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.
Principal Issues: 1) Application of subsection 402(4.1) of the Regulations where goods are destined for the US 2) Application of subsection 402(6) of the Regulations.
Position: 1) If the gross revenue derived from the sale of the goods destined for the US are not subject to US taxation, the gross revenue is allocated as stipulated by paragraphs 402(4.1)(d) and (e) of the Regulations. 2) Subsection 402(6) of the Regulations applies to allocate a partnership's gross revenue to its partners. The amount so determined is added to any other amount determined for the purposes of subsection 402(3) of the Regulations.
Reasons: 1) See above. 2) See above.
2005-011289
XXXXXXXXXX Shelley Lewis
613) 941-7239
April 23, 2007
Dear XXXXXXXXXX:
RE: Technical Interpretation Request - Part IV of the Income Tax Regulations.
This is in response to your letter of January 19, 2005, inquiring about the appropriate interpretation of Part IV of the Income Tax Regulations (the "Regulations") with respect to the determination of gross revenue reasonably attributable to a permanent establishment ("PE") in a province or country. We apologize for the delay in responding.
Our understanding of the facts is as follows:
1. Canco, a taxable Canadian corporation, is resident in Alberta.
2. Canco2, a taxable Canadian corporation, is resident in Saskatchewan.
3. Canco (10%) and Canco2 (90%) have formed a partnership ("P").
4. P has a PE in the United States of America ("US"). For US income taxation purposes, P has elected to be treated as a corporation.
5. Canco2 carries on a separate business from that carried on by P and sells products manufactured in Saskatchewan to P for $1,000.
6. P then sells the products to US residents for $1,100.
7. Canco2's only PE in the US is by virtue of its interest in P and otherwise Canco2 does not have any other PE in the US. Canco2's $1,000 sale to P is not allocable to a PE under the Canada-US Income Tax Convention (1980).
8. You are satisfied that the "destination" of the products of Canco2 is to a customer in the US.
Your concern is with how gross revenue should be allocated to each Canadian Corporation and to P's PE in the US.
In particular, your enquiry relates to
1. the application of the provisions of paragraph 402(4.1)(c) of the Regulations to Canco2's sales to P; and
2. the interpretation of the wording "in respect of those operations" in subsection 402(6) of the Regulations.
Your Opinion
If the conditions in paragraphs 402(4.1)(a), (b) and (c) are satisfied, the modifications in paragraph 402(4.1)(d) and (e) are applicable to the gross revenue allocation. It is your opinion that subsection 402(4.1) of the Regulations does not apply in respect of Canco2's gross revenue of $1,000 because the criteria in paragraph 402(4.1)(c) of the Regulations are not met. Specifically, it is your view that the conditions of paragraphs (a) and (b) of subsection 402(4.1) are met because the destination of Canco2's merchandise is to a customer in a country other than Canada (i.e., the US) and Canco2 has a PE in the US by virtue of its partnership interest in P.
Furthermore, in your view, neither of the two "or" tests in paragraph (c) of subsection 402(4.1) is met. The first "or" test is that Canco2 is not subject to income or profits taxation on its income under the laws of the other country by virtue of a taxing statute of the other country or a tax treaty or convention that the other country has with Canada. In your view, Canco2 does not meet this test because Canco2, through its partnership interest in P, is subject to income or profits taxation on its income by reason of having a PE in the US. The second "or" test requires that Canco2's gross revenue of $1,000 is not included in computing the income or profit for income or profits taxation by the other country by virtue of a taxing statute of the other country or a tax treaty or convention that the other country has with Canada. In your view, Canco2 does not meet this second "or" test. In your view, since the sale by Canco2 to P represents "gross revenue" to Canco2 and a "cost of sale" to P, Canco2's gross revenue of $1,000 "is" included in computing the income or profit for income or profits taxation purposes in the other country.
It is also your opinion that, for the purpose of computing the gross revenue used in the formula in subsection 402(3) of the Regulations, the wording of subsection 402(6) of the Regulations operates to divide the $1,100 gross revenue of P between Canco and Canco2 in their respective partnership shares, namely $110 for Canco and $990 for Canco2. You are concerned that the wording in the mid-amble to subsection 402(6) "shall include in respect of those operations, only that portion of" operates to eliminate other amounts, such as Canco2's sales of $1,000 in the above situation, that may be part of the calculation of gross revenue in subsection 402(3).
