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.
January 14, 1999
Mark O'Connor International Section
International Tax Advisor S. Leung
Atlantic Region 957-2115
981253
Installation Project
Paragraph 3 of Article 5 of the OECD Model Convention
We are writing in reply to your memorandum of May 11, 1998 in which you requested our view as to whether the assembling of equipment carried out in Canada pursuant to the two specific contracts you provided to us (we have not been provided with the appendices to the contracts), can be considered to be installation project for the purposes of paragraph 3 of Article 5 of the Canada-Germany Income Tax Convention (the "German Convention") and the Canada-Netherlands Income Tax Convention (the "Netherlands Convention").
The first contract ("Contract One") involves the purchase of XXXXXXXXXX The total contract price is about $XXXXXXXXXX which includes the prices for erection (assembling of equipment) at XXXXXXXXXX, of about $XXXXXXXXXX, commissioning (tests and adjustments without actual production) of about $XXXXXXXXXX, start-up (tests with actual production) of about $XXXXXXXXXX, and training of XXXXXXXXXX staff during commissioning and start-up of about $XXXXXXXXXX. The contract called for Germanco to design, fabricate, deliver and erect XXXXXXXXXX. The scope of work included all matters including design, engineering, equipment, supervision, instruction materials and labour as set forth in the contract. According to the contract, the erection would last from XXXXXXXXXX. Commissioning would follow immediately after the completion of the erection. The date for start-up (test run) would be XXXXXXXXXX and the take-over date would be XXXXXXXXXX. Inspection would be arranged by XXXXXXXXXX and Germanco within a period of XXXXXXXXXX after the take-over date.
The second contract ("Contract Two") involves XXXXXXXXXX. The former is a Canadian company and the latter a Dutch company. Pursuant to the contract, Netherlandsco agreed to sell and deliver to XXXXXXXXXX and to assemble, install and commission at the plant to be built by a third party in XXXXXXXXXX (the "Plant") as described in the attachments to the contract (these attachments were not provided to us). Netherlandsco also agreed to (i) supply XXXXXXXXXX the technical manuals relating to the design, installation and commissioning operation and maintenance of the Plant; (ii) to co-ordinate with the contractor of the factory building; and (iii) to train XXXXXXXXXX operating staff how to operate and maintain the Plant. The total contract price is $XXXXXXXXXX. Pursuant to your memorandum, Netherlandsco indicated that approximately $XXXXXXXXXX of work would be completed in Canada. They would subcontract with a number of Canadian firms to carry out various aspects of the project that need to take place in Canada. The breakdown of the $XXXXXXXXXX work to be completed in Canada is approximately $XXXXXXXXXX for Canadian sub-contracts and $XXXXXXXXXX for Project Management and supervision. From the sheet detailing the breakdown of the contract price of $XXXXXXXXXX, we note that approximately $XXXXXXXXXX was for installation and approximately $XXXXXXXXXX was for commissioning. The work to be completed in Canada would last approximately XXXXXXXXXX to further commission and adjust the Plant. Netherlandsco indicated that the actual starting date was XXXXXXXXXX and the completion date was expected to be XXXXXXXXXX.
Paragraph 3 of Article 5 of the German Convention is identical to paragraph 3 of Article 5 of the Netherlands Convention. Those paragraphs are identical to paragraph 3 of Article 5 of the OECD Model Convention. Paragraph 3 of Article 5 of all these conventions (collectively referred to as the "Convention") states:
"A building site or construction or installation project constitutes a permanent establishment only if it lasts more than twelve months."
If the majority of the work completed in Canada pursuant to the above-noted contracts is considered to be an installation project, the project, in and by itself, would not constitute a permanent establishment in Canada because it did not last for more than 12 months. The issue is whether the majority of the work performed in Canada in relation to the sale of equipment by the non-resident suppliers in these cases would be considered to be an installation project for the purposes of paragraph 3 of Article 5 of the Convention.
The word "install" in the Concise Oxford Dictionary is defined as: (i) place (person in office or rank) with ceremonies, (ii) establish (person, oneself, in place, condition, etc.); place (heating or lighting apparatus etc.) in position for use. "Installation" in that same dictionary means installing or being installed; apparatus etc. installed. The judge in the case of City of Winnipeg v. Brian Investments Ltd. (1952), 7 W.W.R. (N.S.) 241 (C.A.) stated that
"'Install' would seem to connote the doing of something of some complexity, difficulty and importance, probably requiring some skill, involving the integration of an article or articles into the building or machine in which the installing takes place, and causing a change of some importance in the building or machine."
Arvid A. Skaar in his book "Permanent Establishment" states that based on case law, German doctrine has traditionally described "installation" as assembly of modules into a complete, technical plant, or erection of such a plant. The doctrine has generally required that the tasks are "constructional installation". However, under tax treaty law, 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 co-ordinated with, rather than subordinated to, the construction alternative.1
Mr. Skaar continues to comment that Belgian, Norwegian and Danish tax authorities all held the position that installation of machine and equipment constitutes a construction PE under the OECD-based treaties. Moreover, it was stated by the Belgian authorities that German tax authorities held the same position regarding the tax treaty between the two countries.2
In his book "Klaus Vogel on Double Taxation Convention", Professor Vogel states that the term 'installation project' means the putting together or regrouping of pre-fabricated elements, such as the erection of steel scaffolding or units of production. The final assembling of parts of moveable 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 Article 5(1) - and possibly also those of Article 5(2)(d).3
In file #9335225 this Directorate has expressed an opinion that in the absence of any legal precedents on this issue, we subscribed to the view espoused by the above-noted authors that an installation project does not have to be related to a construction project, implying that installation of machine and equipment could be construed as installation project for the purposes of paragraph 3 of Article 5 of the Convention.
Therefore, in the cases at hand, it is our view that the placing of equipment in a building for use would meet the definition of installation for the purposes of paragraph 3 of Article 5 of the Convention. Placing of equipment for use would include all the activities of assembling, commissioning and test run until the equipment is fully functional. The equipment would not be functional if it is only assembled without being tested for operation. In other words, it is our view that an installation project includes not only erection or assembling of the plant but also those activities such as commissioning and test run to render the plant operational and productive.
The two contracts described in this memorandum both involve the purchase of equipment from non-resident suppliers and the installation of equipment by the suppliers in Canada to the point where the equipment or the plant can be used for actual production. We note that the price allocated to the installation of equipment comprises only a small percentage of the total contract price (for example, in Contract One, the price for erection, commissioning, start-up and training represents only about 10% of the contract price; this percentage is even smaller in Contract Two). As a result, if the term "installation project" is taken to mean the entire contract, since the installation is only a small part of the total contract in the cases at hand, the whole contract would not be considered to be an installation project. However, it should be noted that the term "installation project" is used in paragraph 3 of Article 5 of the Convention, not "installation contract". The word "project" is defined in the Concise Oxford Dictionary as "plan, scheme; planned undertaking, esp. by student(s) for presentation of results at specified time". In the Webster Third New International Dictionary, a "project" is explained as a "special plan or design" or a "planned undertaking". The activities carried out by the non-resident suppliers in Canada to assemble/erect the equipment/plant would generally be considered to be a project of the suppliers to be completed in Canada. This project includes assembling, planning, scheduling, managing, supervising, co-ordinating and training and is different from the functions of designing, developing, manufacturing and selling the equipment/plant which functions were performed in the non-resident suppliers' own countries. Although the assumption is that one contract is one project,4 in the cases at hand, the placing of equipment in a building for use can also be considered as a project different from the functions of selling the equipment. It would not seem appropriate to say it is an installation project of an arm's length sub-contractor of the non-resident supplier if the installation is done by the sub-contractor but it is not if it is done by the supplier himself.
In stating that Belgian, Norwegian and Danish tax authorities all held the position that installation of machine or equipment constitutes a construction PE, it is understood that the equipment is normally manufactured by the installer only who has the technical knowledge to install the equipment. This is illustrated by the German case Machine Installation5 where a German machine manufacturing corporation was engaged in 1968 in the construction of three plants in Romania, Mexico and Brazil, all countries with which Germany had not concluded tax treaties at that time. The enterprise manufactured and installed machines. Each project lasted for more than 6 months. Although the Supreme Court found that the company did not perform construction work under the domestic law of Germany, this case illustrates the point that the installer of the equipment is usually the manufacturer of the equipment. Therefore, as noted above, for tax treaty law purposes, when the Belgian tax authorities stated in a case in 1979 that the German tax authorities held the same position as the Belgian that a foreign enterprise which delivered and assembled machinery in Belgium would be subject to PE taxation under the construction clause if the "duration test" of the treaty was met, it is understood that installation of an equipment was only a part of the contract of manufacturing and sale of the equipment. In citing the case Mr. Skaar commented that (where the duration test is met,)'the profits from the manufacture of the machine would not be attributable to the PE, only the profits from the assembly'. We found no compelling reason to disagree with such a comment and to adopt a different position. Therefore, we feel that in determining whether an installation of equipment in Canada is an installation project under paragraph 3 of Article 5 of the Convention, it does not matter whether the installation is only a part of the sale contract where the sale of the equipment comprises the majority of the contract price.
Conclusion
In the situations involving the two contracts at hand, we feel that the better argument is that the activities of erecting, commissioning, test-run, etc. carried out by the non-resident suppliers be considered to be the activities of an installation project for the purposes of paragraph 3 of Article 5 of the Convention. As long as the duration of these activities carried out in Canada is less than 12 months, the installation project would not constitute a PE of the non-resident suppliers in Canada pursuant to that paragraph.
If you have any question regarding the above, please do not hesitate to contact the writer.
for Director
Reorganization and International Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch
P.S.: For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Legislation Access Database (LAD) on the Department's mainframe computer. A severed copy will also be distributed to the commercial tax publishers for inclusion in their database. The severing process will remove all material that is not subject to disclosure including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the LAD version or they may request a copy severed using the Privacy Act criteria which does not remove client identity. Request for this latter version should be made by you to Jackie Page at (613)957-0682. The severed copy will be sent to you for delivery to the client.
ENDNOTES
1 see pages 398 and 399 of the 1991 edition.
2 Ibid., pages 399 and 400.
3 see page 306, 3rd edition, 1997.
4 "Permanent Establishment" by Arvid A. Skaar, 1991 Ed., page 355.
5 BFH in BStBI 1979 II 527 in footnote 43 on page 398 of Arvid A. Skaar's book "Permanent Establishment", 1991 Edition.
??
All rights reserved. Permission is granted to electronically copy and to print in hard copy for internal use only. No part of this information may be reproduced, modified, transmitted or redistributed in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, or stored in a retrieval system for any purpose other than noted above (including sales), without prior written permission of Canada Revenue Agency, Ottawa, Ontario K1A 0L5
© Her Majesty the Queen in Right of Canada, 1999
Tous droits réservés. Il est permis de copier sous forme électronique ou d'imprimer pour un usage interne seulement. Toutefois, il est interdit de reproduire, de modifier, de transmettre ou de redistributer de l'information, sous quelque forme ou par quelque moyen que ce soit, de facon électronique, méchanique, photocopies ou autre, ou par stockage dans des systèmes d'extraction ou pour tout usage autre que ceux susmentionnés (incluant pour fin commerciale), sans l'autorisation écrite préalable de l'Agence du revenu du Canada, Ottawa, Ontario K1A 0L5.
© Sa Majesté la Reine du Chef du Canada, 1999
Email this Content