2 November 1989 External T.I. 74015 F - Canada-U.S. Income Tax Convention

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.

Subject: 24(1) Canada-U.S. Income Tax Convention (1980) (the "new treaty") Canada-U.S. Income Tax Convention (1942) (the "old treaty")

This is in response to your memorandum of June 9, 1989. You have requested our opinion whether 24(1)  In your view, neither the old or the new treaty would require Canada to permit such deductions.

24(1)

In our view this is the type of scenario contemplated in Article III, paragraph 1 of the old treaty where it refers to deductions permitted in the determination of net industrial and commercial profits. i.e. the deductions that a contracting state must permit are those incurred which are reasonably allocable to the permanent establishment. Similarly, Article VII, paragraph 3 of the new treaty also refers to expenses that are incurred for the purposes of the permanent establishment. Accordingly, in this case, 24(1)

In addition, 24(1) For the purposes of Article VII, paragraph 2 of the new treaty, the permanent establishment would not be operating "under the same or similar conditions" as those of the enterprise if it was to considered to be renting the assets rather than owing them.

The 24(1) situation can be distinguished from a situation involving transfer pricing where certain income earning activities relating to a Canadian contract take place outside Canada i.e. where a product is manufactured to a certain stage of completion and then transferred to the Canadian branch for completion and distribution.  In such a case it is appropriate to transfer the unfinished goods to the branch at fair market value as this will result in the quantum of income taxed in Canada to be consistent with the economic functions performed in Canada. Another instance where fair market value may be more appropriate is where the business operation of the branch and the business operation of the company outside Canada are different and where the foreign operation performs a service to the branch in the ordinary course of its business. It could be argued in these situations that the result is simply an allocation of net income to the country in which it is earned. However neither approach is compatible with the facts of this particular situation.

In sum, it is our view 24(1)

We have read the U.K. court case Ostime v. Australian Mutual Provident Society, however it does not appear to be on point because the issue in that case is whether the taxpayer is subject to tax in the U.K. on income calculated based on a notional calculation and not whether the various allocations made in arriving at the actual income attributable to a permanent establishment are appropriate. 23

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