15 May 2002 External T.I. 2002-0123755 - Active Income of Foreign Affiliate

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 CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues: Whether paragraph 95(3)(b) applies to manufacturing services provided by an affiliate to goods owned throughout by the Cdn. parent corporation.

Position: No.

Reasons: The phrase "services performed in connection with the ... sale of goods" is limited to services that are related to the sale activity and do not extend to the manufacture of the goods.

XXXXXXXXXX
2002-012375
May 15, 2002

Dear XXXXXXXXXX:

Re: Paragraphs 95(2)(b) and 95(3)(b) of the Income Tax Act (the "Act")

We are writing in reply to your letter of February 14, 2002 wherein you requested our opinion regarding the application of paragraphs 95(2)(b) and 95(3)(b) of the Act (all further statutory references in this letter are to the Act) in a situation where a controlled foreign affiliate of a Canadian corporation performs manufacturing services on goods owned by the Canadian parent corporation.

The situation in your letter may be briefly described as follows:

A corporation resident in Canada ("Canco") carries on a manufacturing business in Canada. Canco also owns all of the shares of a controlled foreign affiliate ("FA") that is resident in a foreign country. Canco ships certain goods to FA and also purchases raw materials in the foreign country which FA then uses in processing and manufacturing operations to create finished goods for Canco. Canco continues to hold all ownership rights in the materials and the goods throughout the manufacturing and processing operations. The finished goods are then sold by Canco to a related distribution corporation in the foreign country for sale to arm's length customers in that same foreign country.

You indicate that, but for the possible application of paragraph 95(3)(b), paragraph 95(2)(b) would apply to deem the manufacturing and processing services provided by FA to Canco to be provided in a separate business, other than an active business, carried on by FA and to deem any income from that business to be income from a business other than an active business.

Your question is whether the manufacturing and processing services provided by FA to Canco would be considered "services performed in connection with the ... sale of goods" within the meaning of paragraph 95(3)(b) and therefore excluded from the deeming rule in paragraph 95(2)(b).

Your request appears to relate to a proposed transaction or a completed transaction. Confirmation of the income tax consequences of proposed transactions involving specific taxpayers will only be provided in response to a request for an advance income tax ruling. To make such a request the advance income tax ruling must be submitted in accordance with the guidelines set out in Information Circular 70-6R4 ("IC-70-6R4") dated January 29, 2001. However, if the situation relates to a completed transaction a request for the Canada Customs and Revenue Agency's views must be made to your local Tax Services Office. We can, however, provide the following general comments.

At the 1997 Tax Executives Institute Conference (Question XV: Foreign Affiliates - Services Performed In Connection With the Purchase or Sale of Goods) (Document No.: E 9729770), in reply to the question whether post-sales services performed by a U.S. subsidiary of a Canadian parent corporation on products purchased by customers directly from the Canadian parent would be considered "services performed in connection with ... the sale" for the purposes of paragraph 95(3)(b), Canada Customs and Revenue Agency answered, in part, as follows:

"Generally, however, it is the our view that only services that are directly related to the sales function would qualify. Therefore services provided by a foreign affiliate to a taxpayer in connection with either a guarantee or a warrantee associated with a product sold by the taxpayer would not qualify for the exclusion under paragraph 95(3)(b) as having been performed in connection with the sale of goods." [Emphasis added.]

Relying on certain statements made in the case of Nowegijick v. The Queen, 83 DTC 5041 (SCC), you have submitted that the words "in connection with", found in paragraph 95(3)(b), convey only some connection between two related subject matters, not necessarily a direct connection".¹ And on that basis you submit that the manufacturing and processing services described herein should be considered services performed in connection with the sale of goods by Canco.

We do not agree with your view. We consider that the structure of the phrase "services performed in connection with the ... sale of goods" refers to activities that are more immediately linked or related to the process of selling goods and transferring property in the goods from the seller to the purchaser (i.e. identifying and obtaining agreement as to the parties to the contract, the goods to be sold, the price to be paid and manner of payment and arranging for delivery of risk in, title to and possession of the goods sold). On this basis, and in our view, the activity undertaken to create the goods that are sold is not a service performed in connection with the sale of those goods.

Our comments are provided in accordance with the practice outlined in paragraph 22 of IC-70-6R4.

Yours truly,

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

ENDNOTES

¹ The portion of the decision in the Nowegijick case referred to reads as follows:

"in respect of" are, in my opinion, words of the widest possible scope. They import such meanings as "in relation to", "with reference to" or "in connection with". The phrase "in respect of" is probably the widest of any expression intended to convey some connection between two related subject matters: