23 January 2012 External T.I. 2011-0418281E5 - Employment income - treaty exemption

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. Where there is a service contract between USco and Canco and the services rendered in Canada by USco are charged at cost to Canco, will the US employee's remuneration be exempt from tax in Canada under paragraph 2(b) of Article XV?
2. Where there is no service contract between USco and Canco, but USco charges Canco for the US employee's remuneration via an intercompany charge, will the remuneration be exempt under paragraph 2(b) of Article XV?

Position: 1. Question of fact
2. Question of fact

Reasons: 1. and 2. Provided all the other requirements of subparagraph 2(b) of Article XV of the Treaty are met, the remuneration may be exempt if the only employer of the employee is nevertheless USco both in substance and in form.

XXXXXXXXXX
					2011-041828
					J. Nichols

January 23, 2012

Dear XXXXXXXXXX :

RE: Article XV of the Canada - US Tax Convention

We are writing in reply to your letter dated August 24, 2011. In your letter you pose questions regarding the positions taken in a previous technical interpretation issued by this Directorate (i.e. 2011-0403551E5 dated July 15, 2011) concerning the application of subparagraph 2(b) of Article XV of the Canada-US Tax Convention (the "Treaty"). That previous technical interpretation set out the following hypothetical scenario.

• US Co is a corporation that is resident of the United States ("US") for the purposes of the Treaty. US Co is also a "qualifying person" as defined in paragraph 2 of Article XXIX-A of the Treaty;
• US Co does not currently and will not at any future time carry on business in Canada or have a permanent establishment ("PE") in Canada within the meaning of Article V of the Treaty;
• Canco is a corporation incorporated in and resident in Canada;
• Canco carries on business in Canada;
• US Co and Canco do not deal at arm's length;
• US Co and Canco concluded an intercompany services agreement
• ("Service Contract") where a fee ("Service Fee") is charged for intra-group services (such as administration, management, engineering or technical assistance);
• A US resident individual who is an employee of US Co ("US Employee") will be temporarily sent to Canada to perform services for Canco as required under the Service Contract;
• The US Employee, at all times, remains a resident of the US for purposes of the Treaty;
• The US Employee is present in Canada 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;
• The US Employee will remain on the payroll of US Co and will be remunerated by US Co for the services performed during the period US Employee is in Canada;
• The US Employee, at all times, will remain an employee of US Co and will not be an employee of Canco in substance or in form;
• The total remuneration of the US Employee for the services performed in Canada in a particular calendar year exceeds $10,000 (Canadian); and
• A Service Fee will be charged by US Co to Canco for the services provided under the Service Contract.

Based on these facts, the conclusions reached in the earlier technical interpretation were, inter alia, that pursuant to subparagraph 2(b) of Article XV of the Treaty, the US Employee's remuneration for the services performed in Canada is exempt from Canadian taxation and that, subject to US Co obtaining a waiver, section 105 of the Regulations applies to require Canco to withhold 15% of the Service Fee.

You request our view whether the same conclusions would be reached if:

A.- the Service Fee was equal the cost to US Co of providing the services to Canco under the Service Contract; or

B. - there was no Service Contract and the fee charged to Canco was equal to the amount of remuneration paid to the US Employee in respect of employment exercised in Canada in connection with the services.

Finally, you request our confirmation that if US Co had a PE in Canada and the services under the Service Contract were provided by US Co through that PE, then the Employee would not be exempt from tax in Canada under paragraph 2 or Article XV of the Treaty.

Our Comments

Whether or not the Service Fee charged by USco in respect of the services rendered to Canco includes a profit element, does not change the position taken in technical interpretation 2011-0403551E5 dated July 15, 2011 nor would that position change if the arrangement lacked a formal Service Contract. However, in order for the exemption in subparagraph 2(b) of Article XV of the Treaty to apply, the facts present must support the conclusion that the true and only employer of the Employee both in substance and in form is US Co and not Canco. As indicated in the Technical Explanation of paragraph 2 of Article XV:

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.

If the arrangement between Canco and US Co lacks a Service Contract this may suggest that US Co is not in position to exercise the functions of an employer as it appears not to be in position to know exactly what services are in fact required by Canco possibly leaving it to Canco to exercise the functions of the employer of the US Employee. In addition, if the Service Fee is limited to the amount of US Employee's remuneration this may suggest that US Co is not exercising the functions of an employer since if it were, it would be expected to be billing Canco for the cost of doing so. However, these indicators are not determinative of who is in fact exercising the functions of an employer.

Regulation 105 and Service Fee at Cost

Regulation 105 is applicable to all services rendered in Canada by a non-resident, whether or not there is a profit element in the fee.

Canadian PE of USco

In the above hypothetical scenario, if US Co provides the services though a PE in Canada, then the Employee's remuneration derived from employment exercised in Canada in the course of providing the Services may be taxed in Canada in accordance with paragraph 1 or Article XV of the Treaty. The exemption in subparagraph 2(b) of Article XV is not met as the remuneration paid to the employee would be borne by the Canadian PE of US Co. The term "borne by" is defined for the purposes of Article XV in the Technical Explanation of Article XV of the Treaty to mean "allowable as a deduction in computing taxable income" of US Co. As the remuneration paid to the US Employee in respect of employment exercised in Canada in the course of performing the services for Canco would be deductible to US Co in computing its income that is taxable Canada derived from the PE, such remuneration would be "borne by" the PE of US Co in Canada.

We trust that the above is the information you require.

Yours truly,

Olli Laurikainen CA
for Director
International Section II
Income Tax Rulings Directorate
Legislative Policy & Regulatory Affairs Branch