28 November 1986 Income Tax Severed Letter 5-2023 - [861128]

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.

Mr. J. Gertler Acting Director International Air Transport Branch Air Transport Committee Canadian Transport Commission Ottawa, Ontario 1986. K1A ON9

15-1-15CF

R.A. Primeau 957-2127

November 28, 1986

Dear Mr. Gertler,

This is in reply to your letter of July 29, 1986

You refer to our letter to you of November 19, 1985 which indicates that in those instances where the operation by a U.S. airline of an aircraft in Canada is not the operation of the aircraft in "international traffic" and thus the profits therefrom are not exempt under Article VIII of the 1980 Canada-U.S. Income Tax Convention (the "treaty") (see our comments below re "international traffic"), such profits would be taxable in Canada by virtue of Article VII of the treaty only to the extent that they are attributable to a permanent establishment in Canada through which the U.S. airline carries on business in Canada. You now ask us for a definition of "permanent establishment" in Canada, particularly for a U.S. airline which transports local traffic within Canada.

We cannot give an all-inclusive definition of "permanent establishment" for purposes of the airline industry. We can, however, give what we think would be the more common instances where such a permanent establishment would exist. As background thereto, we first quote the relevant paragraphs of Article V of the treaty which concerns the term "permanent establishment", that is, paragraphs 1, 2, 5, a portion of 6(e), 7, 8 and 9 thereof:

"1. For the purposes of this Convention, the term '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.

"2. The term 'permanent establishment' shall include especially:

(a) A place of management; (b) A branch; (c) An office; (d) A factory: (e) A workshop; and (f) A mine, an oil or gas well, a quarry or any other place of extraction of natural resources.

"5. A person acting in a Contracting State on behalf of a resident of the other Contracting State - other than an agent of an independent status to whom paragraph 7 applies - shall be deemed to be a permanent establishment in the first-mentioned State if such person has, and habitually exercises in that State, an authority to conclude contracts in the name of the resident.

"6. Notwithstanding the provisions of paragraphs 1, 2 and 5, the term 'permanent establishment' shall be deemed not to include a fixed place of business used solely for, or a person referred to in paragraph 5 engaged solely in, one or more of the following activities:

(e) Advertising, the supply of information . . .

"7. A resident of a Contracting State shall not be deemed to have a permanent establishment in the other Contracting State merely because such resident carries on business in that other State through a broker, general commission agent or any other agent of an independent status, provided that such persons are acting in the ordinary course of their business.

"8. The fact that a company which is a resident of a Contracting State controls or is controlled by a company which is a resident of the other Contracting State, or which carries on business in that other State (whether through a permanent establishment or otherwise), shall not constitute either company a permanent establishment of the other.

"9. For the purposes of the Convention, the provisions of this Article shall be applied in determining whether any person has a permanent establishment in any State."

Based on the above provisions, a U.S. airline would in our opinion have a permanent establishment in Canada if an employee of the airline at an airport or other location in Canada sells airline tickets or enters into other contracts in the name of the airline. However, the U.S. airline would not be considered to have a permanent establishment in Canada merely because it sells airline tickets or conducts other business through an independent travel agency at an airport or other location in Canada.

In any event, it is our view that based on the above provisions, any office space, hangar space, repair shop space or other space at an airport or other location in Canada which is used by a U.S. airline on a relatively permanent basis, whether owned or leased by the airline, would constitute a permanent establishment of the airline in Canada.

The above comments are given merely as guidelines since the question of whether a permanent establishment exists is a question of fact to be decided in each particular case. Please note also that under Article VII of the treaty, it is only the business profits that are attributable to a permanent establishment in Canada that may be taxed in Canada. In calculating such business profits deductions are allowed for expenses which are generally allowed under the Canadian Income Tax Act and which are incurred for the purposes of earning income attributable to the permanent establishment.

It is also important to keep in mind that where there is a conflict, the specific provisions of Article VIII of the treaty, which deal with income in the transportation industry, override the general provisions of Article VII, which deal with business profits. That is, notwithstanding that a U.S. resident may have a permanent establishment in Canada to which business profits are attributable, Article VIII nevertheless provides for an exemption from Canadian tax for those profits of that U.S. resident which are derived from the operation of ships or aircraft in "international traffic".

Paragraph 1(h) of Article III of the treaty defines "international traffic" as follows:

"The term 'international traffic' with reference to a resident of a Contracting State means any voyage of a ship or aircraft to transport passengers or property (whether or not operated or used by that resident) except where the principal purpose of the voyage is to transport passengers or property between places within the other Contracting State."

In addition to the above provisions in the treaty, paragraph 81(1)(c) of the Canadian Income Tax Act (the "Act") provides an exemption from tax for the income of a non-resident person earned in Canada from the operation of a ship or aircraft in "international traffic" if the country where that non-resident resides grants substantially similar relief to a resident of Canada. For this purpose, subsection 248(1) of the Act defines "international traffic" as follows:

'"international traffic' means, in respect of a non-resident person carrying on the business of transporting passengers or goods, any voyage made in the course of that business where the principal purpose of the voyage is to transport passengers or goods

(a) from Canada to a place outside Canada, (b) from a place outside Canada to Canada, or (c) from a place outside Canada to another place outside Canada."

As can be seen from the above, the provisions in both the treaty and the Act regarding "international traffic", although worded somewhat differently, are essentially the same. That is, they are based on a "principal purpose" test for each individual voyage.

During our telephone discussions, you have asked us to provide you with an illustrative example to clarify the "principal purpose" test. Let us say that a U.S. airline has a flight from Montreal to Toronto to Chicago. We understand that under existing Canadian air transport regulations, passengers on such a flight could go from Montreal to Chicago or from Toronto to Chicago but not from Montreal to Toronto. The "principal purpose" test would clearly be met for such a voyage because it is possible for passengers to travel only from a place inside Canada to a place outside Canada, and not from a place inside Canada to another place inside Canada. Thus, the flight would fall within the meaning of "international traffic" for purposes of both the Act and treaty, and the profits therefrom would be exempt from income tax in Canada.

We trust that the above will be of assistance to you.

Yours truly,

for Director Reorganizations and Non-Resident Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch