Computing Pt I tax on Canadian distribution profits of a U.S. producer (p. 657)
Section 4(1)(b) of the ITA provides that when a business is carried on in two or more different places, the net profit from the part of the business carried on in one of those places should be computed “on the assumption the taxpayer had ... no income ... except from the part of the business that was carried on in that particular place...”. The Canada Revenue Agency has interpreted that totally uninformative provision in the context of a nonresident offering goods for sale in Canada that the non-resident produced outside Canada as, when computing the profits taxable in Canada, permitting a deductionof the fair market value of the goods when they enter Canada [citing 2006-0196221C6]. But query at what level of trade that FMV is to be established.
… Assuming there is no domestically defined permanent establishment in a province to which the sale is referable, the federal rate will be 25 percent plus a branch profit tax of 25 percent (asuming no treaty reduction) on the residual 75 percent unless reinvested.
Treaty-limits on what Canada may tax on sales by U.S. into Canada (p.658)
Under the prior version of Code s. 863, the gross revenue of a U.S. person from goods produced by it in the U.S. and sold outside the U.S. could often be allocated partly to the other country for U.S. foreign tax credit (FTC) purposes. Revised s. 863 allocates all gross revenue from production and sales to the place of production (the U.S.) for FTC purposes. This has the effect of eliminating FTCs for any income tax that is imposed by the other country on the profits of the sales transaction, thereby triggering double taxation where such taxes are imposed in accordance with any applicable Treaty limitations (e.g., under Art. VII of the Canada-U.S. Treaty). In this regard, Mr. Boidman stated:
[T]he portion of the USA seller’s overall profit that Canada may tax is determined by the language in Article VII, as explained by the Treasury’s Technical Explanation (which Canada accepts as reflecting the intention of the parties) and an OECD–related competent authority agreement... .
Section 9 of Annex B to the 2007 protocol states that the two countries “understood that the business profits to be attributed to a permanent establishment shall include only the profits derived from the assets used, risks assumed and activities performed by the permanent establishment. The principles of the OECD transfer pricing guidelines shall apply for purposes of determining the profits attributable to a permanent establishment....”. In light of the OECD's subsequent publication of the “[Authorized OECD Approach”] AOA and the principle therein - that is, that the profits attributable are those the PE would have made were it a separate legal entity (for example, a corporate subsidiary) - the two countries then signed a competent authority agreement on June 26, 2012 that adopts the AOA. See ... CRA “Canada – US Tax Convention – Agreement between Competent Authorities on the Interpretation of Article V11 (Business Profits)”, (June 26, 2012). The bottom line is that a U.S. seller operating through a Canadian PE has firm guidelines to use to determine the amount of tax that the treaty will allow Canada to impose on profits derived from producing goods in the United States and selling them in Canada.
Allocation of income on sale of U.S.-produced goods all to the U.S. for U.S. FTC purposes under revised Code s. 863 (p. 655)
[There is] a (conceptually) irrational revision of the IRC section 863 sourcing rule for inventory sales … made by the 2017 Tax Cuts and Jobs Act [teh TCJA]) … .
[T]he sourcing rules in section 863 have been changed in a fashion which eliminates the pre-existing related FTCs [foreign tax credits]. …
Under prior section 863 and related regulations, for purposes of deterining FTCs the gross revenue of a US person from the production in the United States and sale outside the United States would be allocatedbetween the United States and the other country using one of three rules. …
Revised section 863 allocates all gross revenue from production and sales to the place of production. That rule is unequivocal where the producer/seller is a U.S person and all production takes place in the United States.
Double tax if also tax under ITA ss. 115(1)(a)(ii) and 253 (p. 657)
[I]f the sale to the distributor is concluded in Canada or it is concluded outside but further to an offer to sell that was made in Canada, then the U.S seller does carry on business in Canada and will be liable or Canadian federal income tax on the portion of the overall profit from producing and selling that is considered to arise in Canada. That would trigger the double taxation resulting from the new denial of U.S. FTCs in accordanced with the new section 863 sourcing rule.
Whether Code s. 863 overrides Art. XXIV(1) of the Treaty (pp. 658-9)
It is those taxes [imposed by Canada under s. 115(1)(a)(ii) and in accordance with Art. VII of the Canada-U.S. Treaty] that the United States should allow FTCs for under section 901 notwithstanding the TCJA amendment to section 863. That is because Article XXIV(1) – taking into account the sourcing rule in Article XX1V(3) – seems to be straightforward in providing those credits.
However ... does the TCJA amendment override, this and deny the credit, either because of the later in time rule of section 7852(d)(1) (regarding conflicts between the code and a treaty provision) or the language in the 1984 Treasury Technical Explanation ... “The direct and deemed paid credits allowed by paragraph 1 are subject to the limitations of the Code as they may be amended from time to time without changing the general principle of paragraph 1. Thus as is generally the case under US income tax conventions, provision such as code sections 901(c), 904 ... apply for purposes of computing allowable credit under paragraph 1. In addition, the United States is not required to maintain the overall limitation currently provided by US law”?
… [R]egarding the later-in-time rule and the oft stated view that it requires clear Congressional intent for a treaty to be overridden, consider the comments referenced above … [which] indicate a clear absence of any congressional expression of that intent … .
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