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: Whether certain payments from a Canadian corporation to its non-resident parent are subject to Part XIII tax.
Position: Yes.
Reasons: The portion of the payments that are for "rent" are subject to Part XIII tax by virtue of paragraph 212(1)(d) of the Act and the portion of the payments that are for "services" are subject to Part XIII tax by virtue of subparagraphs 212(1)(d)(iii) and (v) of the Act.
December 1, 2005
Robert Thomson HEADQUARTERS
International Tax Advisor A. Seidel, CMA
XXXXXXXXXX (613) 957-2058
c/o XXXXXXXXXX TSO
Attention: XXXXXXXXXX
XXXXXXXXXX TSO
2005-016138
XXXXXXXXXX & Part XIII Tax
We are writing in response to your May 19, 2005 memorandum and your November 10, 2005 e-mail in which you requested our comments concerning the application of paragraph 212(1)(d) of the Income Tax Act (the "Act") to certain payments made by XXXXXXXXXX. ("Canco") to its parent in the United States ("US"), XXXXXXXXXX ("Parent").
Background
1. Canco leased several XXXXXXXXXX (the "Aircraft") from Parent pursuant to the terms of separate lease agreements entered into in respect of each Aircraft. All such agreements are collectively referred to herein as the "Lease". Parent was a LLC until XXXXXXXXXX. Canco used the Aircraft in its business in Canada and withheld Part XIII tax on the lease payments. Canco's lease payments to Parent totaled $XXXXXXXXXX in XXXXXXXXXX.
2. The Lease provides that Canco will pay "Periodic Rent" of $XXXXXXXXXX per month and $XXXXXXXXXX per hour for each hour flown by an Aircraft.
3. Article XXXXXXXXXX of the Lease provides that Canco will keep the Aircraft equipped with the "Engines, Components and Rotables" installed on the Aircraft or with substitutes or replacements made in accordance with the terms of the Lease and that Canco will service, repair, maintain, overhaul, test or cause the same to be done to the Aircraft in accordance with the Approved Maintenance Program. The Approved Maintenance Program includes scheduled maintenance, condition-monitored maintenance and on-condition maintenance of the Aircraft.
4. To fulfill its obligations under the Lease, Canco entered into separate maintenance agreements with the Parent for each Aircraft it leased from Parent. All such maintenance agreements are collectively referred to herein as the "Agreement". The Agreement states that Canco "will need certain maintenance parts" and that Parent "is willing to provide such parts pursuant to the terms" of the Agreement (see paragraph 5 below). Pursuant to the terms of the Agreement, Canco must pay Parent a "maintenance and overhaul reserve" at a fixed dollar amount per "Flight Hour", as defined in the Lease. Canco did not withhold any tax on the payments made to Parent pursuant to the Agreement. Canco's payments to Parent under the Agreement totaled $XXXXXXXXXX in XXXXXXXXXX ($XXXXXXXXXX in XXXXXXXXXX) (the "Maintenance Payments").
5. The Agreement contains the following provisions:
XXXXXXXXXX. Parent will provide all parts and supplies reasonably necessary to keep the Aircraft in operating condition, including major components, engines, rotables and supplies.
XXXXXXXXXX. Components and engines requiring maintenance or replacement will be exchanged for a refurbished or overhauled similar component or engine. Canco is required to ship any replaced parts to the Parent, at its own expense, as soon as the replacement part has been installed on the aircraft.
XXXXXXXXXX. Rotables that can be overhauled or refurbished will be exchanged for the replacement item. Again the replaced part is to be shipped to the Parent as soon as the replacement part has been installed on the aircraft.
XXXXXXXXXX. Parent will maintain an inventory of supplies and ship them to Canco on an on-going basis as required by Canco.
XXXXXXXXXX. Canco will pay Parent a maintenance and overhaul reserve per "flight hour" of the aircraft.
XXXXXXXXXX. Canco will pay Parent a maintenance and overhaul reserve for all supplies. The amount of the payment is equal to the cost of the supplies to Parent.
XXXXXXXXXX. Canco shall pay all shipping costs, sales taxes, custom duties, goods and services taxes or other taxes imposed on all of the components, engines, rotables and supplies.
XXXXXXXXXX. The components, engines, rotables and supplies shall remain the property of Parent, as lessor, upon installation on the aircraft.
6. Canco and Parent also entered into a "XXXXXXXXXX" agreement pursuant to which Parent agrees to provide Canco with "technical support and specialized maintenance services beyond the capability or training level of Canco's employees". Canco will engage Parent's services "as the manufacturer approved specialized service provider, to ensure Canco's compliance with Parent's Approved Maintenance Program". The services provided by Parent will be invoiced to Canco in accordance with the prevailing outside service rate charged by Parent. The Maintenance Payments do not include any charges under this agreement.
Issue
Do any of subparagraphs 212(1)(d)(i), (iii) or (v) of the Act apply to the $XXXXXXXXXX and $XXXXXXXXXX of "maintenance" payments made by Canco to Parent pursuant the Agreement?
Taxpayer's Representations - February 14, 2005 Letter
The Maintenance Payments made by Canco to Parent are not subject to Part XIII tax. The maintenance agreements are contracts for services, not contracts for the use of property, such that the Maintenance Payments are not "rent, royalty or similar payments" as described in paragraph 212(1)(d) of the Act. The Lease provides a complete and absolute right for Canco to use the Aircraft and related "Components", "Engines" and other spare parts, including replacement parts. The Agreement is simply a contract for services.
Section XXXXXXXXXX of the Lease provides that whenever any engines, components, rotables or other parts are replaced, pursuant to the Lease, they automatically become subject to the terms of the Lease. Thus, the right to use such parts is governed by the Lease and is paid for in the Lease and not in any other document.
Subparagraph 212(1)(d)(v) of the Act is not applicable as the paragraph is only intended to capture payments that are rents, royalties or similar payments. Subparagraph 212(1)(d)(v) of the Act is not intended to capture a payment for one thing (a service) that is based on or calculated from the use of another (any property). It is intended to capture any payment that depends upon the use of a property where the payment relates to that property, i.e. the payment must still be a rent, royalty or similar payment.
Audit's Position
Pursuant to the Agreement, Parent has agreed to provide spare parts to Canco. It is Audit's view that the Agreement was a contract for use of aircraft spare parts and not an agreement to provide "services". Pursuant to Articles XXXXXXXXXX of the Agreement, Parent will provide all parts and supplies reasonably necessary to keep the Aircraft in operating condition. Furthermore, "Components" and "Engines" requiring maintenance or replacement will be exchanged for a refurbished or overhauled similar "Component" or "Engine". Therefore, the payments made pursuant to the Agreement are subject to Part XIII tax by virtue of subparagraph 212(1)(d)(i) of the Act as "rent ... or similar payment, including ... any payment ... for the use of or the right to use ... any property".
Alternatively, the payments made pursuant to the Agreement are subject to Part XIII tax by virtue of subparagraph 212(1)(d)(v) of the Act as "any payment ... that was dependent on the use of ... property in Canada". Canco must pay the Parent a "maintenance and overhaul reserve" based on the number of "Fight Hours" of the Aircraft, i.e., the amount of the payment is dependent upon the use of the Aircraft.
Finally, it is Audit's position that paragraph 212(1)(d) of the Act is intended to include payments for the use of, or the right to use, aircraft "spare parts" where the payor and the payee are not dealing at arm's-length since subparagraph 212(1)(d)(xi) of the Act specifically exempts such spare parts if the payments are being made to an arm's length person.
Legislation
Subject to certain exceptions, subparagraph 212(1)(d)(i) of the Act provides that every non-resident person shall pay an income tax of 25% on every amount that a person resident in Canada pays or credits, or is deemed by Part I to pay or credit, to the non-resident person as, on account or in lieu of payment of, or in satisfaction of, rent, royalty or similar payment, including, but not so as to restrict the generality of the foregoing, any payment for the use of or for the right to use in Canada any property, invention, trade-name, patent, trade-mark, design or model, plan, secret formula, process or other thing whatever.
Subject to certain exceptions, subparagraph 212(1)(d)(iii) of the Act provides that every non-resident person shall pay an income tax of 25% on every amount that a person resident in Canada pays or credits, or is deemed by Part I to pay or credit, to the non-resident person as, on account or in lieu of payment of, or in satisfaction of, rent, royalty or similar payment, including, but not so as to restrict the generality of the foregoing, any payment for services of an industrial, commercial or scientific character performed by a non-resident person where the total amount payable as consideration for those services is dependent in whole or in part on the use to be made of, or the benefit to be derived from, those services, production or sales of goods or services, or profits, but not including a payment made for services performed in connection with the sale of property or the negotiation of a contract,
Subject to certain exceptions, subparagraph 212(1)(d)(v) of the Act provides that every non-resident person shall pay an income tax of 25% on every amount that a person resident in Canada pays or credits, or is deemed by Part I to pay or credit, to the non-resident person as, on account or in lieu of payment of, or in satisfaction of, rent, royalty or similar payment, including, but not so as to restrict the generality of the foregoing, any payment that was dependent on the use of or production from property in Canada whether or not it was an instalment on the sale price of the property, but not including an instalment on the sale price of agricultural land.
Interpretive Issues with Respect to Paragraph 212(1)(d) of the Act
The taxpayer's representative submits that the Tax Court of Canada decision in Zainul and Shazma Holdings Ltd. o/a Holiday Inn Hinton v. Her Majesty the Queen, 2004 DTC 3015 supports their view that subparagraphs 212(1)(d)(i), (iii) or (v) of the Act cannot apply unless a payment is a "rent", "royalty" or "similar payment" within the opening words of paragraph 212(1)(d) of the Act. In our view this case does not stand for the principle that an amount must be a "rent, royalty or similar payment" in order for paragraph 212(1)(d) of the Act to apply. This case dealt with the issue of whether a "one-time license fee" was a "rent, royalty or similar amount" subject to Part XIII tax. The corporate taxpayer was required to pay a "one-time license fee" accompanying its application to a US-based corporation for a Holiday Inn franchise. The Minister's position was that the fee was a "rent, royalty or similar amount" within the meaning of paragraph 212(1)(d) of the Act. The TCC concluded that the one-time fee was not a rent, royalty or similar payment, but an application fee. The Minister lost this case because the TCC found that the one time application fee did not fit into "rent, royalty or similar payment" and did not fit into, in this particular case, subparagraph 212(1)(d)(i) of the Act.
It is our view that a payment can be included in subparagraphs 212(1)(d)(i), (iii) or (v) of the Act even if it is not a "rent, royalty or similar payment". Our view is supported by the Tax Court of Canada decision in Hasbro Canada Inc. v. Her Majesty the Queen, 98 DTC 2129, and the Federal Court of Appeal decision in Her Majesty The Queen v. Farmparts Distributing Ltd., 80 DTC 6157.
In Hasbro, Counsel for Hasbro argued that a payment which comes within the ambit of one of the subparagraphs of paragraph 212(1)(d) of the Act but is not a "rent, royalty or similar payment", as per the preamble of paragraph 212(1)(d) of the Act, should not be subject to tax under paragraph 212(1)(d) of the Act. Dussault, T.C.C.J. stated: "I disagree with this submission." The Judge went on to say that a payment which comes within the ambit of one of the subparagraphs of 212(1)(d) need not also come within the ambit of the phrase "rent, royalty or similar payment" to be subject to Part XIII tax and that the subparagraphs should be applied as extensory inclusions to, rather than examples of, what is "rent, royalty or similar payment".
In Farmparts Distributing, counsel for the Crown argued that the words immediately following the introductory words in paragraph 212(1)(d), namely "... including, but not so as to restrict the generality of the foregoing, any payment" have the effect of including within the scope of the section the payments described in subparagraphs (i) to (v), including a single or lump sum payment, and that such a payment is subject to the charge of the section, whether or not it falls within the category of rent, royalty or a similar payment. In support of this submission, counsel for the Crown argued that the intent of Parliament to widen the scope of paragraph 212(1)(d) is evidenced by the fact that section 106(1)(d), the predecessor to section 212(1)(d) was amended in 1968 by deleting the words "any such payment" and substituting the words "any payment". The FCA concluded that this submission by the Crown's counsel is well founded and that the combination of the 1968 amendment and the use of the word "including" is a clear indication that Parliament intended that the payments described in subparagraphs (i) to (v) be subject to the charge of the section whether or not those payments can be said to be ejusdem generis with "rent, royalty, or a similar payment".