The situation outlined in your letter appears to relate to a factual one, involving a specific taxpayer. It is not this Directorate's practice to comment on proposed transactions involving specific taxpayers other than in the form of an advanced income tax ruling. For more information about how to obtain a ruling, please refer to Information Circular 70-6R5, "Advanced Income Tax Rulings, dated May 17, 2002. This Information Circular and other CRA publications can be accessed on the Internet at http://www.cra-arc.gc.ca. Should your situation involve a specific taxpayer and a completed transaction, you should submit all relevant facts and documentation to the appropriate Tax Services Office ("TSO") for their views. A list of TSOs is available on the "Contact Us" page of the CRA website. Although we cannot comment on your specific situation, we are prepared to provide the following general comments, which may be of assistance.
Our comments below are based on the assumption that P is a partnership at law, Canco2's sale of $1,000 in products to P is from a business carried on by Canco2 that is separate from the business carried on by P, and the transactions do not involve tax avoidance. If these assumptions are incorrect, our responses would differ.
Whether P is a partnership at law is a question of fact. The meaning of partnership is discussed in Interpretation Bulletin IT-90, What is a Partnership.
Whether Canco2's sale of $1,000 in products to P is from a business carried on by Canco2 that is separate from the business carried on by P also involves a question of fact. The subject of separate businesses is discussed further in Interpretation Bulletin IT-206R, Separate Businesses.
Section 402 of the Regulations governs the allocation of taxable income for a taxation year between provinces in which a taxpayer has a PE. Subsection 402(3) of the Regulations provides rules for the allocation of taxable income to a PE based on a formula. The formula uses as a parameter the gross revenue, provided the gross revenue is not nil for the year. Subsections 402(4), (4.1), (5) and (6) of the Regulations clarify what amounts of gross revenue should be included in the formula.
In the situation you have provided, paragraphs 402(4)(a) and subsections 402(4.1) and (6) of the Regulations are relevant.
Subsection 402(4) of the Regulations outlines how gross revenues are attributed to a PE in a province or country other than Canada for the purpose of the formula in subsection 402(3). Of particular relevance for Canco2's $1,000 sale is paragraph 402(4)(a), which provides that where the destination of a shipment of merchandise to a customer (P) to whom the merchandise is sold is in the particular province or country other than Canada (U.S.) where there is a PE, the gross revenue derived therefrom should be attributable to the PE in the province or country where the customer is located.
However, subsection 402(4.1) of the Regulations acts to modify this result when certain circumstances occur. Subsection 402(4.1) provides, inter alia:
For the purposes of subsections (3) and (4), where, in a taxation year,
(a) the destination of a shipment of merchandise to a customer to whom the merchandise is sold by a corporation [Canco2] is in a country other than Canada [US]...
(b) (b) the corporation [Canco2] has a permanent establishment in the other country [US], and
(c) the corporation [Canco2] is not subject to taxation on its income under the laws of the other country [US], 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 [US], 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.
We agree with your interpretation of the application of paragraphs (a) and (b) of subsection 402(4.1) of the Regulations in respect of Canco2's sales of $1,000. However, we disagree with your interpretation of paragraph 402(4.1)(c). As you indicated, paragraph 402(4.1)(c) provides for two "or" tests. In our view, in order for paragraph 402(4.1)(c) to be applicable, only one of the two "or" tests needs to be satisfied. In our view, Canco2 meets the second "or" test. Canco2's gross revenue of $1,000 derived from the sale to P is not included in computing Canco2's income or profits for income or profits taxation by the US by virtue of being a cost of sale in P's income computation. Rather the $1,000 is deducted in computing P's profit.
Based on the scenario described, since the conditions of paragraphs (a), (b) and (c) of subsection 402(4.1) of the Regulations are met, paragraphs (d) and/or (e) of this subsection are triggered. In particular, paragraph 402(4.1)(d) provides, inter alia, that
- paragraph 402(4)(a) does not apply; and
- paragraph 402(4)(c) is modified so that the gross revenue derived from the sale of merchandise destined to a customer in a foreign country is allocated to the PE in the province where the merchandise was produced or manufactured.
In our view, the gross revenue of Canco2 allocated to Saskatchewan would be $1,000 and the gross revenue allocated to the PE in the US would be $110 for Canco and $990 for Canco2.
With regard to subsection 402(6) of the Regulations, we agree with your application of this subsection in the situation you described.
The wording in the mid-amble to subsection 402(6) "shall include in respect of those operations, only that portion of" does not operate on its own to eliminate other amounts that may be part of the calculation of gross revenue in subsection 402(3). Thus, in the case of Canco2, its share of the partnership's total gross revenue ($990) would be added to any other gross revenue determined in accordance with paragraph 402(4.1)(d) ($1000) so that the amount referred to by the wording "total gross revenue for the year" in subparagraph 402(3)(a)(i) of the Regulations will be $1,990.
We trust these comments are of assistance.
Sandy Parnanzone
For Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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