11 May 2012 External T.I. 2011-0428791E5 - Foreign 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.

Principal Issues: Whether an amount paid to the state of XXXXXXXXXX is eligible for either the foreign business or non-business tax credit under the Income Tax Act? If not, does Article XXIV of the Canada- United States Tax Convention (1980) (the “Treaty”) apply?

Position: The amount paid may be eligible for the foreign business tax credit under subsection 126(2) of the Income Tax Act.

Reasons: The amount paid may be considered an income or profits tax where a corporation is carrying on business in the foreign country.

XXXXXXXXXX
2011-042879

May 11, 2012

Dear XXXXXXXXXX:

Re: XXXXXXXXXX State Tax

This is in response to your enquiry regarding whether a Canadian resident Corporation with no permanent establishment (“PE”) in the United States (“Canco”) is eligible for a foreign tax credit (“FTC”) on an amount paid in respect of a XXXXXXXXXX franchise tax (the “State Tax”). In particular, you question whether the State Tax is an income or profits tax and whether Canco is carrying on business in the US for the purposes of claiming a FTC pursuant to subsection 126(2) of the Income Tax Act (the “Act”). You also question whether the source rules in paragraph 3 of Article XXIV of the Canada United States Tax Convention (1980) (the “Treaty”) would apply to Canco if a FTC is not available under the Act.

Generally, subsection 126(2) of the Act allows a taxpayer that is resident in Canada, and carries on business in a country other than Canada, to claim a FTC for business-income tax paid in that country, subject to certain limitations. Paragraph 126(6)(a) of the Act extends the availability of a foreign tax credit under section 126 where such taxes are paid to a state, province or other political subdivision of a foreign country.

Subsection 126(7) of the Act defines a business-income tax in part as, “the portion of any income or profits tax paid by the taxpayer for the year to the government of a country other than Canada that can reasonably be regarded as tax in respect of the income of the taxpayer from a business carried on by the taxpayer in the business country…”. Interpretation Bulletin 270R3 – Foreign Tax Credit ( “IT-270R3”), provides that in order for a foreign tax to qualify as an income or profits tax the basis of taxation must be substantially similar with that of the Act and in order for the scheme to be substantially similar the foreign tax must be levied on net income or profits. Accordingly, it is our view that the State Tax to the extent that it is determined as a percentage of Canco’s allocated net income, would be considered an income or profits tax, and fall within the meaning of a business-income tax by virtue of subsection 126(7) of the Act, assuming that a business is carried on in XXXXXXXXXX and all of the other conditions are met. As such, the State Tax is creditable pursuant to subsection 126(2) of the Act. Any unused foreign tax credit would not be deductible under either subsection 20(12) or 9(1) of the Act.

It is always a question of fact whether a resident of Canada is carrying on business in a country other than Canada. The definition of “business” in subsection 248(1) of the Act generally includes a profession, calling, trade, manufacture, undertaking of any kind whatever and… an adventure or concern in the nature of trade but does not include an office or employment. If there is a business, we determine whether it is carried on, which generally requires some continuity and regularity.

There is no requirement that the business be carried on through a PE in a foreign jurisdiction for purposes of subsection 126(2) of the Act, as it applies to an income or profits tax paid to a foreign government. Without intending to be exhaustive, the following is a list of relevant facts that have to be considered to determine whether a person is carrying on a business in a particular place for the purpose of the Act:

• The place where a contract which is the basis of the transaction is made;
• The place where goods are delivered or payments made;
• The location where decisions to purchase and sell are made;
• The location of the business assets;
• The place where the goods are produced or the services performed;
• Whether an agent or independent contractor is utilized;
• The location of the profit making operations (as opposed to where the profits are realized);
• The nature of the activities/transactions;
• The establishment of a bank account, listed telephone number or address;
• Whether the taxpayer intended to do business in the jurisdiction;
• The degree of supervisory or other activity in the jurisdiction;
• The substance or object of the transaction;
• The presence of a representative or resident expert;
• Whether activities in the jurisdiction are merely ancillary to the main business (e.g., the business of buying, storing, selling or manufacturing the product);
• Whether individuals in the jurisdiction assist (or are available to assist) the taxpayer in his/her endeavor;
• The reason for the taxpayer's existence; and
• The place where a reasonable person would consider the business to be carried on.

A non-business foreign tax credit is provided under subsection 126(1) of the Act generally in respect of investment and other non-business income. A foreign income or profits tax paid, to the extent that it is not a business-income tax and satisfies the other requirements under the definition provided in subsection 126(7) of the Act, can generally qualify for purposes of the non-business foreign tax credit under subsection 126(1) of the Act.

It is our view that for FTC purposes, in determining the net foreign business income (i.e., the amount by which the total of the qualifying incomes exceeds the total of the qualifying losses referred to in subparagraph 126(2.1)(a)(i) of the Act) the amount would be that as computed under subsection 126(9) of the Act and would not be the amount that is the portion of the taxable income allocated to the State of XXXXXXXXXX using the three factor formula. Paragraphs 23 and 24 of IT-270R3 provide CRA’s general views on allocating profits to different jurisdictions. Reference should also be made to paragraphs 30 to 36 of IT-270R3 with regards to calculating net income from sources in a foreign country.

The primary purpose of the Treaty is to minimize double taxation. Paragraph 7 of Article XXIV of the Treaty effectively provides the same treatment to taxes of a political subdivision or a local authority as those described in paragraph 126(6)(a) of the Act, where such taxes are levied in a manner consistent with the provisions of the Treaty. However, taxation of a corporation’s business profits where no PE exists is contrary to the source rules in Article VII of the Treaty. Paragraph 7 of Article XXIV of the Treaty does not provide relief where a tax is levied in a manner inconsistent with the provisions of the Treaty. Since relief for the State Tax paid would seem to be provided for under Canada’s FTC system, Article XXIV of the Treaty generally would not apply to decrease the FTC, if available, under the Act.

We trust these comments will be of assistance to you.

Yours truly,

Lita Krantz CA,
Assistant Director,
International Division/ Division des opérations internationales
International Section III
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch