13] The Minister disallowed a portion of the expenses but there is no evidence of the amounts allowed or disallowed. They are not mentioned in either the notice of appeal or the reply, and the assessment was not put in evidence.

[14] Although the notice of appeal alleges that the Minister failed to allow expenses that the appellant says should have been allowed, no evidence was adduced to support the expenses claimed or the appropriateness of their deduction in computing Canadian source income. I must therefore assume that, if Roxanne is taxable at all in Canada, it is taxable on the amount determined by the Minister, simply because on this point the burden of proof lay on Roxanne and that burden was not discharged.

[15] Roxanne's position is that under the Canada-U.S. Income Tax Convention it is not taxable in Canada. To appreciate the force of this contention one must examine with some care the relations between Roxanne and Gordon Sumner.

[16] Mr. Robert Kornreich was the accountant from the New York accounting firm Phillips Gold and Company who handled Roxanne's and Mr. Sumner's North American accounting affairs, including filing of income tax returns. Its office was Roxanne's mailing address. He testified that Wyneco B.V., a Netherlands company that owned all of the shares of Roxanne, was itself wholly owned by a Mr. Dihkof and that Mr. Dihkof had no business connections with Mr. Sumner. He obtained this information from Mr. Sumner's U.K. accountants, Ernest & Young. The evidence is of course hearsay but even accepting it at face value it does not go far enough to rebut the Minister's assumption that Roxanne and Mr. Sumner did not deal at arm's length. It seems somewhat improbable that a company whose sole function is to handle Mr. Sumner's concert tours in Canada, the United States, Japan, Australia and New Zealand and which is committed to paying him 95% of its profits can be considered to be at arm's length with him. I would require rather more persuasive and admissible evidence than evidence of what Mr. Sumner's U.S. accountants heard from his U.K. accountants.

[17] In the result, however it does not matter whether they are at arm's length or not. The legal relations are, it must be admitted, however, a little peculiar.

[18] On September 4, 1990 an agreement was entered into between Mr. Sumner and Wyneco in which Mr. Sumner is described as "the employee". Among the clauses in the agreement, Wyneco agreed to pay Mr. Sumner 95% of its "net receipts" as defined under a further agreement between Wyneco and Roxanne. Wyneco in effect "loaned out" Mr. Sumner's services within the area covered by the agreement of September 4, 1990. It was agreed that throughout the term of the loan-out agreement Mr. Sumner was the employee of Wyneco and not of Roxanne. Roxanne agreed to pay to Mr. Sumner 95% of Roxanne's net receipts, as defined, attributable to the North American loan out services.

[19] Counsel for the respondent preferred to describe the remuneration received by Mr. Sumner from Roxanne as a form of profit sharing rather than salary. This may well be in substance what it is — 95% of Roxanne's net receipts from Mr. Sumner's concerts could easily be seen in that light — but I do not think it is necessary to recharacterize the amounts received by Mr. Sumner in any way other than the manner in which they are described in the agreement.

[20] The foregoing sets out the factual background of the two cases.

[21] The dispute in the case of Mr. Sumner boils down to a choice between two fractions of his salary of $1,488,000:

(a) days in Canada over an assumed 240 days in the U.S. (the "time" method) or;

(b) gross Canadian receipts over gross North American receipts (the "gross receipts" method).

[22] I might observe at the outset that 6/240 is a little suspect because it became clear from the cross-examination of Mr. Kornreich that the denominator of 240 days included an unspecified number of days that had nothing to do with the North American tour.

[23] Quite apart from that it has not been established that the "time" method is any more accurate than the "gross receipts" method. Neither Article XVI of the Canada-U.K. Income Tax Convention nor paragraph 115(1)(a)(ii) of the Income Tax Act provide any guidance. Subsection 4(1) of the Act requires a factual determination or allocation between sources of income in different places but apart from requiring an assumption that income from a particular location is the only income and a reasonable allocation of expenses, it provides no rules.

[24] In this case the employer itself has made an allocation using the gross-receipts method and while this is not binding and gives rise to no estoppel it is at least prima facie evidence of an attempt to make a reasonable allocation. The situation might well be different if Mr. Sumner were not an employee and his employer had not made an allocation. If one were attempting to determine the income from the business of putting on rock concerts in different countries I should think that expert accounting evidence would be of great assistance. It may well be that the operations in one country yielded a loss and in another a profit. The question of the allocation of head office overhead should also be dealt with. I do not wish this judgment to be taken as sanctioning one method over another. I can see problems in both methods, and other allocation formulae may be appropriate. My decision in the case of Mr. Sumner is based solely on the fact that it has not been established that the time method is more reasonable or appropriate than that used by the Minister. Therefore Mr. Sumner's appeal is dismissed.

