17 January 1996 External T.I. 9520065 - BORROWINGS EFFECTIVELY CONNECTED TO A PE

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.

Principal Issues:

Whether borrowings by a US parent to acquire flow-through shares of its Canadian subsidiary would be "effectively connected" to the business carried on by the US parent through a PE in Canada.

Position:

Question of fact, generally, no.

Reasons:

The borrowing would not be attributable to the assets or activities of the PE as required in paragraph 7 of Article VII of the Canada-US Treaty.

		952006
XXXXXXXXXX	A. Seidel
(613) 957-8974

Attention: XXXXXXXXXX

January 17, 1996

Dear Sirs:

Re: Business operations "effectively connected"

This is in reply to your letter dated July 21, 1995, in which you requested our views as to whether borrowings used by a US resident corporation ("USCo") to acquire flow-through shares issued by its wholly-owned Canadian resident corporation ("Canco") would be "effectively connected" with the business carried on in Canada by USCo through a permanent establishment ("PE") so that the interest paid on the borrowings would be deductible in computing the income of the PE for Canadian tax purposes. The expression "flow-through share" has the meaning assigned by subsection 66(15) of the Income Tax Act (the "Act") and the expression "permanent establishment" has the meaning assigned by Article V of the Canada-United States Income Tax Convention, 1980 as amended by the protocols signed on June 14, 1983, March 28, 1994, and March 17, 1995 (hereinafter referred to as the "Treaty"). The expression "effectively connected" is not defined in the Act or in the Treaty.

It appears that the interpretation you seek relates to specific taxpayers and, therefore, we bring to your attention Information Circular 70-6R2 dated September 28, 1990, and the Special Release thereto dated September 30, 1992, issued by Revenue Canada. Confirmation with respect to proposed transactions involving specific taxpayers will only be provided in response to a request for an advance income tax ruling. If you wish to obtain an advance income tax ruling for particular taxpayers with respect to specific contemplated transactions, a written request for an advance income tax ruling should be submitted in accordance with the Information Circular. Nevertheless, we can offer the following general comments in response to your letter.

A non-resident who carries on business in Canada through a PE is taxed on the business profits attributable to that PE as if that PE were a distinct and separate person. Pursuant to paragraph 7 of Article VII of the Treaty, the business profits attributable to a PE shall include only those profits derived from the assets or activities of the PE.

It is our view that the meaning of the term "attributable to" as used in paragraph 7 of Article VII of the Treaty has the same meaning as the term "effectively connected" as used in Articles X, XI and XII of the Treaty since in both cases the term is relating the income or the income source to the PE of USCo.

Whether or not the borrowings used to acquire flow-through shares of a wholly-owned subsidiary of USCo can be "effectively connected" to the business carried on by the PE of USCo is a question of fact that can only be determined after a review of all of the relevant details of a particular situation. However, it is our view that, generally, unless there are specific facts to the contrary, the borrowings by USCo to acquire flow-through shares issued by one of its wholly-owned subsidiaries would not be attributable to the assets or activities of the PE and the borrowings would not be effectively connected to the business of the PE. Accordingly, the interest expenses related to the borrowings to acquire the flow-through shares of Canco would not be deductible in computing the income of the PE for Canadian tax purposes.

These comments are provided in accordance with the guidelines set out in paragraph 21 of IC 70-6R2.

Yours truly,

for Director
Manufacturing Industries, Partnerships
and Trusts Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch