24 April 1998 External T.I. 9730155 - OVERSEAS EMPLOYMENT TAX CREDIT

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: Dans la situation donnée, est-ce que l'employeur "exploitait une entreprise à l'étranger se rapportant à ... un projet d'installation" aux fins du crédit d'impôt 122.3 ?

Position: Notre réponse fait le tour de la question - IT, jurisprudence ... et conclut que l'employeur satisfait aux critères de l'article 122.3

Reasons: L'objet de l'article 122.3 est de permettre aux employeurs Canadiens d'être compétitifs à l'étranger; de plus l'expression "exploitait une entreprise à l'étranger se rapportant à ... un projet d'installation" peut être interprétée de façon très large.

April 24, 1998

Policy & Procedures Marie-Marthe Gagnon
International Audit Division (613) 957-8953
International Tax Directorate

Attention: René Fleming, Interim Manager
7-973015

Section 122.3 - Overseas Employment Tax Credit

This is in reply to your letter of November 12, 1997, requesting our comments concerning the application of the Overseas Employment Tax Credit in a particular factual situation. We apologize for the delay in responding to your request.

FACTS

Canco is a specified employer for the purpose of section 122.3 of the Income Tax Act (hereafter the "Act"). Canco manufactures and sells XXXXXXXXXX equipment throughout the world. When Canco sells any XXXXXXXXXX equipment to foreign purchaser, it sends its Canadian staff to perform all key foreign site activities. Canco's mechanical, electrical and electronic crews travel to the foreign sites to perform the installation activities.

The individuals performing the tasks are Canadian residents employed by Canco. They performed their duties in connection with a contract with respect to an installation activity. The period of employment outside Canada is more than 6 consecutive months for each of these individuals as required for the purpose of section 122.3 of the Act.

YOUR QUESTIONS

Your questions are whether Canco "carried on business outside Canada" and whether Canco "carried on business outside Canada with respect to an installation activity".

In addressing the issues, you request that we take into consideration the representations made by a taxpayer's representative in a particular factual situation.

ANALYSIS

Generally, the Overseas Employment Tax Credit (hereafter OETC) is available to individuals resident in Canada, employed outside Canada for at least six consecutive months, by a specified employer, inter alia, in connection with a contract under which the specified employer carried on business outside Canada with respect to any construction, installation, agricultural or engineering activity.

Purpose of the OETC

The purpose of the OETC, as stated in the "Tax Measures: Supplementary Information and Notices of Ways and Means Motion" released by the Department of Finance on March 6, 1996 as part of the Budget Papers, is the following:

The primary purpose of this credit is to ensure that Canadian firms, employing Canadian staff, are in a position to compete against foreign firms in bidding on overseas work. The tax systems of a number of countries other than Canada provide tax relief to their residents working abroad, thus allowing firms from those countries to base their bids for overseas contracts on the reduced salary costs that such tax relief allows. Similarly, the OETC enables Canadian employers to reduce their employment costs with respect to foreign contract work, while maintaining the after-tax value of the remuneration their employees receive in connection with such work.

Since the substantial benefits that the OETC provides are intended to enhance the competitiveness of Canadian firms through lower wage bills, rather than to serve as an incentive for individuals resident in Canada to work offshore, the credit is limited to income from an employer that is resident in Canada or a foreign affiliate of a Canadian resident.

Carrying on Business Outside Canada

As you mentioned in your letter, the question whether or not a taxpayer carried on business outside Canada is a question of fact that must be determined on an examination of all of the circumstances surrounding each case. In this regard, the courts have distinguished several factors that connect a business to a particular place in dealing with the determination of carrying on business in the context of specific types of business activities.¹ Usually, not a single factor taken in isolation was conclusive, but rather a series of factors was pondered in light of the economical and business environment of the taxpayer.

Legislation

The Act does not define the expression "carried on business outside Canada". Subsection 248(1) of the Act provides an inclusive definition of what is a "business":

"business" includes a profession, calling, trade, manufacture or undertaking of any kind whatever and, except for the purposes of paragraph 18(2)(c), section 54.2, subsection 95(1) and paragraph 110.6(14)(f), an adventure or concern in the nature of trade but does not include an office or employment;

Section 253 of the Act extends the meaning of "carrying on business in Canada", but again, is not exhaustive in specifying the circumstances in which a non-resident may be considered to carry on business in Canada.

One can argue that the judicial criteria used to determine whether a taxpayer carried on business in Canada could also be used to determine whether a taxpayer carried on business outside Canada. However, in our view, when interpreting these expressions, one should approach the taxpayer's situation with a clear understanding of the intent of the specific provisions applicable. In this regard, as submitted in the representations referred to us in your request, the following extract of the Supreme Court of Canada decision in the Corporation Notre-Dame du Bon-Secours case is relevant:

A legislative provision should be given a strict or liberal interpretation depending on the purpose underlying it, and that purpose must be identified in light of the context of the statute, its objective and the legislative intent: this is the teleological approach;²

Departmental publications

The Department published its views regarding the commencement of business operations in paragraph 5 of Interpretation Bulletin IT-364³ as following:

5. In another situation that was reviewed in the courts, a corporation was formed with the objective of overseas marketing of liquefied petroleum gases. The essential preliminaries to the carrying on of this business in an active way included assurances of supplies from producing oil companies, plans for extracting, gathering, and transporting the gas to seaboard by pipeline or other means, the obtaining of export permits, arrangements for refrigerated storage and loading facilities at the seaboard and transport for shipments overseas, and the negotiating of firm contracts with overseas buyers. It was held by the courts that this corporation commenced business when these preliminary studies and negotiations were undertaken even though, in the end, the project was abandoned. The fact that no revenue was generated during this period was held not to be a significant consideration in determining whether the business had commenced and was being carried on.

Paragraph 10 of Interpretation Bulletin IT-270R2⁴ concerning the Foreign Tax Credit provides that section 253 should not be used to assess whether a taxpayer carries on business outside Canada:

It should be noted that a foreign income or profits tax is recognized as a "business-income tax" for foreign tax credit purposes only if it is paid in respect of a business carried on outside Canada by the payer. Whether or not a taxpayer is carrying on business inside or outside Canada is determined under Canadian jurisprudence with no consideration given to the extended meaning under section 253 of carrying on business in Canada.

Paragraphs 26 and 27 of the said bulletin describe some criteria used by the Department to determine the territorial source of income:

26. A determination of the place where a particular business (or a part thereof) is carried on necessarily depends upon consideration of all the relevant facts, but has been stated in general terms to be the place where the operations in substance take place. In determining where a particular type of business is carried on, the Department usually relies on the following guidelines:

(a) Development and sale of real property - the place where the property is situated;

(b) Merchandise trading - the place where the sales are habitually completed, but other factors such as the location of the stock, the place of payment or manufacture may be considered relevant in particular situations;

(c) Trading in intangible property (e.g., stocks and bonds) - the place where the purchase or sale decisions are normally made;

(d) Money lending - the place where the loan arrangement is in substance completed;

(e) Personal property rentals - the place where the property available for rental is normally located;

(f) Real property rentals - the place where the property is situated;

(g) Service - the place where the services are performed.

27. In the case of a single business comprising more than one of the above-mentioned activities, each segment is considered separately in determining in which country or countries the business is carried on. An exception is made in the case where one activity is clearly incidental to a predominant one; e.g., a vendor of machinery providing the services of an engineer to supervise installation of machinery sold.

Interpretation Bulletin IT-497R3,⁵ which deals specifically with the OETC, clarifies that in some cases, an employee of an employer whose business does not qualify can obtain the OETC when the employee is working abroad in a qualifying activity and his employer has a sub-contract with a specified employer:

8. Ordinarily, the specified employer will itself directly carry on the qualified activities described in par.6(a) to (c) above, that entitle employees to claim the OETC. However, assuming all of the other requirements of subsection 122.3(1) are met, the OETC is also available to employees of a specified employer that carries on business outside Canada in other than a qualifying activity. Often referred to as a sub-contractor, such a specified employer would be one who has a contract or subcontract to provide its services through its employees to another person in respect of a qualifying activity carried on by that person outside Canada, or in respect of such a qualifying activity which that person has subcontracted to a third party. For example, assume that a specified employer (A Ltd.) has contracted to carry on business outside Canada by providing data processing services to a non-resident company (B Ltd.) whose only business is the exploration for natural gas. Assuming the other requirements of subsection 122.3(1) are met, the employees of A Ltd. providing the data processing services would qualify for the OETC, since their employment is in connection with a contract under which the specified employer carried on business outside Canada with respect to qualifying activities.