[25] Roxanne's appeal is based solely on paragraph 1 of Article VII of the Canada-U.S. Tax Convention, which reads:

1. The business profits of a resident of a Contracting State shall be taxable only in that State unless the resident carries on business in the other Contracting State through a permanent establishment situated therein. If the resident carries on, or has carried on, business as aforesaid, the business profits of the resident may be taxed in the other State but only so much of them as is attributable to that permanent establishment.

[26] Since it is admitted that Roxanne had no permanent establishment in Canada, the other provisions of Article VII need not be reproduced.

[27] Clearly, if only Article VII were applicable, Roxanne would not be taxable in Canada.

[28] The respondent relies upon Article XVI of the Canada-U.S. Tax Convention. Paragraphs 1 and 2 of Article XVI read:

1. Notwithstanding the provisions of Articles XIV (Independent Personal Services) and XV (Dependent Personal Services), income derived by a resident of a Contracting State as an entertainer, such as a theatre, motion picture, radio or television artiste, or a musician, or as an athlete, from his personal activities as such exercised in the other Contracting State, may be taxed in that other State, except where the amount of the gross receipts derived by such entertainer or athlete, including expenses reimbursed to him or borne on his behalf, from such activities do not exceed fifteen thousand dollars ($15,000) in the currency of that other State for the calendar year concerned.

2. Where income in respect of personal activities exercised by an entertainer or an athlete in his capacity as such accrues not to the entertainer or athlete but to another person, that income may, notwithstanding the provisions of Articles VII (Business Profits), XIV (Independent Personal Services) and XV (Dependent Personal Services), be taxed in the Contracting State in which the activities of the entertainer or athlete are exercised. For the purposes of the preceding sentence, income of an entertainer or athlete shall be deemed not to accrue to another person if it is established that neither the entertainer or athlete, nor persons related thereto, participate directly or indirectly in the profits of such other person in any manner, including the receipt of deferred remuneration, bonuses, fees, dividends, partnership distributions or other distributions.

[29] Counsel for the appellant contended that paragraph 2 of Article XVI envisaged an either/or situation, that is to say, where a performer succeeds in diverting his or her income earned from performances in a contracting state into a corporation that state can tax the corporation notwithstanding the absence of a permanent establishment. Under the agreement between Wyneco and Roxanne, Mr. Sumner clearly does participate in its profits.

[30] Counsel's position is that paragraph 2 does not apply where, as here, Mr. Sumner has admitted taxability and is in fact taxed on his earnings from the concerts in Canada. Her contention is that paragraph 2 is an anti-avoidance provision to be used where an individual has succeeded in escaping taxation as contemplated by paragraph 1 of Article XVI.

[31] With respect, I do not think that this analysis bears close scrutiny, and for several reasons.

[32] In the first place, the plain words of paragraph 2 do not support the conclusion that all of an entertainer's income from personal activities as an entertainer need be diverted to another person before the paragraph applies. All that is required is that "income" should accrue not to the entertainer but to another person. Had the contracting parties to the convention intended that the article apply only if the entertainer's entire income from the specified source is diverted to the other person, they would have been quite capable of saying so.

[33] Second, the exception in the second sentence of paragraph 2 contemplates the very type of arrangement which we have here: a sharing of the income between the other person — presumably a corporation — and the entertainer who participates in the profits. The exception does not apply because that is precisely what is happening here — Mr. Sumner participated in the profits of Roxanne "directly or indirectly... in any manner, including... bonuses... or other distributions".

[34] Third, paragraph 2 of the technical explanation to paragraph 2 of Article XVI contemplates exactly the situation involved here and described in the second sentence of paragraph 2.

[35] The technical explanation to paragraph 2 of Article XVI reads as follows:

Technical Explanation [1984]:

Paragraph 2 provides that where income in respect of personal activities exercised by an entertainer or an athlete accrues not to the entertainer or athlete himself but to another person, that income may, notwithstanding the provisions of Article VII (Business Profits), Article XIV, and Article XV, be taxed in the Contracting State in which the activities are exercised. The anti-avoidance rule of paragraph 2 does not apply if it is established by the entertainer or athlete that neither he nor persons related to him participate directly or indirectly in the profits of the other person in any manner, including the receipt of deferred remuneration, bonuses, fees, dividends, partnership distributions, or other distributions.

Thus, if an entertainer who is a resident of Canada is under contract with a company and the arrangement between the entertainer and the company provides for payments to the entertainer based on the profits of the company, all of the income of the company attributable to the performer's U.S. activities may be taxed in the United States irrespective of whether the company maintains a permanent establishment in the United States. Paragraph 2 does not affect the rule paragraph 1 that applies to the entertainer or athlete himself.

[36] The technical explanation to the provisions of an international treaty agreed to by both parties to the convention are of far greater importance in interpreting a treaty than are, say, interpretation bulletins issued by the Department of National Revenue (compare A.G. of Canada v. Kubicek Estate, 97 DTC 5454 at page 5456 (F.C.A.) with The Queen v. Crown Forest Industries Limited et al., 95 DTC 5389 at page 5396 to 5399 (S.C.C.)).

[37] Fourth, the Crown's position is supported by the OECD model convention and the commentary. That convention is the basis of all or virtually all of Canada's international network of tax treaties and is a useful extrinsic aid in interpreting such treaties.

[38] Article 17 of the draft OECD convention reads:

Article 17

ARTISTES AND SPORTSMEN

1. Notwithstanding the provisions of Articles 14 and 15, income derived by a resident of a Contracting State as an entertainer, such as a theatre, motion picture, radio or television artiste, or a musician, or as a sportsman, from his personal activities as such exercised in the other Contracting State, may be taxed in that other State.

2. Where income in respect of personal activities exercised by an entertainer or a sportsman in his capacity as such accrues not to the entertainer or sportsman himself but to another person, that income may, notwithstanding the provisions of Articles 7,14 and 15, be taxed in the Contracting State in which the activities of the entertainer or sportsman are exercised.

[39] Paragraph 11 of the commentary on paragraph 2 of the model convention reads:

Paragraph 2

11. Paragraph 1 of the Article deals with income derived by individual artistes and sportsmen from their personal activities. Paragraph 2 deals with situations where income from their activities accrues to other persons. If the income of an entertainer or sportsman accrues to another person, and the State of source does not have the statutory right to look through the person receiving the income to tax it as income of the performer, paragraph 2 provides that the portion of the income which cannot be taxed in the hands of the performer may be taxed in the hands of the person receiving the remuneration. If the person receiving the income is an enterprise, tax may be applied by the source country even if the income is not attributable to a permanent establishment there. If the person receiving the income is an individual, the income may be taxed even in the absence of a fixed base. But it will not always be so. There are three main situations of this kind.

a) The first is the management company which receives income for the appearance of e.g. a group of sportsmen (which is not itself constituted as a legal entity).

b) The second is the team, troupe, orchestra, etc. which is constituted as a legal entity. Income for performances may be paid to the entity. Individual members of the team, orchestra, etc. will be liable to tax under paragraph 1, in the State in which a performance is given, on any remuneration (or income accruing for their benefit) as a counterpart to the performance; however, if the members are paid a fixed periodic remuneration and it would be difficult to allocate a portion of that income to particular performances, Member countries may decide, unilaterally or bilaterally, not to tax it. The profit element accruing from a performance to the legal entity would be liable to tax under paragraph 2.

c) The third situation involves certain tax avoidance devices in cases where remuneration for the performance of an artiste or sportsman is not paid to the artiste or sportsman himself but to another person, e.g. a so-called artiste company, in such a way that the income is taxed in the State where the activity is performed neither as personal service income to the artiste or sportsman nor as profits of the enterprise, in the absence of a permanent establishment. Some countries "look through" such arrangements under their domestic law and deem the income to be derived by the artiste or sportsman; where this is so, paragraph 1 enables them to tax income resulting from activities in their territory. Other countries cannot do this. Where a performance takes place in such a country, paragraph 2 permits it to impose a tax on the profits diverted from the income of the artiste or sportsman to the enterprise. It may be, however, that the domestic laws of some States do not enable them to apply such a provision. Such States are free to agree to other solutions or to leave paragraph 2 out of their bilateral conventions.

[40] The third sentence of paragraph 11 of the commentary reads in part:

... paragraph 2 provides that the portion of the income which cannot be taxed in the hands of the performer may be taxed in the hands of the person receiving the remuneration.

(emphasis added)

[41] This clearly indicates that paragraph 2 of the Canada-U.S. treaty does not envisage an either/or, or all or nothing situation. Rather it contemplates that a performer's income may be earned in part by the performer personally and in part by the company, and both may be taxed.

[42] For these reasons, I can see no error in the assessments of either appellant.

[43] The appeals are dismissed with costs. The respondent is entitled to her costs on the basis of one counsel fee for both appellants.

Signed at Ottawa, Canada, this 7th day of December 1999.

"D.G.H. Bowman"

J.T.C.C.