18 February 1998 Internal T.I. 9712976 - PERMANENT ESTABLISHMENT - MANAGEMENT CONSULTING COMPANY

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 a U.S. management consulting company which had short-term (e.g. 2 months) and longer term contracts (e.g. 11 months) with the same Canadian clients for several consecutive years where its employees worked in various locations in Canada in its clients' premises would be considered to have carried on business through a permanent establishment or establishments in Canada for purposes of the Canada-U.S. Income Tax Convention.

Position:

With respect to the longer term contracts, the company would be considered to have a permanent establishment in Canada. Depending on the facts of the situation, the short-term contracts may be part of a large and ongoing engagement. If so, they would constitute a permanent establishment also.

Reasons:

See arguments presented and court cases cited in the memorandum.

		February 18, 1998

	Toronto North Tax Services Office	International Section
	Michael K. Yee	S. Leung
	International Tax Advisor	957-2115
	Southern Ontario Region
		971297

XXXXXXXXXX
Permanent Establishment Issue

We are writing in response to your memorandum of May 14, 1997 in which you requested our comments on XXXXXXXXXX submission of February 14, 1997 with respect to the issue of whether XXXXXXXXXX carried on business through a permanent establishment in Canada for the years XXXXXXXXXX for purposes of the Canada-United States Income Tax Convention (the "Convention") and your proposed rebuttal to that submission.

Facts

XXXXXXXXXX

Our Comments

As noted in your memorandum, essentially, XXXXXXXXXX has four major arguments against the existence of a permanent establishment in Canada through which XXXXXXXXXX carried on business in the years in question. We agree with most of your proposed responses to these arguments. We would also like to add the following comments to rebut the arguments presented by XXXXXXXXXX.

1. Taxpayer's Own Business

XXXXXXXXXX cited several U.S. court cases to advance their argument that "the requirement for a permanent establishment suggests that the taxpayer must have a presence in Canada from which it advances its own business interest". One of the cases they cited is Champlin Petroleum Company v. Heins, a U.S. case. It should be noted that that Texas Court of Appeal case merely defined "fixed and established place of business" for the purposes of the Deceptive Trade Practices Act of the U.S. in determining which was the appropriate district to launch a civil action. That case did not deal with a tax treaty issue. The court summarized several U.S. federal court decisions on the meaning of "fixed and established place of business" as a place where a party is engaged in carrying on in a continuous manner a substantial part of its ordinary business, which requires a significant on-going presence by a defendant in a country where his venue is alleged to lie..." That meaning is different from the meaning of "permanent establishment" described in paragraph 1 of Article V of the Convention where it states that the term of "permanent establishment" means a fixed place of business through which the business of a resident of a Contracting State is wholly or partly carried on. It is evident that under the definition of "permanent establishment" in paragraph 1 of Article V of the Convention, there is no need that a "substantial" part of the ordinary business is carried on in the particular place.

The Texas Court of Appeal in that case also cited a 1922 case Winterbottom v. Casey which states that a "regular and established place of business" is a place where the same kind of business, in kind, if not in degree, is carried on as is done at the home office or principal place of business of the person or company involved. We feel that this requirement is too restrictive for the meaning of permanent establishment used in the Convention. We see no requirement in the Convention that an enterprise of a Contracting State cannot be considered to carry on a business at a particular place in another Contracting State if the business carried on at that place in the second-mentioned State is a separate business different from the business of the enterprise in the first-mentioned State.

Based on the above U.S. cases, XXXXXXXXXX interpreted "the taxpayer's place of business" to mean the place from which the taxpayer advances its own business interests and, in their opinion, since XXXXXXXXXX consulting activities in Canada cannot be said to advance its own business interests, such activities are not the business of XXXXXXXXXX for purposes of the definition of "permanent establishment" in Article V of the Convention. We do not agree with their interpretation. We feel that since the business of XXXXXXXXXX is management consulting services, the part of such services provided in Canada constitutes the business of XXXXXXXXXX carried on in Canada. In our view there is no requirement that XXXXXXXXXX has to promote its own business interests from its clients' premises, receive orders from its customers, or use letterhead that identified the premises it used as a place of business before XXXXXXXXXX would be considered to have a place of business in Canada.

We have reviewed several articles as well as the Commentaries on both the OECD Model Treaty and the U.S. Model Treaty (1981) and have found nothing to indicate that the taxpayer has to promote its own business interests in Canada before it can be said to have a permanent establishment in Canada.

In the case Commission of Internal Revenue v. Consolidated Premium Iron Ores Limited cited by XXXXXXXXXX, the company involved did not have any employees working in the U.S. where a permanent establishment was alleged to have been situated. The "office" in that case was merely an address with no assets and no employees. Therefore, the office of Consolidated Premium was incapable of supporting the conduct of income earning activities. That case can be distinguished from the present situation in that Consolidated Premium was not a management consulting company like XXXXXXXXXX which had several employees in Canada providing services to certain clients repeatedly for certain periods of time over several years. The activities carried out by those employees in Canada represented the essence of the business of XXXXXXXXXX. The space employed by XXXXXXXXXX in its client's premises was therefore clearly able to support the conduct of XXXXXXXXXX business activities.

It is, therefore, our view that none of the court cases cited by XXXXXXXXXX is on point with the fact situation of the case at hand.

2. Control over Premises

It is our position that control over a premise or premises is not a requirement in determining whether a permanent establishment or permanent establishments exist. The Supreme Court case Sunbeam cited by XXXXXXXXXX can be distinguished because it did not deal with the definition of "permanent establishment" within the context of tax treaties that Canada had with other countries. In that case the decision was made on December 1962 prior to the first OECD Model Treaty which was reported by the Fiscal Committee of the OECD in 1963. Therefore, the judges of that case did not have the opportunity to consider the provisions of the OECD Model Treaty and the Commentary thereon which, in light of the Crown Forest case, are important tools for the interpretation of the terms and provisions of international tax treaties. Having said that, however, we do not suggest that you put too much emphasis on the difference between "through a permanent establishment" and "has a permanent establishment". It should be noted that these two terms seem to be used interchangeably in Article V of the Convention¹ without any distinction.

XXXXXXXXXX referred to an article titled "Permanent Establishments in Canada" by Richard Tremblay (1989 CR 38:1) and stated that the author of that article concluded that the Sunbeam case is still relevant to the analysis and that it provides "strong support for the view that the element of control is a continuing requirement" for a permanent establishment to be found to exist. We would like to point out in the same article, Mr. Tremblay indicates that the provision of services in Canada by employees of a non-resident enterprise may give rise to a permanent establishment of that enterprise in Canada. For examples, Mr. Tremblay states that "where a non-resident undertakes to achieve a particular result in Canada through personnel (and equipment) such that the personnel are under the direction, responsibility, and control of the non-resident, the provision of the services by personnel of the non-resident in Canada may give rise to a permanent establishment (1989 CR 38:52). He also states in that article (1989 CR 38:53-54):

"The furnishing of services is specially dealt with in the recently signed US income tax treaty with India. The term "permanent establishment" is stated to include especially the furnishing of services within a country; however, where the services are performed for an unrelated person, they will constitute a permanent establishment only if they continue for a period of at least 90 days. The inclusion of such a provision in the "especially" paragraph suggests that the furnishing of services would prima facie have given rise to a permanent establishment even in the absence of such a provision, on the basis of the discussion in the commentary on article 5(2) of the 1977 OECD model convention." (Emphasis added)

We do not agree with the following statement made by

XXXXXXXXXX

It is not clear to what extent German cases concerning the interpretation of German domestic law can be considered instructive of the proper interpretation of Article V of the Convention. However, even if such cases were useful, we find that the cases cited by Mr. Skaar may be more helpful in advancing the Department's interpretation than that of XXXXXXXXXX. For example, XXXXXXXXXX refers to discussion by Skaar of the German case AW (Hessisches Finanzgericht, EFG 1973, at 496) dealing with circumstances that "closely parallel" the present case. To understand how the decision of AW was arrived at, it is necessary to first understand the background of the "right to use test". According to Mr. Skaar,² an important background to the "right to use test" is the former German domestic definition of agency PE, which required that the principal had the right to use the place of business of the agent. Because of this, many German court decisions specifically deal with the "right to use test". The German Supreme Court has held a restrictive position on this issue under domestic laws. The Court has found that the mere possibility of using somebody else's place of business is not sufficient for the "right of use test". Moreover, actual use of the facilities was generally found insufficient if no other evidence of a legal right to organize business activities could be proved. However, the above case represents only the traditional German view. Furthermore, the case did not deal with tax treaty, only German domestic law.

