11 July 1991 Internal T.I. 903359 F - Offshore Activities Article (Tax Treaties)

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.

	July 11, 1991
TO:	FROM:
Non-Resident Taxation Division	Rulings Directorate
K. Hillier	Jim Wilson
Director	957-2120
Attention: R.F. Power
	FILE	903359

SUBJECT:     Offshore Activities Article Canada-Netherlands Income Tax Convention

We are writing in reply to your memorandum dated November 22, 1990, in which you requested our comments concerning the offshore activities article in the above-noted treaties.

Article XXVIIA of the Canada-U.K. Income Tax Convention (U.K. Treaty)

Questions:

1.     What would be considered "activities" for purposes of paragraph 2 of Article XXVIIA of the U.K. Treaty?

2.     Are the "activities" to be considered only those that take place in the offshore area during the period the oil production facilities are in place or are the activities inclusive of the construction, installation and operation of the production facilities in total?

3.     Would a U.K. resident be deemed to have a permanent establishment in Canada when all activities related to the development of the oil fields are carried out onshore, offshore, or both?

4.     What are to be considered activities that would be carried on in Canada in connection with the exploration or exploitation of the seabed and subsoil and their natural resources ("in connection with the offshore resources")?

5.     If a U.K. resident were to provide engineering services to a Canadian corporation which had a major contract related to the construction of a portion of the production facility, would the U.K. resident be said to be carrying on activities in connection with the  offshore resources?

Your Views:

"Activities" include all construction, installation and operational services (and contract work related thereto) leading up to and including the production stage of the oil development whether performed onshore or offshore. Furthermore, the phrase "in connection with the offshore resources" is broad enough to include the construction of the production facilities and any other services performed prior to the actual extraction of the oil.

All activities carried on in connection with the projects would be considered to be carried on through a permanent establishment in Canada if carried on by a U.K. resident, for a period of at least 30 days in any 12 month period.

Paragraph 4 of Article XXVIIA deals with the taxability of the salary and wages of the U.K. resident employees that would be employed during the development of the offshore oil fields. Those salaries and wages earned by all U.K. resident employees for those services which are performed in the "offshore area" would be taxable in Canada by virtue of this paragraph.

In considering the application of paragraphs 2 and 4 of Article XXVIIA, the following may take place:

-      24(1)

The employer is considered to be operating in Canada through a permanent establishment by virtue of paragraph 2 of Article XXVIIA and therefore the company is taxable in Canada on the income earned. Since all services to be performed by the employees will be at the site, paragraph 4 of Article XXVIIA is considered to tax the salary and wages earned by the employees of the UK. company.

The taxing provision under paragraph 2 of Article XXVIIA is considered to apply to a corporation, as well as to an independent (self-employed) individual.

Our Comments:

In regard to question 1, the phrase "carries on activities in the other Contracting State in connection with the offshore resources" should be given a very broad interpretation and include all supporting services related to these projects. This should include direct or indirect services performed during the start-up and winding down periods of these projects. Also included should be airborne surveillance and seismic studios carried on in Canada which pertain to the exploration or exploitation of the sea bed and subsoil. We are therefore in agreement that activities carried on by a resident of a Contracting State in the other Contracting State in connection with the exploration or exploitation of offshore resources includes all activities (i.e. construction, installation and operational services etc.) leading up to and including the production and winding down stages (including all contract work related thereto) and to all services performed in connection with such exploration or exploitation whether carried out onshore or offshore.

Regarding questions 2 and 3, we are of the view that the activities do not have to be performed in the offshore area and are not limited to the time period in which the oil production facilities are in place (see comments above). For example, construction or servicing of a drilling rig or component parts thereof performed completely onshore in respect of a proposed or established oil exploration or exploitation project would constitute activities carried on in connection with the offshore resources.

With respect to question 5 concerning a U.K. resident providing engineering services in Canada, we agree that subject to paragraph 3 of Article XXVIIA such services would be activities described in paragraph 2 of Article XXVIIA with the result that the U.K. resident would be deemed to be carrying on business in Canada through a permanent establishment. In our opinion, the engineering services performed in connection with the offshore resources, whether by a U.K. company or independent professional, would be governed by Article VII of the Treaty. It is our view that Article XIV does not apply in the situation where a resident of the UK derives income from professional services which constitute an activity described in paragraph 2 of Article XXVIIA as Article XXVIIA applies notwithstanding any other provisions of the Treaty.

We would like to point out that the administrative position set out in paragraph 11 of Information Circular 75-6R does not affect the application of paragraph 3 of Article XXVIIA. The administrative policy was established to avoid complex determinations with respect to the existence of a fixed base. Since, in the circumstances described in paragraph 2 of Article XXVIIA, the non-resident is deemed to have a permanent establishment, a determination involving complex questions of fact is not necessary.

Transportation activities (e.g. ferrying of supplies and personnel) in connection with the offshore resources fall within paragraph 2 of Article XXVIIA. However, where such activities constitute an operation of a ship or aircraft in international traffic as defined in section 248 of the Act, the income is exempt from taxation in Canada pursuant to paragraph 81(1)(c) of the Act.

Our comments with respect to paragraph 2 of Article XXVIIA apply to paragraph 4 of Article XXVIIA. This provision would not be limited to the development period of the offshore exploration or exploitation projects. It would apply to remuneration received from direct or indirect services performed during the exploration and development phases. We are in agreement with the remainder of your comments on the assumption those services are performed offshore and are in regard to an employment described in paragraph 4.

In addition, salaries, wages and similar remuneration derived by a resident of the U.K. in respect of an employment exercised aboard a ship or aircraft engaged in the transportation of passengers or goods to these projects would be subject to this provision to the extent such employment duties are performed in Canada's offshore. Our comments above regarding indirect activities apply equally here.

In our opinion, employment income earned in connection with the offshore resources, to the extent that the duties are performed onshore, is subject to the general rules in Article XV.

Accordingly, where the employer is a resident of the United Kingdom and has a permanent establishment in Canada, as described in Article V or deemed by paragraph 2 of Article XXVIIA, the remuneration from employment will generally be taxable in Canada. We should also point out that the number of days that a U.K. resident is present in Canada in respect of the offshore employment will be included in applying the 183 day test in paragraph 2(a), Article XV when determining the right of Canada to tax other remuneration received during the year in respect of an employment exercised in Canada that is not described in paragraph 4 of Article XXVIIA.

We are in agreement with your comments pertaining to the diving services provided by the U.K. employer. We should point out, however, that any wages and salaries earned by these employees prior to their arrival in Canada would not be taxable under paragraph 2(3)(a) of the Act.

Article 23 of the Canada-Netherlands Income tax Convention (Dutch Treaty)

Questions

1.     What "activities" are to be considered for the purposes of paragraph 1 of Article 23 of the Dutch Treaty?

2.      What would be considered to be "offshore" for the purposes of this Article?

Your Views:

The activities, whether preparatory or not, performed offshore in connection with the offshore resources would be considered to be carried on through a permanent establishment in Canada and therefore taxable in Canada, if carried on for a period exceeding 30 days in any 12 month period. The activities performed onshore would be considered to be exempt from taxation in Canada by virtue of paragraph 1 of Article 23. The offshore is considered to be the area where the production in regard to the oil field will take place. This would include those areas where vessels traverse between the production site and their home port within Canada, other than in international waters, for purposes of activities related to the offshore development.

For purposes of paragraph 3 of Article 23, income derived from services of an independent nature would be subject to taxation in Canada, if carried on offshore in connection with the offshore resources. This paragraph deems the non-resident to be operating from a fixed base in Canada.

For purposes of paragraph 4 of Article 23, a resident of the Netherlands operating a supply vessel, tugboat, etc., between ports in Canada, or between a port in Canada and an oil production site offshore, other than in international traffic, will be deemed to be carrying on business in Canada through a permanent establishment. This would not apply to those vessels considered to be operating in international traffic as Article 8 is considered to exempt such income from taxation in Canada.

In regard to paragraph 5 of Article 23, the employment income earned by those employees, other than those specified in subparagraph 5(b) of the Article, employed in the offshore area in connection with the offshore resources will be taxable in Canada by virtue of subparagraph 5(a)

of the Article. Subparagraph 5(b) will apply to those employees employed aboard a ship or aircraft engaged in international transportation and those employees employed aboard vessels (e.g. supply vessels) whether considered in Canada or in international traffic. These employees would be exempt from taxation in Canada on any such employment income earned.

Our Comments:

In regard to question 1, our comments to questions 1 through 4 above pertaining to paragraph 2 of Article XXVIIA of the U.K. Treaty apply equally to this provision to the extent such activities are performed offshore.

With respect to question 2, there is a significant difference between paragraph 2 of Article XXVIIA of the Canada-U.K. Treaty and paragraph 1 of Article 23 of the Dutch Treaty. In the case of the Dutch Treaty, in order for the activities of a Netherlands resident to be deemed to be carried on through a permanent establishment, the activities must be performed offshore. The term "offshore" is not defined in the treaty nor in the Income Tax Act. However, since this provision applies to activities carried on in "Canada" (by virtue of the definition of "State" in subparagraph 1 (a) of Article 3), in our opinion, the term "offshore" should include, in addition to our territorial sea as defined in the Territorial Seas and Fishing Zones Act (i.e. 12 nautical mile limit), the offshore area described in the definition of Canada pursuant to section 5 of the Income Tax Conventions Interpretation Act. This would include every area beyond our territorial seas that, in accordance with international law and the laws of Canada, is an area in respect of which Canada may exercise rights with respect to the sea bed and subsoil and their natural resources (i.e. Canada's continental shelf) and the seas and airspace above such area.

In regard to the definition of "offshore" in your memorandum, it would not be restricted to "the area where the production from the oil field will take place". The "offshore" would include, in addition to our territorial seas, the seas and airspace directly above our continental shelf by virtue of the definition of Canada provided above.

We do not agree with your statement that the activities performed onshore would be considered to be exempt from taxation in Canada by virtue of paragraph 1 of Article 23. Where activities are performed onshore, they are not subject to Article 23 but would be subject to the general rules in Article 7 and 14. Therefore, if the onshore activities can be attributed to a permanent establishment or fixed based in Canada as described in Article 5 of the Treaty, they may be taxed in Canada.

With regard to paragraph 4 of Article 23, even though paragraph 1 of that Article may deem a resident of the Netherlands to be carrying on business through a permanent establishment in Canada, paragraph 4 provides that where the profits of that non-resident enterprise are from the operation of ships and aircraft in international traffic as determined pursuant to paragraph 1(g) of Article 3 and Article II of the Protocol, such profits are subject to Article 8 and shall be taxable only in the State (the Netherlands) where the effective management of the enterprise is situated. It should be noted that the definition of international traffic in paragraph 1(g) of Article 3 is a broader definition than that in section 248 of the Act and Article II of the Protocol does not appear to operate to restrict that definition with respect to the operation of aircraft. Article 11 does restrict it with respect to the operation of ferry-boats, deep-sea ferry-boats and other vessels if the conditions set out in Article II of the Protocol are met.

Where a resident of the Netherlands operates a ship or aircraft solely between places in Canada or operates a boat or vessel as described in Article II of the Protocol, income from such activities, if any, that are in connection with the offshore resources would fall within paragraph 1 of Article 23 because such activities are not performed in international traffic (see subparagraph 1(g) of Article 3). However, it should be noted that in no circumstances can we tax any profits exempt by virtue of paragraph 81 (1)(c) of the Act. Each situation that involves the operation of ships or aircraft in international traffic in connection with the offshore resources will have to be determined on its own merits.

We are in agreement with your comments concerning subparagraph 5(a) of Article 23 if they were worded as follows:

"The employment income earned by a resident of the Netherlands, other than income specified in subparagraph 5(b), employed in Canada's offshore area in connection with the offshore resources may be taxed in Canada to the extent that the employment is exercised offshore Canada".

However, we would like to point out that Canada may otherwise have the right to tax income of a resident of the Netherlands from other employment exercised in Canada including employment exercised onshore in Canada in connection with the offshore resources if such resident of the Netherlands was

(a)     was present in Canada for period or periods (including days present offshore in Canada) for more than 183 days in the calendar year concerned, or

(b)     the remuneration for the services was paid by on behalf of an employer who is resident of Canada, or

(c)     the remuneration was borne by a permanent establishment or fixed base (deemed or otherwise) that the employer has in Canada.

Subparagraph 5(b) of Article 23 provides that salaries and wages earned in respect of international transportation, regardless of its connection with the offshore resources, will not be subject to subparagraph 5(a) of Article 23. In this regard, we are not in agreement with your statement that subparagraph 5(b) applies to "those employees employed aboard vessels (e.g. supply vessels) whether those vessels operate in Canada or in international traffic". The wording "in respect of an employment exercised aboard a tugboat or similar vessel in connection with such activities" as used in paragraph 5(b) is unclear. However, it is our view that the provision is intended to exclude from taxation in Canada remuneration received from employment exercised aboard ships, aircrafts, tugboats or similar vessels engaged in the international transportation of supplies or personnel. Subparagraph 5(a) of Article 23 should apply to employment exercised offshore aboard ships, vessels, aircrafts, tugboats or similar vessels operating between places in Canada in connection with the offshore resources.

Other Issues Pertaining to Both Treaties

Your Views

In considering the application of both the U.K. and Dutch Treaties with respect to the phrase "in connection with the offshore resources" a possible allocation problem must be taken into consideration. That is if a resident of one of the countries should be considered taxable in Canada for income earned "offshore", how do we handle any income that can be allocated to an "onshore" activity? This may also happen if a resident is considered taxable on the "onshore" income and not on the "offshore" income. In such cases the determination of "offshore" versus "onshore" income would have to be done initially and then an allocation would have to be considered.

Section 255 of the Income Tax Act (Act) includes the offshore areas where the oil production is to take place and therefore under the Act the income, whether employment or business income, is considered to be earned in Canada.

Our Comments:

We agree that allocation problems could arise under both the U.K. and Netherlands treaties and separate computations from each particular source (i.e. onshore business activities vs. offshore business activities) may have to be done, particularly where only one source is taxable in Canada. As these allocation problems appear similar to other sourcing problems, we are unclear as to what assistance you require from us.

We agree with your comments concerning "Canada" as it applies in the Income Tax Act.

General Comments:

It should be noted that both Articles XXVIIA of the UK Treaty and Article 23 of Dutch Treaty deal with the difficult issues of determining whether or not a permanent establishment exists by deeming one to exist. This does not mean that one might not factually exist where residents of either the U.K. or the Netherlands carry on the activities described in those Articles. Furthermore, residents of other treaty countries may also have permanent establishments with respect to activities such as the Hibernia project. For example, a permanent establishment or fixed base can exist where space is made available to a non-resident to permit him to carry on his business on or in someone else's permanent establishment or fixed base (see commentary in paragraph 4, page 59 of the OECD Model Double Taxation Convention). For example, where a non-resident person under a personal, services agreement agrees to supply qualified personnel who are its employees and these personnel perform their services on the oil rig (permanent establishment) of the person who contracted for the services, the non-resident person, depending upon the facts, could have a permanent establishment of his own. If such a non-resident person has a permanent establishment in Canada, its non-resident employees will be taxable in Canada on their earnings for services exercised on the oil rig.

Facts Must Be Determined On A Case By Case Basis

The variety of situations (including the various definitions of permanent establishment in our treaties) that will be faced make it almost impossible to come up with general guidelines and taxpayers should be requested to provide all the details of their operations in Canada in order that we can make an informed decision.

The above comment applies equally to the determination of whether or not a non-resident is deriving his income from the operations of ships or aircraft in international traffic. The definition of international traffic differs from treaty to treaty and the definition in the Act is often different from the definition in a treaty. Therefore, when dealing with residents of treaty countries and international traffic, it is essential to know what definition is being referred to and how the treaty definition and the definition in the Act interact.

We are prepared to assist you on specific cases that may arise.for Director

Reorganizations and Non-Resident DivisionRulings DirectorateLegislative and Intergovernmental     Affairs Branch

c.c. Publications Division