In the same Interpretation Bulletin we can find the following comments concerning the major factors to consider while determining the existence of a business abroad:

15. Whether or not a specified employer is carrying on business outside Canada is always a question of fact. In determining this, the major factors to be considered are:

(a) the objects of the employer's business; and

(b) the nature of the activities the employer is carrying on outside Canada.

Employment with the Government of Canada or a provincial or municipal government generally does not qualify for the purposes of section 122.3, because a body politic or government would not usually carry on business outside Canada under a contract.

Previous Opinions

We have previously considered a case where an employee was working abroad for a Canadian employer.⁶ The employee was providing services to an American corporation related to the Canadian employer. The American corporation was building XXXXXXXXXX for a "local entity". Based on the fact that the Canadian employer was simply sub-contracted by the American corporation, it was therefore not directly involved in the construction XXXXXXXXXX (it was not even mentioned in the contract between the American corporation and the "local entity"), we ruled that the Canadian employer was not carrying on business outside Canada. However, we indicated in our response than we would need more facts to make a final decision.

Recently, we addressed in a round table the issue whether the activity of the employer abroad should be the principal activity of the employer:

Question

In a technical interpretation dated April 18, 1995 (document number 9500997), Revenue Canada stated that an employer will not be considered to be carrying on business in another country with respect to one of the specified types of activities set forth in clause 122.3(1)(b)(i)(B) of the Act unless the activity is the principal activity of the employer. Please clarify the basis for Revenue Canada's position since the Act does not specify that the required activity be a principal activity.

Department's Response:

This technical interpretation relates to a unique circumstance. The reference to the "principal activity of the employer" is specific to this set of facts only; no new precedent or change in policy is intended.⁷

Installation Activity

Departmental Publications

In paragraph 3 of the Interpretation Bulletin IT-411R concerning the meaning of "construction", the Department distinguishes construction and installation activities as following:

As a general rule, the on-site fabrication, installation and erection of machinery and equipment, regardless of size, is not considered to be construction, unless it constitutes a component part of a building or structure (e.g. heating system, air-conditioning equipment, sprinkler system, plumbing, wiring, etc.) Machinery or equipment which will form an integral part of a manufacturing or processing activity carried on inside the building is not regarded as a component part of the building, even though it may be firmly attached to it because of vibrations, weight, size, etc. In some cases, where the installation of machinery and equipment coincides with the construction and erection of a building or other structure, there may be practical difficulties in determining what activities are construction. In these cases, the following criteria apply:

(a) The installation and erection of the foundation, walls, floors, roof and infrastructure for the machinery or equipment... is regarded as construction.

(b) The fabrication, installation and erection of the machinery and equipment inside the structure (including related wiring, plumbing, ductwork, etc.) that is primarily for the purpose of a manufacturing or processing activity which will be carried on inside the structure is not regarded as construction.

Case Law

In Cutlers Guild Limited v. Her Majesty The Queen, 81 DTC 5093 (FC-TD), Dubé J. concerning the determination of the territorial situs of a business made the following observation:

Whether or not a taxpayer is carrying on a business in another country is a question of fact to be determined in each case. Courts have ruled that the place where sales, or contracts of sale, are effected is of substantial importance. However, the place of sale may not be the determining factor if there are other circumstances present that outweigh its importance.

Another test emanating from the jurisprudence is `Where do the operations take place from which the profits arise?' Soliciting orders in one country may only be ancillary to the exercise of a trade in another county (sic). Certain authorities establish that activities and operations other than contracts for sale constitute the carrying on of a business, especially where these respective activities and operations produce or earn income. While income may be realized through sales, it may not arise entirely from that one activity or operation. Purchasing of merchandise in one country (i.e. Japan) with the view of trading in it elsewhere (Canada) does not, of course, constitute an exercise of the trade in the former country.