Even under German domestic law, a 1990 German case, Football Trainer (BFH in BStBl 1990 II 23), reflects a different approach by the Supreme Court of Germany. The case dealt with an individual who performed independent personal services as a football trainer. The taxpayer had no legal right of use to the various football arenas, but he performed his services there. The Court concluded that a taxpayer who is obliged to perform independent personal services without having a PE of his own, is deemed to have a PE where he performs his services. The rationale of the case is that the premises of the client are sufficient to establish a PE when the taxpayer is obliged to perform his services there.

Mr. Skaar also mentioned a German Supreme Court's decision in Consultancy 1990 (BFH in BStBl 1990 II 166) and arrived in his analysis of that case at the conclusion that it can not be generally concluded on the basis of Consultancy 1990 that regular use of the client's premises is insufficient for establishment of a PE. He further cited a case Pegrum (Stavanger byrett in Utv. 1989. at 496 (appealed)) decided by a Norwegian lower court concerning a U.K. geologist who was employed by a U.K. corporation controlled by himself. The U.K. corporation used office facilities in the client's main office in Norway, although not the same office every time. The visits to Norway were many, and amounted to approximately 6 months in one year. Nonetheless, a substantial part of the work was performed in the U.K. The lower court of Norway concluded that there was no PE in Norway because the employee's power to conclude contracts was not used habitually. However, according to Mr. Skaar, the question of PE should have been discussed under the basic rule (as opposed to the "deeming" rule). It cannot be decisive to deny a PE on the basis that the taxpayer changes office from time to time, at the request of the client, if it is represented that the performance of the taxpayer's obligations under the contract requires him to work in the office facilities of the client. Thus, Mr. Skaar's overall conclusion is that a PE did de facto exist in Pegrum under the basic rule. This conclusion is consistent with the rationale of Football Trainer where the taxpayer was deemed to have a PE based in the places where the football trainer was obliged to perform his services. Mr. Skaar's conclusion is that a taxpayer who has a contract in which it is presupposed that he will use the client's premises, unless he prefers to rent or buy his own facilities near the client, meets the "right of use test" for PE.³ Thus, we would submit that the materials in Mr. Skaar's text are of more assistance in advancing the argument that XXXXXXXXXX had a PE in the premises of its Canadian clients in the present case.

The above conclusion is consistent with the OECD commentary on Article 5 of the OECD Model Treaty where it states:

"A place of business may also exist where no premises are available or required for carrying on the business of the enterprise and it simply has a certain amount of space at its disposal. It is immaterial whether the premises, facilities or installations are owned or rented by or are otherwise at the disposal of the enterprise. A place of business may thus be constituted by a pitch in a market place, or by a certain permanently used area in a customs depot. Again the place of business may be situated in the business facilities of another enterprise." (Emphasis added)

The above quotation clearly indicates that there is no need to have control over a premise by a taxpayer before the taxpayer can be said to have a permanent establishment. As long as a certain amount of space is at the disposal of the taxpayer, a permanent establishment exists.

In the case of XXXXXXXXXX, in spite of the fact that XXXXXXXXXX performed its work in numerous physical locales in different Canadian cities,⁴ as long as XXXXXXXXXX regularly performed services in its client's premises in Canada, XXXXXXXXXX would be considered to carry on its business through a permanent establishment or establishments in Canada.

3. Fixed Place of Business

Whether the space used by the employees of XXXXXXXXXX in its client's premises can be considered to be a fixed place of business is essentially a question of fact. The word "fixed" denotes some sort of permanency as opposed to temporariness. It is our understanding that an average contract between XXXXXXXXXX and its Canadian clients lasted from 2 to 11 months and the average proportion of the time spent by XXXXXXXXXX employees in Canada for each contract ranged from 10% to 89% depending on the projects. In the last several years XXXXXXXXXX has concluded several contracts with its Canadian clients and had its employees performing services in Canada for the same clients (though serving different divisions of the same clients) and has earned substantial fees from its Canadian clients. Hence, the activities of XXXXXXXXXX in Canada appear to be of a recurring nature with a sense of permanency.

The above position is consistent with paragraph 6 of the commentary on Article 5 of the OECD Model Tax Treaty which states in part that "(w)here a place of business which was, at the outset, designed for a short temporary purpose only, is maintained for such a period that it cannot be considered as a temporary one, it becomes a fixed place of business and thus - retrospectively - a permanent establishment".

We do not agree with XXXXXXXXXX that XXXXXXXXXX consulting business did not share any of the qualities that persuaded the court in the German football case mentioned above. We see several similarities such as both businesses are service businesses and both involved performing services at different locations in a country for a short period of time in each location. In the German football case, as described above, the court decided that the football trainer performed services through a permanent establishment.

4. Insufficiency of Mere Human Connection

Paragraph 5 of Article V of the Convention is a deeming rule which, with certain exceptions, deems a person acting in Canada on behalf of a U.S. resident to be a permanent establishment in Canada if such person has, and habitually exercises in Canada, an authority to conclude contracts in the name of the U.S. resident. This rule is in addition to the rules described in paragraphs 1 to 4 of Article V of the Convention. XXXXXXXXXX says that they "XXXXXXXXXX". They realize that notwithstanding paragraph 5 of the Article, paragraphs 1 to 4 can also render an enterprise to have a permanent establishment in Canada through which it carries on business in Canada. However, they emphasize that to have a permanent establishment otherwise than because of paragraph 5 of Article V the enterprise needs to have a physical presence in Canada and they contend that XXXXXXXXXX did not have such a physical presence, such as an office or building site, in Canada to render it to have a permanent establishment in Canada. They supported their argument with the decision of the Supreme Court of Canada in the Sunbeam case.

We agree that the mere presence of the employee(s) of the enterprise in Canada does not necessarily render the enterprise to have a permanent establishment in Canada. Factors such as the nature of the activities carried out by the employees in Canada, the duration of those activities, the premises in which those activities were carried out, etc. have to be taken into account to determine whether the enterprise has a permanent establishment in Canada. If the employees performed services long enough at a place in Canada which was at the disposal of the enterprise, chances are that a permanent establishment of the enterprise in Canada exists. For the reasons described earlier, we do not feel that the Sunbeam case cited by XXXXXXXXXX in supporting their argument in this regard is relevant to the case at hand. Rather, we refer you to the cases of Mats Johansson and Scanwell AB v. Stavanger Municipality and Creole Production Services Inc. v. Stavanger Municipality which in our view are more relevant.

The court decision of the case Mats Johansson and Scanwell AB was first issued in 1989 and affirmed in 1991 by the Norwegian court. This case concerns the tax year of 1982 and the double taxation convention between Norway and Sweden which at that time contained standard OECD Convention clauses to determine a PE. The facts of the case are that a Swedish company was hired as a consultant for an estimated time of 15 months in connection with the hook-up of a drilling platform on the Norwegian continental shelf. The Swedish company had only one employee, Mats Johansson, who was an engineer and his duties consisted of supervision and guidance at stations where work was performed on the platform. He was provided with some space aboard the platform in order to do paperwork. This space was not available for his exclusive use as it was simply a room containing 25 desks and was used by employees of other companies. Both the plaintiff and the defendant agreed that the OECD Commentary for Article 5 of the OECD Model Convention should prevail. The court found that the entire business activity of the consulting company was performed by its employee aboard the platform and that the company did not perform any activities elsewhere. The court concluded that the Swedish company through the use of that space had a PE in Norway.

