1 December 1992 Income Tax Severed Letter 9235160 - Transfer Pricing and Independent Agent (4112-2-5)

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.

TAX EXECUTIVES INSTITUTE (December 1992)

Question IV

INCOME OF NON-RESIDENT/INDEPENDENT AGENT

Assume the following facts:

• A non-resident corporation, X, manufactures or processes goods outside Canada, with no processing or purchasing of raw materials taking place in Canada.
• X does not have an office or any employees in Canada.
• X appoints as its agent its parent corporation Y, which is resident in Canada to sell its product in and outside Canada. Y has, under a contract, the authority to negotiate and conclude the sales contracts in the name of X. Y will also arrange the transportation and documentation.
• For its services to X, Y will receive a commission based on sales. The rate of commission is equivalent to what an arm's-length party would have charged X.
• X is not a resident of a country with which Canada has a tax treaty.
• Section 253 of the Income Tax Act (the "Act") deems a non-resident person in respect of the activities listed in that section to have been carrying on business in Canada. Therefore, under section 115 of the Act, the taxable income of the non-resident would be determined under section 3 of the Act on the income from the particular activities carried on by the non-resident in Canada.

A. Would the income of the non-resident X be equal to:

• 1. Nil, on the assumption that RCT would accept the revenue of Y to be a fair market commission?
• 2. Its sales income of the product to Canada at actual price less the market price and commission and any other reasonable costs, assuming there is a world market price for the product?

or,

3
. An allocation of the profit of X on sales to Canada
to include the manufacturing profit made in the
country of X's residence?

• Are ground rules such as the treaty-type permanent establishment rules used by RCT in such cases?

B. 1. Since the parties are dealing with each other at non-arm's length, please confirm whether, if X were a U.S. resident, Y would qualify as an agent of independent status under paragraph 7 of Article V of the Canada-U.S. Income Tax Convention (the "U.S. Convention").

2
. Would Y be disqualified from such status by reason
of paragraph 251(1)(a) of the Act?

3
. What criteria does RCT use to determine the
independent status of an agent?

Department's Position

A.

• X's income would be determined pursuant to the provisions of section 115 of the Act.
• In computing its income under section 115 of the Act, X would include all income from sales of its product by Y, and deduct costs incurred to earn that income. These costs would generally include a notional cost of sales, commissions, and other expenses that could reasonably be attributed to the business activity in Canada. The notional cost of sales would represent the fair market value of the goods manufactured or processed as determined by arm's length sales of these goods by X under comparable conditions.
• In general, the Department would use guidelines similar to the provisions in our Tax Treaties for attributing income and expenses to the business activity in Canada.

B.

1
. Without knowing all of the facts and circumstances
in a situation, it is difficult to give a
definitive answer on whether a person is an agent
of independent status for the purposes of paragraph
7 of Article V of the U.S. Convention.
Nevertheless, based on our understanding of the
facts in the situation described above, it is our
view that Y is not such an agent.

2
. Generally speaking, paragraph 251(1)(a) of the Act
has no bearing in determining whether Y is an agent
of independent status for the purposes of paragraph
7 of Article V of the U.S. Convention .

3. There are no precise tests to determine whether a
person is an independent agent of another person,
however, some of the factors the Department
considers in making such a determination are as
follows: (Please note that no one factor is
conclusive in and by itself.)

- Whether the person is independent of the other person both legally and economically.

- Whether the person is subject to detailed instructions or to comprehensive control by the other person.

- Whether the entrepreneurial risk is borne by the person or the other person the person represents.

- Whether the person sells goods in his own name, rather than in the name of the other person.

- Whether the person receives title to the goods and bears risk of loss upon delivery.

• • Whether the person is referred to as an independent contractor rather than as an agent.

- Whether the person must pay the other person for goods received, whether the goods are subsequently sold or not.

- Whether the person acts as an agent for a couple of other persons or many other persons.

- Whether the person has authority to conclude contracts on behalf of the other person.

Question "A" - R. Kauffman Question "B" - G. Middleton December 1992 File #923516 Doc. Type "9" Applicable Sections: section 253 of the Act; sections 400 and 2600 of the Income Tax Regulations; Article V of the Canada-U.S. Income Tax Convention and Article 5 of the OECD Model Convention. Subjects: Transfer pricing and independent agents