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 or not the Taxpayer is liable for Canadian income tax based on the facts provided for four different scenarios.
Position: Scenario 1, 2 & 3: Question of fact. Scenario 4: Question of fact but likely yes.
Reasons: Scenario 1, 2 & 3: Overview of relevant Treaty Articles provided. Scenario 4: A PE likely would exist pursuant to Article V(2).
October 18, 2011
Dear XXXXXXXXXX :
Re: Technical Interpretation request - International tax issues
This letter is in response to your letter in which you ask whether or not a company incorporated in the United States ("US") would be liable for Canadian income tax based on the facts and circumstances set out in four separate scenarios.
The company ("USCo") is incorporated in the US and its headquarters are located in the US. USCo's business is the sale and service of industrial machines. The sale of a machine involves both its manufacture and installation. USCo does not have any inventory in Canada and does not own or lease any property in Canada. USCo does not do any advertising in Canada.
USCo employs an individual who is a Canadian citizen and resident ("Canadian Employee"). The Canadian Employee works out of his/her house. The Canadian Employee solicits orders for new machines and service contracts for new and used machines. The Canadian Employee meets with both potential new and existing customers. The Canadian Employee also meets with customers after the installation of the machine to ensure the customer is satisfied. The Canadian Employee has no decision-making authority. All terms of the sale and services contracts are approved at USCo's headquarters.
The machines are manufactured outside Canada and are shipped to Canadian customers via a third-party carrier. The specific terms of the contract include but are not limited to the price, payment terms, the delivery timeframe, the warranty period and various other items. The contract is payable in US dollars and USCo does not maintain a Canadian bank account. USCo hires another company to install the machines. Employees of USCo who are both US citizens and US residents ("US Employees") would be sent to a Canadian customer's location to supervise the installation and provide technical assistance to the installers. The US Employees would generally spend anywhere from a few days to a few months in Canada depending on the size of the installation.
With respect to servicing contracts, machines are serviced by US Employees who either drive or fly to the Canadian customer's location. The US Employees would generally spend anywhere from one day to one week in Canada depending on the complexity of the service required.
The facts are identical to Scenario 1 except that instead of hiring employees to do the sales and service functions, USCo would hire independent contractors who are both Canadian citizens and residents to perform those functions.
The facts are identical to Scenario 1 except that USCo would do a limited amount of advertising in Canada. This would include establishing a Canadian website and/or advertising in appropriate Canadian industry trade journals or other print media.
The facts are identical to Scenario 1 except that USCo would lease a small facility. The facility would be used as a sales office and to inventory a limited number of common replacement/repair parts.
Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, Advance Income Tax Rulings, dated May 17, 2002. Where the particular transactions are completed, the inquiry should be addressed to the relevant tax services office. We are, however, prepared to offer the following general comments, which may be of assistance. Our comments are intended to provide you with an overview of the provisons of the Act and the Canada - U.S. Tax Convention that are to be considered in determining whether a Canadian tax liability may arise.
Liability for Canadian Tax
Based on the facts provided, USCo would be considered a resident of the US and therefore treated as a non-resident person under the Income Tax Act (the "Act"). In general, pursuant to paragraph 2(3)(b) of the Act, a non-resident person who carried on a business in Canada is liable to pay Canadian income tax, as required by the Act, on its taxable income earned in Canada. The determination of whether a non-resident is "carrying on business in Canada" is always a question of fact and is based on factors which have been developed through case law. After reviewing the specific factors with respect to USCo's machinery sales in Canada, we could arrive at the conclusion that a business is not carried on in Canada according to the common law tests. Nevertheless, the extended meaning of 'carrying on business in Canada' is provided in paragraph 253(b), which states that where a person who is a non-resident person "solicits orders or offers anything for sale in Canada through an agent or servant, whether the contract or transaction is to be completed inside or outside Canada or partly in and partly outside Canada", the person shall be deemed, in respect of the activity or disposition, to have been carrying on business in Canada in the year. In this case, USCo employs an individual who is a Canadian citizen and resident who solicits orders for new machines as well as service contracts for new and used machines. Therefore, USCo would be deemed to be carrying on business in Canada under paragraph 253(b). With respect to the maintenance services performed in Canada, such activity would also normally be considered to be carrying on business in Canada. As a result, the non-resident corporation will be liable for income tax on its taxable income earned in Canada for the year determined in accordance with section 115 of the Act.
As noted in your letter, in accordance with the Canada-U.S. Income Tax Convention (the "Convention"), the business income of a non-resident is generally taxable only in their country of residence, unless a taxpayer has a permanent establishment ("PE") in the other country. Pursuant to paragraph 1 of Article VII of the Convention, the business profit of a resident of the United States shall be taxable only in United States unless the resident carries on business in Canada through a PE situated in Canada. Where a Canadian PE exists, the U.S. resident will be taxed in Canada on the business profits attributable to that PE.
Existence of a PE
Generally speaking, Article V provides the conditions that, if met, will cause a place of business in the Other Contracting State to constitute a PE, or in some cases deem the resident of a Contracting State to have a PE in the Other Contracting State. Paragraph 1 of Article V contains the general definition of a PE. An actual determination of the existence of a PE in Canada is always a question of fact, and would only be made after a thorough review of all the relevant facts.
Paragraph 1 of Article V provides that, for the purposes of the Convention, the term "permanent establishment" means a fixed place of business through which the business of a resident of a Contracting State is wholly or partly carried on. Paragraph 2 states that a PE includes an office.
According to the Commentary on Article 5 of the Organisation for Economic Co-operation and Development's Model Tax Convention on Income and on Capital ("OECD Model Tax Convention"), the definition of PE contains the following conditions:
- There must be a place of business,
- the place of business must be fixed, and
- the non-resident must be carrying on its business wholly or partly through this fixed place of business.
As stated in Income Tax Technical News #33 ("ITTN 33"), these three conditions form an appropriate framework for a PE analysis and any relevant factor to a PE determination has to revolve around one of those three conditions. We suggest that you refer to the Example of Factors in ITTN 33 for items that may assist you in determining whether these conditions exist. ITTN 33 is available at http://www.cra-arc.gc.ca/E/pub/tp/itnews-33/itnews-33-e.html.
A PE may exist in other circumstances, even where it is determined that a "fixed place of business" does not exist. For example, pursuant to paragraph 5 of Article V, the Canadian Employee shall be deemed to be a PE in Canada if the Canadian Employee has, and habitually exercises in Canada, authority to conclude contracts in the name of USCO. Based on the information you have provided, it is unlikely that USCO would have a PE in Canada pursuant to paragraph 5.
If an enterprise is found not to have a PE by virtue of paragraphs 1, 2 and 4 to 8 of Article V, paragraph 9 provides that a PE may be deemed to exist if certain conditions are met. Paragraph 9 was added to the Convention through the 2007 Protocol and has implications for enterprises which provide services in the other Contracting State. Subject to the provisions of paragraph 3 of Article V, if an enterprise meets either of the two tests as provided in subparagraphs 9(a) and 9(b), the enterprise will be deemed to provide services through a PE in Canada.
The Technical Explanation to the Convention states in part:
- The first test as provided in subparagraph 9(a) of Article V has two parts. First, the services must be performed in the other State by an individual who is present in that other State for a period or periods aggregating 183 days or more in any twelve-month period. Second, during that period or periods, more than 50 percent of the gross active business revenues of the enterprise (including revenue from active business activities unrelated to the provision of services) must consist of income derived from the services performed in that State by that individual. If the enterprise meets both of these parts, the enterprise will be deemed to provide the services through a PE.
- The second test as provided in subparagraph 9(b) of Article V provides that an enterprise will have a PE if the services are provided in the other State for an aggregate of 183 days or more in any twelve-month period with respect to the same or connected projects for customers who either are residents of the other State or maintain a PE in the other State with respect to which the services are provided.