In Transocean Offshore Limited v. Her Majesty the Queen, 2005 DTC 5201 (FCA), Sharlow, J.A., while considering the application of paragraph 212(1)(d) of the Act in the context of whether it applied to a payment that was "in lieu of" rent, made the following comments:
"Paragraph 212(1)(d) imposes tax on any payment of rent ... or for the right to use property in Canada. ... Thus a payment made as compensation for the use of property in Canada or for the right to use property in Canada is within the scope of paragraph 212(1)(d) of the Act.
By virtue of the additional words in paragraph 212(1)(d), that provision also applies to any payment made on account of such compensation, or in satisfaction of such compensation. That would appear to cover virtually all situations in which a payment is made to discharge, in full or in part, an obligation to pay compensation to a non-resident for the past or current use, in Canada, of property."
Sharlow, J.A. concluded that paragraph 212(1)(d) of the Act was broad enough to include a payment made "in lieu of" compensation for the use, in Canada, of property since the words in the preamble of subsection 212(1) of the Act provide that it applies to every amount that is "on account or in lieu of payment of, or in satisfaction of" those items enumerated in paragraph 212(1)(d) of the Act.
As set out below, we consider the Agreement to provide for services to be rendered to Canco by Parent. In our view, the principle discussed in Transocean does not permit one to conclude that a payment for services, (i.e. the maintenance of the Aircraft), would be in lieu of rent for the use of the Aircraft simply because the services related to Aircraft leased to Canco by the maintenance service provider. While it is true that a payment for the lease of spare parts may have been included in paragraph 212(1)(d) of the Act as "rent" had Canco and Parent not entered into the Agreement and, in order to avoid downtime, Canco had leased spare parts from Parent, that is not what the Agreement provides. The fact that this notional alternative course of action exists does not allow us to conclude that the payments under the Agreement are in "lieu of rent" for the lease of spare parts.
Payments Pursuant to the Agreement
Under the Agreement, Parent agrees to maintain an inventory of spare parts and supplies that is available to Canco as the need arises. In our view, the portion of the Maintenance Payments attributable to this undertaking by Parent is for a service rendered by Parent to Canco. If any portion of the Maintenance Payments could be viewed as having been paid by Canco for the use of the spare parts that are not at the particular time installed on the Aircraft, it would not be for "use in Canada", for purposes of subparagraph 212(1)(d)(i) of the Act, as the spare parts generally remain in the US until they are needed by Canco. Payments for the use of the parts installed on the Aircraft would, in our view, be governed by the Lease and not the Agreement.
Subparagraph 212(1)(d)(iii) of the Act applies to a payment for services of an industrial, commercial or scientific character performed by a non-resident person where the total amount payable as consideration is dependent in whole or in part either on the use to be made of, or the benefit to be derived from, those services, on production or on sales of goods or services, or on profits. The postamble of subparagraph 212(1)(d)(iii) of the Act states that the provision does not apply to a payment made for services performed in connection with the sale of property or the negotiation of a contract, neither of which are applicable here. Clauses 212(1)(d)(iii)(A) through (C) of the Act require that the total amount payable to a non-resident provider of services be dependent to some extent on the "use to be made of or the benefit to be derived from, those services" on "production or sales of goods or services" or on "profits". In Hasbro, supra, Dussault, T.C.C.J. stated that "it is difficult to interpret that provision as applying only to payments for a particular category of services when the words used have definitely a wide import and are not qualified in any manner". In this situation, the relevant portion of the $XXXXXXXXXX per hour payment to the Parent that is a payment for services provided by Parent in connection with the maintenance of the Aircraft, is a payment that is dependent upon Canco's use to be made of the Parent's services provided under the Agreement. This is so because the amount of the payment and the quantity of services required by Canco are directly proportional to the use of the Aircraft by Canco. As such, the Maintenance Payments are a payment for services under the Agreement and subject to Part XIII tax by virtue of subparagraph 212(1)(d)(iii) of the Act.