Creole Production Services Inc. is also a Norwegian case decided in 1981 by the Stavanger County Court in Norway. Creole, an American company, provided data analysis services to another company, Phillips Petroleum Company of Norway which operated a drilling platform off the continental shelf of Norway. The data was collected on the platform by a varying number of Creole employees and then communicated to Houston where it was analysed. A room was provided aboard the platform for the use of the employees of Creole. The court concluded that, based on the Commentary to the 1977 OECD Model Convention, the room had to be considered as a fixed place of business. The court considered that both the collection of data and its analysis were essential business activities of Creole. Since Creole was performing business activities through a fixed place on the platform located on the Norwegian continental shelf, it was concluded that Creole should be considered as having a PE in Norway.

The above two Norwegian cases show that there is no need for the employees of the enterprise working in another country to have the authority to conclude contracts before the enterprise is considered having a permanent establishment in that country. Also, there is no need for the enterprise to have control over the premise in which its employees work. A permanent establishment will exist as long as the space is at the disposal of the enterprise for a considerable length of time. Such space will be considered a fixed place of business and, hence, a permanent establishment of the enterprise.

Conclusion and Recommendation

In conclusion, based on the information available it is our opinion that XXXXXXXXXX carried on business through a permanent establishment or establishments in Canada in the years in question at the very least in reference to its longer term contracts with Canadian clients.

However, we recommend that you follow through by obtaining the information you have requested in your letter to XXXXXXXXXX dated October 31, 1996. The decision as to whether XXXXXXXXXX can be considered to have a permanent establishment in Canada vis-a-vis shorter contracts must ultimately be made based on facts. The preceding analysis merely supports the position that XXXXXXXXXX clients' premises may be viewed as a permanent establishment through which its business is carried on. But that would only be the case if it can be established that the business was carried on in this manner on a regular and continuous basis. In our view this would be clear vis-a-vis a long-term contract (e.g. 11 months) in and by itself. However, it is necessary to gather additional facts in order to establish a connection between contracts of short duration (e.g. 2 months) in order to demonstrate that they, together with all other contracts, comprise business conducted in Canada through a permanent establishment. In order to do this we suggest that you obtain information concerning:

1 Time periods spanned by each contract taking note of the length of time lags between contracts, if any;

2 Number of XXXXXXXXXX employees present in Canada during the relevant time periods and where they were deployed by XXXXXXXXXX;

3 Details of the contracts between XXXXXXXXXX and its clients including, in particular, the renewal terms and the extent to which they were exercised; and

4 Details as to XXXXXXXXXX clients' contract competition processes to assess

1 whether it was reasonable to expect someone else to be awarded contracts with existing XXXXXXXXXX clients, and

2 whether it was necessary for XXXXXXXXXX to have a permanent establishment in Canada in order to become aware of contracts opening for bidding and in order to prepare and submit its bids. Did XXXXXXXXXX employees working in Canada prepare and submit the bids?

While it would not be fatal to your argument if it were not the case, it may be helpful if any other evidence was obtained that would support the view that the series of contracts with the XXXXXXXXXX were in essence two ongoing engagements. For example, the separate contracts may merely be in place to enable clients to allocate costs to profit centres. Evidence of this could be the existence of a master contract.

In conclusion, it would appear on the surface that a good case could be made that the series of contracts of XXXXXXXXXX in Canada constitute an ongoing engagement conducted through a permanent establishment in Canada. However, additional facts are required in order to establish that contracts brief in duration were part of such business. Once you have all the facts, if you are not satisfied that this is the case, we suggest that certain longer term contracts could nevertheless be viewed as permanent establishments of XXXXXXXXXX in and by themselves.

for Director
Reorganizations and International Division
Income Tax Rulings
and Interpretations Directorate
Policy and Legislation Branch

endnotes

¹ The word "through" is used in paragraphs 1 and 8 of Article V (also in paragraphs 1 and 2 of Article VII) while the word "have" or "has" is used in paragraphs 7 and 9 of Article V (also in paragraph 2(b) of Article XV).

² "Permanent Establishment" Arvid A. Skaar, 1991 Kluwer Law and Taxation Publisher, Deventer, at 156 to 158.

³ Ibid., at 187-191.

⁴ see below for further discussion in this respect.

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