Whether USCo meets the tests in subparagraphs 9(a) or 9(b) is a question of fact. However, the maintenance services performed by USCo are stated to be of a typical time frame of one day to one week and therefore not likely to exceed the 183 days threshold. In determining whether the 183 day test in subparagraph 9(b) would be met in respect of USCO's service contracts, note that the subparagraph refers to "same or connected projects". The Technical Explanation to the 2007 Protocol discusses the meaning of "connected projects" and provides additional guidance regarding the factors that are considered in determining whether projects are connected.
Paragraph 3 of Article V, provides that where a building site, construction or installation project lasts for more than 12 months a PE is deemed to exist. The installation services provided by USCo are subject to paragraph 3 of Article V and not paragraph 9.
The overall analysis is the same as scenario 1 with exception of the following points.
Whether the relationship is one of employer-employee or customer-independent contractor is a question of fact, which can only be determined following a complete analysis of the circumstances of a particular situation. Consideration is generally given to the following four criteria: (1) the extent to which the worker is subject to the control of the payor, (2) whether the worker provided his or her own tools, (3) whether the worker has a chance of profit or risk of loss, (4) whether or not the worker is employed as part of the business and performing services integral to the business. No one criterion is determinative as to whether a person is an employee or independent contractor ("Contractor"), but all the criteria are considered relevant. The intention of the parties is also relevant and consideration must be given to the legal relationship between the parties. The CRA publication "RC4110 Employee or Self-employed" further elaborates on these criteria and the intention of the parties.
Paragraph 7 of Article V states that a resident of the US shall not be deemed to have a PE in Canada merely because the resident carries on a business in Canada through an independent agent, provided that such persons are acting in the ordinary course of their business.
Whether the person that USCo hires in Canada is an "independent agent acting in the ordinary course of its business", is a determination that we would make only after a thorough review of all of the relevant facts and agreements, such as those between USCo and the Contractor, between USCo and its customer(s) in Canada, and the Contractor and USCo's customers in Canada, if any. Generally, in order for a Contractor to be an independent agent acting in the ordinary course of its business, the Contractor must be independent both legally and economically and acting in the ordinary course of its business when acting on behalf of USCo. For your assistance we refer you to the Commentary on paragraphs 5 and 6 of Article 5 of the OECD Model Tax Convention, which discusses the concept of "independent agent" and "independent agent acting in the ordinary course of its business".
USCo may have a PE in Canada by virtue of paragraph 9 of Article V, despite the application of paragraph 7. Whether the person performing the service is an employee or an independent agent is not a factor.
The overall analysis is the same as scenario 1 with exception of the following points.
In general, advertising activities carried out at the Canadian Employee's home location would be considered a factor in favour of finding that a PE exists. Where a particular location is solely dedicated to advertising then subparagraph 6(e) of Article V would apply to deem the location not to be a PE. Where a taxpayer utilizes a web site for its Canadian customers, Canada generally follows the Commentary on Article 5 of the OECD Model Tax Convention regarding Electronic Commerce. As in the OECD commentary, it is our view that because a web site is intangible (no location), it cannot be a PE. However, a computer server on which a website is stored can be a PE if the taxpayer owns or leases the server where the server is fixed in place and time and business is carried on through that server. In summary, a non-resident who presents a web site to its Canadian customers may be considered to carry on business in Canada through a PE where all of the following conditions are met:
- the host server is located in Canada,
- the business is being carried on, wholly or in part, through the operation of the web site on that server,
- the host server is at the non-resident's disposal,
- the host server is more or less permanently linked to a geographic location in Canada, and
- the web site is hosted by the particular computer server on a more than merely temporary or tentative basis.
The overall analysis is the same as scenario 1.
Based on the information provided, it is our view that the leased space would likely be considered a PE under paragraph 2 of Article V.
We trust these comments will be of some assistance to you in determining whether a permanent establishment exists in Canada for each of the scenarios you have described. When you have a specific fact situation, we suggest that you contact the Tax Services Office closest to your anticipated location of USCo's operations in Canada to obtain their views as to the existence of a PE. You will find information for tax services office locations at www.cra-arc.gc.ca/cntct/tso-bsf-eng.html.
International & Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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