Even if it were concluded that the amounts paid under the Agreement were not for services, as described in subparagraph 212(1)(d)(iii) of the Act, it is our view that the Maintenance Payments under the Agreement would then fall under the provisions of subparagraph 212(1)(d)(v) of the Act. Based on the FCA's decision in Farmparts, supra, the taxpayer's representations that subparagraph 212(1)(d)(v) of the Act cannot apply to the Maintenance Payments because the paragraph is only intended to capture payments that are rents, royalties or similar payments are unsustainable. It is clear from paragraph XXXXXXXXXX of the Agreement that the Maintenance Payments to Parent were based on the use of the Aircraft. The amount to be paid to the Parent as a "maintenance and overhaul reserve" was determined on a per "Flight Hour" basis. A "Flight Hour" is described in the Lease and, in general terms, is measured from the time that the wheels of the Aircraft leave the ground to the time when the wheels of the Aircraft re-touch the ground. It is, therefore, our view that it is reasonable to conclude that the Maintenance Payments are payments that are dependent on the hourly use of the Aircraft and therefore described in subparagraph 212(1)(d)(v) of the Act.
Conclusion
It is our view that the Maintenance Payments are subject to Part XIII tax. The Maintenance Payments are for services provided under the Agreement or are payments to Parent that are dependent on the use of the Aircraft such that there are reasonable arguments to support the application of Part XIII to such Maintenance Payments under subparagraphs 212(1)(d)(iii) or (v) of the Act, respectively.
The FCA decision in Transocean, supra, is not helpful in resolving the application of paragraph 212(1)(d) of the Act in this particular case. In Transocean, the issue was whether a payment that was in lieu of rent, which rent was never going to be paid, was nevertheless subject to Part XIII tax because of the preamble to subsection 212(1) of the Act. The FCA concluded, based on the clear wording of the preamble of subsection 212(1) of the Act, that the amount paid was in lieu of rent and was therefore subject to Part XIII tax. In this particular situation, there is no payment in lieu of rent or in lieu of any other amount under the Agreement. Canco paid Periodic Rent for the use of the Aircraft under the Lease, paid the Maintenance Payments for the "services" provided by Parent pursuant to the Agreement and paid Parent for further services under the Technical Support and Specialized Maintenance Services agreement. Parent provided Canco everything that was agreed to under each agreement and Canco made payments as set out under the relevant agreements. As a result, we do not consider the case on point in reference to the facts under consideration.
Application of the Convention to Paragraph 212(1)(d) Amounts
Canco's payments for the use of the Aircraft are considered to be "royalty" payments for the purposes of the Convention by virtue of the definition of "royalties" in paragraph 4 of Article XII of the Convention. The tax payable will be 10 percent of the gross amount of the payments made by Canco for the use of the Aircraft pursuant to paragraph 2 of Article XII of the Convention in those taxation years that Parent was a resident of the US under the Convention. To be a resident of the US, the Parent must be liable to tax in the US. Since Parent was an LLC prior to XXXXXXXXXX, Parent would not have been liable for tax in the US prior to XXXXXXXXXX. Accordingly, Parent would not be entitled to the benefits available through the Convention for the period that ends on XXXXXXXXXX.
The Maintenance Payments which are for services provided to Canco and are subject to Part XIII tax pursuant to subparagraph 212(1)(d)(iii) or (v) of the Act, would not meet the definition of "royalties" in paragraph 4 of Article XII of the Convention and would therefore be considered to be business profits of Parent, within the meaning thereof in Article VII of the Convention, in those years where the Parent is a resident of the US under the Convention. If Parent did not carry on business in Canada through a permanent establishment, then Article VII of the Convention would exempt Parent from tax in Canada on the Maintenance Payments.
Withholding
Pursuant to subsection 215(1) of the Act, Canco is required to withhold Part XIII tax on the amounts paid to Parent pursuant to the Lease and pursuant to the Agreement and remit such amounts to the Receiver General on behalf of Parent.
For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Customs and Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the electronic library version, or they may request a copy severed using the Privacy Act criteria which does not remove client identity. Requests for this latter version should be made by you to Mrs. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.
Olli Laurikainen, CA
for Director
International & Trusts Division
Income Tax Rulings Directorate
Policy and Planning Branch
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