7 December 1999 TEI Roundtable, 1999-0007820 - Permanent establishment for customs

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.

TEI Conference
December 7, 1999

Question XXXIV

CRITERIA FOR PERMANENT ESTABLISHMENT - CUSTOMS V. INCOME TAX

Many U.S. TEI members companies have Canadian subsidiaries with operating businesses in Canada. In most cases, the Canadian subsidiaries have been active in Canada for years, paid income taxes, and have been subject to audit by the Income Tax Division. Hence, the companies are substantial enough to be deemed to have a permanent establishment in Canada. Recently, some of these Canadian subsidiaries have been audited by the Customs Division. In their assessment notices, the Customs auditors have asserted a higher valuation for the imported goods based on the end-selling price to customers in Canada. In effect, the Customs auditors ignored the transfer of title to the goods as well as the valuation on the intercompany sale of goods from the U.S. Company to the Canadian subsidiary, asserting that the Canadian companies do not have a PE-at least not for Customs purposes.

A. Will Revenue Canada please explain the basis of, and the differences in, the criteria for a PE for Customs and Income tax purposes ? Please explain how a longstanding, viable Canadian subsidiary that has paid substantial income taxes over the years can be deemed to have a PE for income tax purposes but none for customs purposes.

B. If the parent company made an adjustment to the intercompany billing to the subsidiary, up to the custom's value, would the Canadian subsidiary be entitled to an increased income tax deduction for its cost of goods sold to the Canadian customer ?

C. Are there any other substantive or procedural requirements the subsidiary must satisfy to claim the increased deduction ?

CCRA's Position

A) In the situation described by the TEI it is stated that "...Canadian subsidiaries ... paid income taxes, and have been subject to audit by the Income Tax Division. Hence, the companies are substantial enough to be deemed to have a permanent establishment in Canada...." Under subsection 2(1) of the Income Tax Act, an income tax is payable by persons resident in Canada. Under subsection 250(4), a corporation is deemed to be resident in Canada if it is incorporated in Canada after April 26, 1965. Therefore, a resident corporation does not need to have a permanent establishment or a significant presence in Canada to be liable to income tax in Canada, and the fact that a resident corporation pays federal income taxes does not mean that it has a permanent establishment or a significant presence in Canada.

For customs purposes, however, a significant presence is required in order for a corporation to meet the definition of resident under subsection 2.1(a) of the Valuation for Duty Regulations, Meaning of Purchaser in Canada. For a corporation to be resident in Canada for purposes of determining the "purchaser in Canada", it must carry on business in Canada and the management and control of the day-to-day operations of the corporation must be in Canada. Paragraphs 12 and 13 of D13-1-3, Customs Valuation Purchaser in Canada Regulations (Customs Act, Section 48), provide an illustrative list of the factors which are considered when determining if a corporation is carrying on business in Canada for customs purposes, and thus has a significant presence in Canada. Paragraph 15 of D13-1-3 provides guidance in determining the degree of management and control that exists in Canada.

If a corporation is not managed and controlled in Canada, it is deemed to be not resident for customs purposes. Customs will then determine if this (deemed) non-resident corporation qualifies as a purchaser in Canada by virtue of it having a permanent establishment in Canada. As with the definition of "resident", the definition of "permanent establishment" for customs purposes has a requirement that the corporation be carrying on business in Canada, and therefore, have a significant presence in Canada.

Although legal title to the goods may have been transferred from the U.S. parent to the Canadian corporation, and the tax authorities may accept this transaction for purposes of establishing a transfer price for income tax purposes, Customs will look beyond the paper transaction to determine the Canadian subsidiary's actual role in the sales transaction. Ultimately, Customs is trying to distinguish between a corporation that is acting like a "selling agent" versus a corporation that is acting more like a "buyer and reseller" in respect of the goods. If Customs determines that the subsidiary has limited management and control over its day-to-day operations, or is not carrying on business in Canada, the transaction value (i.e., the basis of appraising the value for duty for customs purposes) may not be seen to be the price set between the U.S. parent and the subsidiary; rather, Customs may conclude that the subsidiary is acting more like a selling agent for the ultimate Canadian customer and, therefore, the selling price to the Canadian customer may be more representative of the transaction value.

Paragraph 9 of D13-1-3 highlights the fact that we are dealing with two very different pieces of legislation when it states, "... where it is determined that a business entity is a resident, carrying business, or maintaining a permanent establishment in Canada for valuation purposes, this, in itself, in no way establishes that the entity would be considered to be a resident, carrying on business, or maintaining a permanent establishment in Canada for the purposes of the Income Tax Act...."

We recognize that differences exist between the policies and rules of Income Tax and Customs, and we are currently in the process of documenting these differences and explaining the reasons for them.

B) For income tax purposes, a sale has occurred between the U.S. parent and the Canadian subsidiary (not the ultimate Canadian customer). In order to determine if the intercompany selling price is that which would have been negotiated on an arm's length basis, the most appropriate transfer pricing method would be applied.

For example, the Income Tax authorities could look for a comparable uncontrolled price at the wholesale level, representing the level of trade between the parent and subsidiary. Provided the intercompany billing price represented an arm's length price, that intercompany price would represent the cost of goods sold to the Canadian subsidiary for income tax purposes. If the resale price method were applied, the end selling price to the Canadian customer would represent the starting point from which an appropriate gross margin would be deducted to arrive at the intercompany price (cost of goods sold) for income tax purposes.

In conclusion, when Customs effectively ignores the selling price between the U.S. parent and the Canadian subsidiary, the end selling price to the Canadian customer represents the transaction value for customs purposes only, and is generally not the intercompany transfer price for income tax purposes.

C) As the response to the above question indicates, there is no increased deduction.

Author :	Brian Bloom
File :		993041
Date :		November 22, 1999

		Draft