5 July 1994 External T.I. 9335225 - MEANING OF PERMANENT ESTABLISHMENT - ARTICLE V U.S.

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

				5-933522

XXXXXXXXXX			P. Diguer

Attention: XXXXXXXXXX

July 5, 1994

Dear Sir/Madam:

Re: Article V, paragraph 3 of the Canada-U.S.

Income Tax Convention (1980)

We are writing in response to your letter dated November 25, 1993, in which you requested the Department's opinion on the meaning of the term "permanent establishment" as used in article V, paragraph 3 of the Canada-U.S. Income Tax Convention (1980) (the "Convention") in the following situation:

A corporation resident in the U.S. ("US Co") sells its software to an unrelated corporation residing in Canada ("Canco"). The terms of the sales contract require that US Co. send employees to provide installation and maintenance services to Canco at the offices of Canco situated in Canada.

You ask three questions with respect to the above situation. We will deal with each in succession. We apologize for the delay in responding to your request.

Question 1

Is Article V, paragraph 3 of the Convention limited in its application to construction projects? If not, what are other industries that it may apply to?

Comment

The 1977 Organization for Economic Co-Operation and Development (the "OECD") Model serves as a standard for the uniform interpretation of income tax conventions. Article V of the Convention is patterned after the Model. Paragraph 3 of Article 5 of the OECD Model Convention states:

"A building site or construction or installation project constitutes a permanent establishment only if it lasts more than twelve months.

The OECD Model Convention commentary does not offer any guidance on the question you have raised. In a book entitled "Permanent Establishment",¹ Arvid A. Skaar explored at page 399, the meaning of installation project:

"... the question is whether only installation projects pertaining to the erection of buildings , etc... may be subject to the ascribed "duration test. ...from a linguistic point of view, the text of the construction clause in the OECD Model treaty indicates that an "installation project" does not have to be performed together with a construction task. From this viewpoint, the installation alternative is coordinated with, rather than subordinated to, the construction alternative.

Skaar concludes as follows, after examining the position adopted by the Belgian authorities that the assembly of machinery in Belgium would be subject to taxation under the construction clause if the "duration test" of the treaty was met:

"The conclusion with respect to the tax treaties, is that all installation tasks meet the "business activity test" of the construction clause, regardless of whether or not the tasks are related to a construction project in a narrow sense."

This question is also examined on page 222 of the book entitled "Klaus Vogel on Double Taxation Conventions", ² wherein the author states:

"The term "installation project" means the putting together or re-grouping of prefabricated elements, such as the erection of steel scaffolding or units of production... The final assembling of parts of movable objects (e.g. airplanes) is also covered by the term: where smaller objects are involved, such as motor cars, an assembly project that lasts more than the minimum period prescribed will normally have already satisfied the requirements of Art. 5(1) - and possibly also those of Art. 5(2)(d)".

(our emphasis)

In absence of any legal precedents on this question, we subscribe to the view espoused by these authors that an installation project does not have to be related to a construction project. We might point out that in our view, the testing of software and the setting up of a data base is probably not installation however.

Question 2

Will Article V, paragraph 3 of the Convention apply to deem U.S. Co to have a permanent establishment ("P/E") in Canada if its employees spend greater than 12 months providing installation and maintenance services?

Comment

If the installation and maintenance services constitute an installation project that lasts more than twelve months, the provision will apply. Whether a contract for the provision of installation and maintenance services constitutes an installation project is a question of fact upon which it is not possible to offer an opinion without having the opportunity to consider all of the relevant facts and circumstances. The fact that some maintenance services are provided will not necessarily disqualify a project provided the project can still be regarded as an installation project as a whole. In our view, in order for a project to be regarded as an installation project, installation has to be the main activity of the project. Whether an activity can be regarded as an installation activity is also a question of fact upon which we can offer no opinion.

Question 3

If the answer to question ii) is yes, are the maintenance services and installation services provided segregated for purposes of meeting the definition of installation project for Article V, paragraph 3 of the Convention?

Comment

As indicated above, it is our opinion that it is the project that should be examined as a whole to determine whether it is an installation project and not each activity within the project. Generally, the determination would entail an assessment of the relative weight of each activity of the project. A project could qualify as an installation project notwithstanding that it may encompass activities that are not installation activities. We have not developed any useful criteria in determining whether an activity is an installation activity or whether a project is an installation project for the purposes of the Convention and each situation must be dealt with on a case by case basis.

Other comments

It should be noted that a fee for installation and maintenance services as described above would generally represent a fee, commission or other amount for services rendered in Canada. Accordingly, payments for such services would fall within the purview of section 105 of the Income Tax Regulations (the "Regulations"). The fact that the payments may be exempt from taxation in Canada pursuant to the Convention would not eliminate the requirement to withhold tax under section 105 of the Regulations. However as indicated in paragraph 16 of Information Circular 75-6R dated January 15, 1988 requests for a waiver or reduction of the amount required to be withheld under section 105 of the Regulations may be submitted to the Chief of Source Deductions of the District Taxation Office that serves the area where the services are to be rendered. In circumstances such as those described above it may be appropriate to also provide a copy of the relevant agreement(s) with the request for waiver.

As a final note, we should mention that a non-resident providing services may be considered to have a permanent establishment in Canada notwithstanding that paragraph 3 of Article V of the Convention may not be applicable if the non-resident is otherwise considered to have a permanent establishment pursuant to said Article V. We have assumed that this question was not at issue in your situation since your request is specific to paragraph 3. This assumption may or may not be valid depending on the circumstances.

The foregoing comments are given in accordance with the practice of providing opinions referred to in paragraph 21 of Information Circular 70-6R2 dated September 28, 1990. These comments are not rulings and are not binding on the Department.

We trust our comments will be of assistance.

Yours truly,

for Director
Reorganizations and Non-Resident Division
Rulings Directorate
Legislative and Intergovernmental
Affairs Branch

¹⁾ Arvid A. Skaar, " Permanent Establishment", Erosion of a Tax Treaty Principle, Series on International Taxation, 1991, Kluwer Law and Taxation Publishers, Deventer, Boston.

²⁾ Klaus Vogel, "Klaus Vogel on Double Taxation Conventions, 1991, Kluwer Law and Taxation Publishers, Deventer, Boston.