26 August 2010 External T.I. 2004-0078321E5 - Computation of branch profits

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 certain transactions between the Canadian branch of a non-resident bank and another branch of such bank situated in a third jurisdiction would be recognized in computing the Canadian branch profits of the bank

Position: Transactions will be recognized to the extent that they are relevant in computing the bank's income earned in Canada under the Act

Reasons: An authorized foreign bank's income earned in Canada is its profit, subject to Part I modifications, reported to the Supt of Financial Institutions

XXXXXXXXXX 							2004-007832
								Ross Kauffman
August 26, 2010

Dear XXXXXXXXXX :

Re: Recognition of Inter-Branch Transactions

This is in reply to your letter in which you asked for our views on whether certain transactions between the Canadian branch of a non-resident corporation and another branch of such corporation situated in a third jurisdiction would be recognized in determining the Canadian branch profits of the corporation for the purposes of the Canada-UK Income Tax Convention (the "Treaty").

To assist in framing the discussion you presented the following hypothetical scenario:

A financial institution incorporated under the laws of the United Kingdom ("Parent") carries on business directly in Canada through a permanent establishment ("Canada Branch"). Parent is an authorized foreign bank for purposes of the Income Tax Act (Canada) (the "Act"). Parent also carries on business directly in the United States through a permanent establishment ("U.S. Branch"). From an operations standpoint, Canada Branch and U.S. Branch are managed separately and may independently enter into certain transactions with each other or with Parent (as though they were separate legal entities). You have asked us to assume that Canada Branch will periodically enter into repurchase agreements and reverse repurchase agreements (both of which are hereinafter referred to as "Repos") with U.S. Branch and you have asked us if these inter-branch transactions would be recognized in computing the income/loss attributable to Canada Branch for Canadian tax purposes. You indicate that a Repo is generally used as a form of short-term financing.

Our Comments

Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request. Where the particular transactions are completed, the inquiry should be addressed to the relevant Tax Services Office. However, we are prepared to provide the following general comments which we hope you will find of some assistance.

For the purposes of Part I of the Act, the taxable income earned in Canada of Parent from carrying on business in Canada through Canada Branch is determined under subparagraph 115(1)(a)(ii) of Act. This subparagraph provides that, subject to other provisions of Part I, an authorized foreign bank's income for the year under section 3 is its profit from that business computed using the bank's branch financial statements. In computing the income of an authorized foreign bank under Part I, paragraph 18(1)(v) of the Act prohibits a deduction for interest by the bank, except as permitted under section 20.2 of the Act (which provides for a deduction for certain notional interest expenses).

Thus, the Act sets out the rules for calculating a foreign bank's profit from carrying on business in Canada and includes rules for the treatment of inter-branch transactions. In applying Article VII of the Treaty to the hypothetical fact scenario set out above, it is our view that the computation of the income of Canada Branch under Part I would, in the circumstances, result in its profit attributable to the permanent establishment of Parent in Canada. This view is supported by section 4 of the Income Tax Conventions Interpretation Act, which requires that, for the purposes of the application of a tax treaty, the profit attributable to a permanent establishment in Canada under the treaty shall, except where the treaty expressly otherwise provides, include amounts required to be included under the Act and exclude amounts that would not be deductible under the Act.

Since the tax treatment of the Repo Agreements would depend on, among other factors, the branch financial statements, as defined in subsection 20.2(1) of the Act, we are unable to provide a definitive answer as to the effect of Repo Agreements on the computation of income of an authorized foreign bank under the Act without examining all the relevant documentation. In this respect, we would be pleased to consider the matter in the context of an advance income tax ruling.

We trust our comments are of some assistance.

Yours truly,

for Director
International & Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch