9 December 2008 Roundtable, 2008-0300571C6 - 5th Protocol - Changes to Article 15(2)(b)

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: What is the CRA's interpretation of the change of the word "employer" to the word "person" in subparagraph 2(b) of Article XV of the 5th Protocol to the Canada-U.S. Tax Convention?

Position: No change in position

Reasons: Whether the word "person" or the word "employer" is used, Canada will refer to principles developed under Canadian jurisprudence and the Quebec Civil Code to determine who, in fact, is exercising the functions of employer.

2008 TEI-CRA Liaison Meeting
December 9, 2008
2008-030057

Question 3(C) - Article XV - Income From Employment

The changes in the Protocol to Article XV(2) of the Treaty seemingly expand the circumstances where one country (the source state) may tax the other country's (the state of residence) residents for the exercise of employment in the source state. Specifically, the reference to "employer" in Article XV(2)(b) is deleted and an employee will be subject to tax in the other Contracting State if remuneration is paid "by or on behalf" of any person resident in the other Contracting State. Thus, it is no longer necessary that the remuneration be borne by an employer resident in the other Contracting State or by a PE or fixed base of an employer in the other Contracting State. As a result of the change, an employee is liable to tax wherever a parent corporation is the employer and provides its employees as a service to the subsidiary (resident in the other Contracting State) for a fee. The provision also applies where the employee of an arm's length service provider provides services and charges a fee to the person resident in Canada or to the Canadian PE.

The U.S. Technical Explanation suggests the language is not intended to be interpreted broadly. Rather, "the change is intended only to clarify that both the United States and Canada understand that in certain abusive cases, substance over form principles may be applied to recharacterize an employment relationship, as prescribed in paragraph 8 of the Commentary to Article 15 (Income from Employment) of the OECD Model." 1 We invite a discussion of the revised Article based on the following questions.

1. How does CRA interpret the new language? Will the language be construed broadly or narrowly and solely to apply the OECD analysis as suggested by the U.S. Technical Explanation?

2. Will CRA provide specific examples of scenarios where the amended Article would apply? Will the amendments apply -

a. Where an arm's length service provider (assume a U.S. resident) provides services and charges a fee to a person resident in Canada?

b. Where a non-arm's length service provider (assume a U.S. resident) provides services and charges an arm's length fee comparable to that in subparagraph a. to a person resident in Canada?

c. Where a U.S. parent provides its employees to a subsidiary in Canada

(for a fee) in order to assist the subsidiary in carrying out its work? 2

d. Where "International Hiring Corporations" are used? (In other words, will the amendments apply solely to situations described in paragraph 8 of the OECD Commentary on Article XV of the Model Treaty where a local employer wishing to employ foreign labour for one or more periods of less than 183 days recruits through an intermediary established abroad who purports to be the employer and hires the labour out to the employer?)

If the intent of the revised Article is to apply a substance-over-form test in abusive situations in order to determine the true economic employer, will CRA provide criteria or guidelines on (1) what it considers "abusive situations" and (2) the application of the OECD's "true economic employer" test?

Answer:

Paragraphs 1 and 2 of Article XV of the Fifth Protocol amending the Canada-U.S. Convention read as follows:

1. Subject to the provisions of Articles XVIII (Pensions and Annuities) and XIX (Government Service), salaries, wages and other remuneration derived by a resident of a Contracting State in respect of an employment shall be taxable only in that State unless the employment is exercised in the other Contracting State. If the employment is so exercised, such remuneration as is derived therefrom may be taxed in that other State.

2. Notwithstanding the provisions of paragraph 1, remuneration derived by a resident of a Contracting State in respect of an employment exercised in the other Contracting State shall be taxable only in the first-mentioned State if:

(a) Such remuneration does not exceed ten thousand dollars ($10,000) in the currency of that other State; or

(b) The recipient is present in that other State for a period or periods not exceeding in the aggregate 183 days in any twelve-month period commencing or ending in the fiscal year concerned, and the remuneration is not paid by, or on behalf of, a person who is a resident of that other State and is not borne by a permanent establishment in that other State.

The relevant paragraph in the Technical Explanation of the Fifth Protocol is as follows:

New subparagraph 2(b) refers to remuneration that is paid by or on behalf of a "person" who is a resident of the other Contracting State, as opposed to an "employer." This change is intended only to clarify that both the United States and Canada understand that in certain abusive cases, substance over form principles may be applied to recharacterize an employment relationship, as prescribed in paragraph 8 of the Commentary to Article 15 (Income from Employment) of the OECD Model. Subparagraph 2(b) is intended to have the same meaning as the analogous provisions in the U.S. and OECD Models.

Whether the word "person" or the word "employer" is used in subparagraph 2(b) of Article 15(Income From Employment) in Canada's income tax conventions, the intention is to determine who, in fact, is exercising the functions of employer. In making this determination, the CRA generally will refer to principles developed under Canadian jurisprudence and the Quebec Civil Code.

Paragraph 8 of the Commentary on Article 15 (Income From Employment) in the OECD Model, describes a situation involving the "international hiring-out of labour". It says:

In this system, a local employer wishing to employ foreign labour for one or more periods of less than 183 days recruits through an intermediary established abroad who purports to be the employer and hires the labour out to the employer. The worker thus fulfils prima facie the three conditions laid down by paragraph 2 and may claim exemption from taxation in the country where he is temporarily working.

In this situation, applying the principles developed under Canada's domestic laws, we would expect that the local employer and the worker have established an employer-employee relationship in spite of the intermediary. As a result, the employee would not be entitled to the exemption in paragraph 2 of Article XV of the Convention.

In another case, a foreign company is retained to provide services to a company resident in Canada, and the services are in fact rendered by the foreign company through its employees. In this case, we would expect that Canada's domestic law will determine that the Canadian company and the employees have not established an employer-employee relationship. Assuming all of the other conditions in paragraph 2 of Article XV are met, the employees should not be denied the benefits therein.

Sherry Thomson
International & Trusts Division
Income Tax Rulings Directorate

ENDNOTES

1 'The OECD Commentary states that in "abusive situations" the formal legal employment relationship should be ignored and an analysis of the functions performed should be undertaken in order to determine who the true employer is. The true employer is understood to be the person having the rights to the work produced as well as one who bears significant responsibilities and risks.

2 The subsidiary is using the non-resident employees to supplement its work force, i.e., the subsidiary is the economic employer, having all the risks and rewards of the work produced, has the authority to instruct, etc.