Hegeman-Harris Company of Canada LTD v. Minister of National Revenue, [1979] CTC 3122, 79 DTC 886

Guy Tremblay:—This case was heard at Montreal, Quebec, on May 8, 1978 and November 9, 1978.

1. Point at Issue

The main point is whether the appellant company has its permanent establishment in Montreal (Canada) or in the United States, and consequently whether it has the right to deduct “from the tax otherwise payable’’ “an amount equal to 10%” of its taxable income as provided in subsection 124(1) of the new Income Tax Act. The whole amount of tax involved is over $20,000 for the 1973, 1974 and 1975 taxation years.

2. Burden of Proof

The burden is on the appellant to show that the respondent’s assessments are incorrect. This burden of proof results especially from several judicial decisions, including the judgment delivered by the Supreme Court of Canada in R W S Johnston v MNR, [1948] CTC 195; 3 DTC 1182.

3. The Facts

(A) Permanent Establishment: Deduction 124(1)

3.01 The appellant carries on the business of real estate construction and management.

3.02 During the years 1973, 1974 and 1975, the appellant carried on construction activities both in the Province of Quebec and in the United States.

3.03 The distribution of gross income attributable to Quebec and the United States is as follows and is not in dispute:

3.04 The gross profit for the years involved as declared in the Federal tax returns and Quebec tax returns is as follows:

3.05 The gross sales for the same years as declared in the USA returns are as follows:

3.06 The president and main shareholder (98% of shares) of the company is Mr Donald Sternberg. He graduated with a Bachelor of Science in Architecture from the Georgia Institute of Technology in Atlanta, Georgia.

3.07 When in the American Armed Forces, he was a Lieutenant in the Corps of Engineers. Since his discharge in 1956, he has been working as a construction manager and executive.

3.08 He is an American citizen. However, he has been a Canadian resident since 1965.

3.09 He is involved in the day-to-day operations of the company. He is the chief executive officer of the company. He is the only permanent staff member of the company.

3.10 The appellant company fancies itself an expert “in leisure activity facilities, racetracks, Jai Alai Frontons on which there are paramutual activities, sports related activities like baseball, world’s fairs, and things of that nature”, (p 9 of the May 8, 1978 transcript). Some projects lasted 5 to 6 months and others 4 to 5 years (p 23 of the November 9, 1978 transcript).

3.11 The main projects executed by the appellant company during the years involved were:

1973: Bonita Springs, West Flagler Dog Track in Miami; Old Vulosia Jai Alai; some sports service in Buffalo;

1974: The Travelodge in Daytona Beach; the Vagabond Motel in Daytona Beach; the Hyatts Cove Motel in Daytona Beach; the New Vulosia Jai Alia in Daytona Beach (the old one burnt down; the appellant company was asked to reconstruct an entire facility); Milespark Raceway in Louisville, Kentucky, Bonita Springs Dog Track in Florida;

1975: The completion of the New Jai Alai project in Daytona Beach, and Bridgeport Jai Alai in Bridgeport, Connecticut.

3.12 During the years under appeal, the main office of the appellant company was located at 1808 Sherbrooke Street West in Montreal. This address appears on the federal, provincial and USA income tax returns for the years involved. The testimony of Mr Sternberg was clear on this point.

However, in the description of the accounting and job cost system of the appellant (exhibit R-1-19) prepared in June 1973 by the firm Fuller, Jenks, Landau, CA, the US office is mentioned three times. The appellant company had the following address in USA: PO Box 1345, Melbourne, Florida 32935. The company also had a telephone number in Florida. It was a telephone answering service.

3.13 Morover, in the 1973 and 1975 federal returns (exhibit R-1, p 12 and p 35) the company answered “yes” to the following question: “Has the corporation a permanent establishment in more than one jurisdiction?”. Mr Stanley Rosen, CA, member of the accounting firm whose services are hired by the appellant company affirmed that the affirmative answer to the said question means Quebec jurisdiction and federal jurisdiction. On the federal tax returns, the appellant claimed 10% of the taxable income pursuant to section 124. On the Quebec tax return for the year 1975, the appellant company claimed exemption of 90.82% of tax on the basis, it seems, that 90.82% of the revenue originates from another territory than Quebec:

Moreover, in the United States income tax returns of foreign corporation, after declaring that Canada is the foreign country under the laws of which income reported is subject to tax (exhibit R-1, pp 15, 16 and 17), the appellant company answers “yes” to the following questions:

Did you have a permanent establishment in the United States at any time during the taxable year within the meaning of section 894(b) and any applicable tax convention between the United States and a foreign country?

the section 894(b) reads as follows:

Income affected by treaty

(b) Permanent establishment in United States.—For purposes of applying any exemption from, or reduction of, any tax provided by any treaty to which the United States is a party with respect to income which is not effectively connected with the conduct of a trade or business within the United States, a nonresident alien individual or a foreign corporation shall be deemed not to have a permanent establishment in the United States at any time during the taxable year. This subsection shall not apply in respect of the tax computed under section 877(b).

The other answer was “if” ‘yes’: name the foreign country”. The answer was Canada.

According to Mr Stanley Rosen, CA, the motivation for those answers was that . . if we did not do things like this, we would have to withhold.. .. All the contractors or the builders in the States would have to withhold 15% because the United States Government wanted their pound of flesh too on these. So we had a problem and in our discussions with Mr Sternberg, at many times, we said he should form two companies: a US company and a Canadian company, but he never did want to do this because he said: ‘It’s a Canadian company even though I am doing business in the States’. So he was paying more tax by operating in this way as one company.” (p 123 of the November 9, 1978 transcript).

3.14 According to Mr Sternberg, the establishment of place of business in USA was a post office box in Melbourne, Florida. One could also contact the appellant company in the USA in each town where the projects were located. The employee who supervised the work, lived there with his wife in the town in an apartment as in Daytona Beach, Florida; Bridge Port, Connecticut; Spokane, Washington, or in a motel (like in Kentucky). The appellant stated that the employee was more effective, performed much better when he was living with his wife in an apartment than when he was alone living in a motel.

3.15 According to Mr Sternberg, the company is not very well-known in the USA. The advertisement made by the company in the USA is the following:

— in the yellow pages of the telephone book;

—on the public sign placed on a construction project;

— in the newspapers for the official openings when a project is completed. According to the witness, a contractor or a consultant is forced to pay this advertisement.

3.16 Associated with the office of Montreal during the years involved, the appellant company had five office personnel people: secretary types, phone calling types, accounting types, estimating types and construction types.

3.17 Concerning the calling types employees, Mr Sternberg explained the function (pp 14 and 15 of transcript of May 8, 1978):

Q. Now, you mentioned calling types initially. I am a calling type. What would be my function within the organization of Hegeman-Harris?

A. I would tell you what we are bidding on a, or trying to achieve some work in a specific location and we need reinforcing steel suppliers to give us a price for this specific job and I would say to you, get a hold of the phone book and let’s call some reinforcing steel suppliers to see what the price of reinforcing steel would be on this job. We would give you a list of all of the sub-trades involved and give you a phone book and ask you to call whoever we needed and you would call them and ultimately these people would call back and give you prices on the various aspects of the work.

3.18 Mr Sternberg estimated his phone bill “in the neighbourhood of 6 or 7 thousand dollars a month”. He filed as exhibit A-1 the phone bill for the month of August 1974 totalling $4,090 (Canadian phone bill $1,798 and USA phone bill $2,292).

3.19 Concerning the functions of estimating type and construction type the witness gave the following explanation (p 16 of the transcript of May 8, 1978):

If you’re an estimating type you take drawings and you prepare budgets, take quantity surveys and prepare estimates of the cost of the work. If you are a construction type, you stay out on the job and supervise the work and assist in the evaluation of bids from various contractors and things of that nature.

3.20 In cross-examination, Mr Sternberg (pp 19 and 20 of the November 9, 1978 transcript) affirmed that every employee is hired on a job basis and is paid on a salary basis by oral agreement. It could be terminated at will by

either party. He added: “In our business, everybody is transient; nobody has a permanent job. When we have a lot of work, we have a lot of people and when we have no work, we let everybody go”.

3.21 The appellant company acted as general contractor in the Province of Quebec but as management consultant in the USA (p 13 of the November 9, 1978 transcript). The main distinction between those two functions is a question of non-liability on the past of the management consultant on the non-performance of the work by any of the sub-contractors. The management consultant does not perform any physical work. The Company owns no machinery in USA, nor uses of it to perform its work.

3.22 The witness explained why the appellant company does not work as general contractor except in the Province of Quebec:

Now, in the public sector, I am competitive here, I bid on as much work as my bonding company will allow me to have and I am either successful or not successful, depending whether we get the work or not; that is, as a general contractor. I do not work as a general contractor very often any place other than in the province of Quebec.

Q. Any reason for that, Mr Sternberg?

A. Yes. There are a couple of reasons. Number one, my bonding company doesn't like to see me wander around the world and then having a fiscal responsibility for bonds in Timbuktu or wherever I end up.

Q. But, surely, Quebec is not Timbuktu, Mr Sternberg?

A. Well, the province of Quebec, I am saying. I work within the province. Florida frightens Continental Casualty .. . that’s my bonding company . . . You say “Florida” to the bonding agent and he raises both hands in the air.

Q. Really?

A. I don’t think that they bond much for American firms in Florida that particular insurance company.

Q. But, surely, there are other bonding companies in the States?

A. No. Bonding is a monopolistic thing in which 6 or 7 insurance companies completely control the bonding market. They re-insure among themselves, they decide pretty much which contractor will work where and how they will allow the contractor to work.

We are on a different subject here, but you have no idea how controlled that particular field is. The same bonding companies that bond in Canada, completely independent of the United States operations, bond in the United States, and for me to get a bond in Canada for more than 2 or 3 million dollars, it has to go through New York to get permission even though there is a headquarters in Toronto for the bonding company. (pp 28-1 and 28-2 of the transcript of November 9, 1978)

3.23 The appellant company was remunerated on the basis of reimbursement of cost (telephone, travelling, salary, etc) plus a nominal fee scale. The fee was 3% on the first two million in a contract, 2 /2% on the next two million and then 2% of all subsequent millions.

3.24 The company had a temporary bank account in the towns of the different projects. In the description of the accounting and job cost system (exhibit R-1-19 prepared in June 1973 by the firm of accountants Fuller, Jenks, Landau,) it is written “there are 14 bank accounts existing of which 5 are active. Cheques are both issued from the Canadian office and the US office.”

3.25 Mr Sternberg in cross-examination (pp 30 to 34 of the November 9, 1978 transcript) after saying that 90% of the appellant’s income was generated in the USA and 10% in the Province of Quebec, affirmed that he spent 60% of his time in the Province of Quebec at the appellant’s office in Montreal and 40% in the USA. He explained that the management work—as the one done as management consultant in the USA—implies a certain amount of administrative activities. . . the paper work gets sent to me from the various projects and I perform most management functions

‘‘I thought seriously of leaving Canada. As you know, I am an American citizen. I don’t make a lot of money here any more. Certain years I do better than other years, but we like it here. My wife and I love Montreal and we regard it as our home, and frankly economically it’s probably the worst thing we could do for ourselves, but we still here because we like it here.”

The witness explained also that if 90% of income was generated in the USA, it was because the clients for the work of the nature the appellant is expert (leisure facilities, ractracks, etc) can be found rather in the USA than in Canada.

(B) Foreign Tax Credit: 126(2)

3.26 The written proceedings of the notice of appeal and the reply to notice of appeal mentions a deduction relating to a foreign-tax credit in virtue of Subsection 126(2). The respondent disallowed an amount of $598. At the beginning of the hearing counsels for both parties advised the Board that this problem would be settled out of court.

4. Law—Precedent Cases—Comments

4.1 Law

The legal sections involved in the present case are 124(1) of the new Income Tax Act and regulations 400, 401 and 402 of the new Income Tax Act, which read as follows:

124. Deduction from corporation tax.

(1) There may be deducted from the tax otherwise payable by a corporation under this Part for a taxation year an amount equal to 10% of the corporation’s taxable income earned in the year in a province other than the Northwest Territory or the Yukon Territory.

400. Taxable Income Earned in a Province by a Corporation

(1) For the purpose of section 40 (sec 124) of the Act, a corporation’s ‘taxable income earned in the year in a province’ means the aggregate of the taxable incomes of the corporation earned in the year in each of the provinces, except the Northwest Territories and the Yukon Territory.

(2) For the purpose of this Part, “permanent establishment” means a fixed place of business of the corporation, including an office, a branch, a mine, an oil well, a farm, a timber land, a factory, a workshop or a warehouse, and

(a) where the corporation does not have any fixed place of business it means

the principal place in which the corporation’s business is conducted;

(b) where a corporation carries on business through an employee or agent, established in a particular place, who has general authority to contract for his employer or principal or who has a stock of merchandise owned by his employer or principal from which he regularly fills orders which he receives, the corporation shall be deemed to have a permanent establishment in that place;

(c) an insurance corporation is deemed to have a permanent establishment in each province and country in which the corporation is registered or licensed to do business;

(d) where a corporation, otherwise having a permanent establishment in Canada, owns land in a province, such land shall be deemed to be a permanent establishment;

(e) where a corporation uses substantial machinery or equipment in a particular place at any time in a taxation year it shall be deemed to have a permanent establishment in that place;

(f) the fact that a corporation has business dealings through a commission agent, broker or other independent agent or maintains an office solely for the purchase of merchandise shall not of itself be held to mean that the corporation has a permanent establishment; and

(g) the fact that a corporation has a subsidiary controlled corporation in a place or a subsidiary controlled corporation engaged in trade or business in a place shall not of itself be held to mean that the corporation is operating a permanent establishment in that place.

401. Computation of Taxable Income

The amount of taxable income of a corporation earned in a year in a particular province shall be determined in accordance with the provisions of this Part.

402. (1) Where, in a taxation year, a corporation had a permanent establishment in a particular province and had no permanent establishment outside that province, the whole of its taxable income for the year shall be deemed to have been earned therein.

(2) Where, in a taxation year, a corporation had no permanent establishment in a particular province, no part of its taxable income for the year shall be deemed to have been earned therein.

(3) Except as otherwise provided, where, in a taxation year, a corporation had a permanent establishment in a particular province and a permanent establishment outside that province, the amount of its taxable income that shall be deemed to have been earned in the year in the province is one-half the aggregate of

(a) that proportion of its taxable income for the year that the gross revenue for the year reasonably attributable to the permanent establishment in the province is of its total gross revenue for the year, and

(b) that proportion of its taxable income for the year that the aggregate of the salaries and wages paid in the year by the corporation to employees of the permanent establishment in the province is of the aggregate of all salaries and wages paid in the year by the corporation.

4.2 Precedent Cases and Doctrine

The parties cited the following cases and articles of doctrine:

1. Estate of Harry A Miller v MNR, [1973] CTC 793; 73 DTC 5583;

2. Edouard Reichmann, 1972 TRB 71-836;

3. No 536 v MNR, 19 Tax ABC 408; 58 DTC 417;

4. No 630 v MNR, 22 Tax ABC 91; 59 DTC 300;

5. Entreprises Blaton-Aubert Société Anonyme v MNR, [1969] Tax ABC 68; 69 DTC 121; [1972] CTC 609; 73 DTC 5009;

6. Heskel S Abed v MNR, [1978] CTC 5; 78 DTC 6007;

7. American Wheelabrator & Equipment Corp v MNR, [1951] Tax ABC 345; 51 DTC 285;

8. Consolidated Premium Iron Ores Ltd et al v CIR, 57 DTC 1146;

9. Chicago Blower (Canada) Ltd v MNR, 41 Tax ABC 292; 66 DTC 471;

10. Enterprise Foundry (NB) v MNR, 36 Tax ABC 283; 64 DTC 660;

11. Gourd) i R Masri v MNR, [1973] CTC 448; 73 DTC 5367;

12. MNR v Panther Oil & Grease Ltd, [1957] Tax ABC 56; 57 DTC 494; [1961] CTC 363; 61 DTC 1222;

13. Juda Rutenberg v MNR, [1978] CTC 38; 78 DTC 6016;

14. Sunbeam Corporation (Canada) Ltd v MNR, [1961] CTC 45; 61 DTC 1053; [1962] CTC 657; 62 DTC 1390;

15. Tara Exploration & Development Co Ltd v MNR, [1970] CTC 557; 70 DTC 6370;

16. MNR v Tara Exploration & Development Co Ltd, [1972] CTC 328; 72 DTC 6288;

1/7. Her Majesty the Queen v Robert Maurice Sherwood, [1978] CTC 713; 78 DIC 6470;

18. An article written by Ernest H Smith in Canadian Tax Journal Vol XXIV No 5, September-October 1976, p 545: “Allocating to Provinces the Taxable Income of Corporations: How the Federal-Provincial Allocation Rules Evolved’’.

4.3 Comments

4.3.1 The Legal Problem

At is appears from the legal text quoted above, section 124(1) of the new Act says that the deduction from the tax is 10% of the taxable income of the corporation “earned in the year in a province other than the Northwest Territory or the Yukon Territory’’.

Regulation 402(1) is to the effect that where a corporation has no permanent establishment in a particular province, no part of its taxable income Shall be deemed to have been earned therein.

Regulations 402(3) and (4) establish the deemed taxable income where a corporation has a permanent establishment in a particular province and a permanent establishment outside that province.

As the figures resulting from the computation of the revenue are not in dispute, the points that the Board has to decide upon are:

Has the appellant a permanent establishment in the Province of Quebec?

Has the appellant a permanent establishment in the USA?

4.3.2 A Permanent Establishment in Quebec?

Referring to the definition of “permanent establishment” quoted above in Regulation 400(2), it is clear to the Board that the appellant company, with the evidence adduced, has a permanent establishment in Quebec. Indeed, it is clearly proven that in the years involved, it has a fixed place of business, its office in Montreal, located at 1808 Sherbrooke Street West (paragraphs 3.12 and 3.14). On that point, the appellant has reversed the burden of proof. The evidence was not contradicted.

4.3.3 A Permanent Establishment in USA?

The Board refers to paragraphs 400(2)(a), (b), (c), (d), (e), (f), and (g) of the Regulations quoted above giving the definition of “Permanent Establishment”.

4.3.3.1 Subsection 400(2)

(2) For the purpose of this Part, “permanent establishment” means a fixed place of business of the corporation, including an office, a branch, a mine, an oil well, a farm, a timber land, a factory, a workshop or a warehouse.

According to the evidence, in 1973,1974 and 1975 the appellant company did not have a fixed place of business in the USA “including an office, a branch, a mine, an oil well, a farm, a timber land, a factory, a workshop or a warehouse”. Even if the study written by the accountants (exhibit R-1-19) refers to USA office, there was no evidence to that effect.

4.3.3.2 Paragraph 400(2)(a)

(a) where the corporation does not have any fixed place of business it means the principal place in which the corporation’s business is conducted.

The subparagraph has no application in the present case because the corporation already has a fixed place of business.

First, the Board thought it had application because in the USA the corporation had no fixed place of business. However, in the wording of subsection 400(2) and paragraph 400(2)(a) there is no reference to the same territory for the application of those two legal sections. It is only referred to a fixed place of business of the corporation in general.

As the corporation has already a fixed place of business (even if it is in Canada) consequently, in the Board’s opinion, paragraph 400(2)(a) has no application to determine a permanent establishment in the USA.

4.3.3.3 Paragraph 400(2)(b)

(b) where a corporation carries on business through an employee or agent, established in a particular place, who has general authority to contract for his employer or principal or who has a stock of merchandise owned by his employer or principal from which he regularly fills orders which he receives, the corporation shall be deemed to have a permanent establishment in that place.

There is nothing in the evidence which shows that the superviser on the job has the authority to contract nor has stock of merchandise.

4.3.3.4 Paragraphs 400(2)(c), (d)

(c) an insurance corporation is deemed to have a permanent establishment in each province and country in which the corporation is registered or licensed to do business;

(d) where a corporation, otherwise having a permanent establishment in Canada, owns land in a province, such land shall be deemed to be a permanent establishment.

Those two legal dispositions at face value have no application at all.

4.3.3.5 Paragraph 400(2)(e)

(e) where a corporation uses substantial machinery or equipment in a particular place at any time in a taxation year it shall be deemed to have a permanent establishment in that place.

The evidence is clear that the company owns no machinery in the USA nor uses it to perform its work. As the management consultant, the corporation does not perform any physicial work (paragraph 3.21 of the Facts).

4.3.3.6 Paragraph 400(2)(f)

(f) the fact that a corporation has business dealings through a commission agent, broker or other independent agent or maintains an office solely for the purchase of merchandise shall not of itself be held to mean that the corporation has a permanent establishment.

According to the evidence it was not in the nature of the appellant company to deal through a commission agent, broker, etc.

4.3.3.7 Paragraph 400(2)(g)

(g) the fact that a corporation has a subsidiary controlled corporation in a place or a subsidiary controlled corporation engaged in trade or business in a place shall not of itself be held to mean that the corporation is operating a permanent establishment in that place.

The appellant company has no subsidiary in the USA.

4.3.4 The inconsistency of the appellant in filing its different returns

Counsel for the respondent underlined the inconsistency of the appellant in filing its different income tax returns. On the USA returns, it declared it had one permanent establishment in the USA and one in Canada. On the Canadian Federal return, it declared it had two permanent establishments: this suggests to mean federal jurisdiction and Quebec jurisdiction.

On the Quebec tax return, the appellant claims 90% of exemption in the computation of tax and so admitting that the revenue originating from the USA originates from a permanent establishmemt outside the province. The definition of “Permanent Establishment” in the Income Tax Act of the Province of Quebec is mutatis mutandis the same as the definition of permanent establishment in the federal Income Tax Act.

The explanation given by the accountant (paragraphs 3.13 and 3.14 of the facts) for those different inconsistent declarations has not convinced the Board that it is only a technical error. However, despite that inconsistency and the intention on which it is based, the evidence shows, in the Board’s opinion, that in fact and in law, there is no permanent establishment in the USA.

The Board examined the jurisprudence cited above and did not find principles which applied in the present case to contradict the conclusion.

5. Conclusion

The appeal is allowed and the matter is referred back to the respondent for reassessment in accordance with the above reasons for judgment.

Appeal allowed.