(at page 5095)

As stated in paragraph 27 of the Interpretation Bulletin IT-270R2, whether a taxpayer performing technical operations in a particular place is carrying on business in that place depends on whether the services are ancillary to sales or whether they constitute an independent profit-making activity. This issue was considered by the Supreme Court of Canada in Linde Canadian Refrigerator Co. v. Saskatchewan Creamery Co., (1915) 51 SCR 400, in the context of determining whether the appellant (Linde) was required to take out an extraprovincial licence under the Foreign Companies Act in order to maintain an action in the province of Saskatchewan.

Linde, whose head office was in the Province of Quebec, in the course of its business, sold and brought certain machinery into the Province of Saskatchewan and did the work of installing it therein for a price which included setting it up and starting it working. An action for the contract price raised by Linde was dismissed by the judgment of the trial court and affirmed by the Supreme Court of Saskatchewan, on the ground that Linde being an unregistered extra-provincial company was denied the right of action in the courts of Saskatchewan. However, the Supreme Court of Canada, in a unanimous decision, allowed the appeal.

The interesting point in this ruling is that two out of five judges addressed the issue of whether Linde carried on business in Saskatchewan. Idington J. found that Linde did not carry on business in Saskatchewan, stating that:

I do not think that the mere installation of the machinery so ordered, shipped and delivered, fairly falls within the meaning of the carrying on business in Saskatchewan. I cannot think it was intended to apply to the mere setting up and starting of machinery by a company doing no more in way of carrying on business that such acts involve.

(at page 404)

However, Anglin J. was of the view that Linde carried on business in Saskatchewan on the basis that:

Although the installing of the plant may in the present case have been a comparatively insignificant part of that which the plaintiffs contracted to do, it was a substantial part of the consideration which they agreed to give to the defendants in return for their money... As pointed out by Mr. Justice Elwood, the installing of refrigerator plants sold by them was admittedly a part of the plaintiffs' ordinary business. Nor was the installation here in question a solitary act of business done in Saskatchewan not indicating a purpose to carry on business in that province... There was evidence that other plants had been installed by the plaintiffs in the province....

Nevertheless, Anglin J. allowed the appeal but for a different reason. Thus, neither position represented the majority position of the court.

Comments

Your first question is whether Canco "carried on business outside Canada" in the situation in point. From our analysis, one could argue that the mere installation of machinery in a country does not amount to carrying on business in that country. Especially in the factual situation in point where the particular corporation seems to pursue no business activity outside Canada but the installation activity. Indeed, this position would be founded, inter alia, on the comments in paragraph 27 of the Interpretation Bulletin IT-270R2 and the position of Idington J. in the ruling of the Supreme Court of Canada in Linde Canadian Refrigerator Co. v. Saskatchewan Creamery Co.

However, we agree with you that the main question at issue is rather whether, for the purposes of the application of section 122.3 of the Act, Canco (the "specified employer") carried on business outside Canada with respect to any installation activity. In this regard, taking into consideration the nature of section 122.3 and the purpose for which it was intended, we are inclined to give a broad interpretation to the words "carrying on business outside Canada with respect to any installation activity" in subparagraph 122.3(1)(b)(i) of the Act. From that point of view, we agree with your conclusion that Canco could be considered as carrying on business outside Canada with respect to an installation activity in the matter in hand.

We trust our comments will be of assistance to you. If you have any further questions in this matter, please contact us.

Maurice Bisson, CGA
for Director
Reorganizations and International Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch

¹ See for instance: London Life Insurance Company v. The Queen, 87 DTC 5312 (FC-TD)

² Corporation Notre-Dame de Bon-Secours v. Communauté urbaine de Québec and City of Québec, et al. [1994] S.C.J. BO 78 (S.C.C.)

³ Interpretation Bulletin IT-364 Commencement of business operation, dated March 14, 1977
⁴ Interpretation Bulletin IT-270R2 Foreign tax credit, dated February 11, 1991
⁵ IT-497R3 Overseas Employment Tax Credit, dated February 12, 1996
⁶ Reference 7-903410, July 4, 1991, letter addressed to the Montréal TSO.

⁷ L1997 E9638870 - OVERSEAS EMPLOYMENT TAX CREDIT, TEI Conference 1996, Round Table, Question XIX - OVERSEAS CREDIT.

??