Principal Issues: [TaxInterpretations translation] In a particular situation, did a taxpayer have to allocate taxable income for the taxation year ended October 16, 2006 between the provinces in which it had a permanent establishment, including the permanent establishments of a partnership in which it is a partner in the particular taxation year, in accordance with subsection 402(3) of the Regulations if in the taxpayer's taxation year that partnership then had permanent establishments only in one province?
Position: We are of the view that the better position in such a situation is that the taxpayer had to allocate its taxable income for the taxation year ended October 16, 2006 between the provinces in which it had a permanent establishment, including the permanent establishments that the partnership had in its taxation year ending October 31, 2005.
Reasons: Tax policy underlying the inter-provincial income allocation rules
March 15,2011
Provincial Compliance Division, Headquarters Section1 of Provincial Advisory Services Income Tax Rulings Directorate Isabelle Landry, M.Fisc. 450-623-0193 Attention: Mr. Yves Leclerc 2011-039409
Taxable income earned in a province by a corporation
This note is in response to your request to comment on the application of paragraph 96(1)(f) of the Income Tax Act (the "Act") and subsections 402(1) to (3) and 402(6) of the Income Tax Regulations (the "Regulations") in connection with a particular situation described below (the "Particular Situation").
1) Particular Situation
The Particular Situation as you have explained it to us is as follows:
1. XXXXXXXXXXXXXX (the "Taxpayer") is a corporation that holds inter alia an interest in a partnership (the "Partnership").
2. The Taxpayer had a permanent establishment in the Province of Quebec during the taxation years under review from which it derived business income. Except for the permanent establishments it had through the Partnership, the Taxpayer did not have a permanent establishment outside Quebec.
3. The Partnership had permanent establishments in several provinces from which it derived business income.
4. The Taxpayer's taxation year ends on October 16 of each year while the Partnership's taxation year ends on October 31 of each year.
5. On October 16, 2005, the Partnership disposed of all its assets located outside the province of Quebec so that from that time on it no longer had a permanent establishment outside Quebec. That transaction was a bona fide transaction to a person with whom the Taxpayer was not dealing at arm's length.
6. In accordance with subsection 96(1) of the Act, the Taxpayer included, in computing its income for the taxation year ended October 16, 2006, its share of the Partnership's income for the Partnership's taxation year ending October 31, 2005.
7. The Taxpayer has taken the position that all of its taxable income for the taxation year ended October 16, 2006 was earned in the province of Quebec in accordance with subsection 402(1) of the Regulations.
2) Position of the Montreal TSO:
The Montreal TSO is of the view that the Taxpayer's taxable income for the taxation year ended October 16, 2006 should instead be allocated according to the formula set out in subsection 402(3) of the Regulations to provinces in which the Taxpayer had a permanent establishment. According to them, this includes permanent establishments from which the Partnership derived business income and which were included in the Taxpayer's income for its taxation year ended October 16, 2006.
3) Summary of Your Position:
You indicated that in the absence of rules in the Act or Regulations to determine the existence of permanent establishments in provinces where the activities of a corporation are carried on in whole or in part through a partnership, we must rely on jurisprudential principles. The jurisprudence (footnote 1) has recognized that members of a partnership are considered to carry on the partnership's business and are considered to have a permanent establishment in all provinces where the partnership itself has a permanent establishment.
Since subsection 402(3) of the Regulations does not provide that a permanent establishment is to be considered at a particular time in a taxation year for the purpose of allocating taxable income, you are of the view that the determination of the existence of a permanent establishment during a corporation's taxation year for the purposes of subsection 402(3) of the Regulations includes the taxation year of the partnership in which it is a partner and which ended in the corporation's taxation year.
Thus, based on the above facts and the relevant legislation, you concluded that the Taxpayer was required, pursuant to subsection 402(3) of the Regulations, to allocate its taxable income to provinces in which it had a permanent establishment including permanent establishments that the Partnership had in its taxation year that ended in the Taxpayer's taxation year.
4) Your Question:
You wish to know if we agree with your position that, for the taxation year ending October 16, 2006, the Taxpayer should allocate its taxable income to the provinces in which it had a permanent establishment, including permanent establishments that the Partnership had in its taxation year ending October 31, 2005 in accordance with subsection 402(3) of the Regulations.
5) Relevant Legislative Provisions
We reproduce here the excerpts from the provisions of the Act and Regulations at issue in this document:
Paragraph 96(1)(f) of the Act:
96 (1) Where a taxpayer is a member of a partnership, the taxpayer’s income, non-capital loss, net capital loss, restricted farm loss and farm loss, if any, for a taxation year, or the taxpayer’s taxable income earned in Canada for a taxation year, as the case may be, shall be computed as if
[...]
(f) the amount of the income of the partnership for a taxation year from any source or from sources in a particular place were the income of the taxpayer from that source or from sources in that particular place, as the case may be, for the taxation year of the taxpayer in which the partnership’s taxation year ends, to the extent of the taxpayer’s share thereof;
Subsection 402(1), (2), (3) and (6) of the Regulations:
402 (1) Where, in a taxation year, a corporation had a permanent establishment in a particular province and had no permanent establishment outside that province, the whole of its taxable income for the year shall be deemed to have been earned therein.
(2) Where, in a taxation year, a corporation had no permanent establishment in a particular province, no part of its taxable income for the year shall be deemed to have been earned therein.
(3) Except as otherwise provided, where, in a taxation year, a corporation had a permanent establishment in a province and a permanent establishment outside that province, the amount of its taxable income that shall be deemed to have been earned in the year in the province is
(a) in any case other than a case specified in paragraph (b) or (c), 1/2 the aggregate of
- (i) that proportion of its taxable income for the year that the gross revenue for the year reasonably attributable to the permanent establishment in the province is of its total gross revenue for the year, and
- (ii) that proportion of its taxable income for the year that the aggregate of the salaries and wages paid in the year by the corporation to employees of the permanent establishment in the province is of the aggregate of all salaries and wages paid in the year by the corporation;
(b) in any case where the gross revenue for the year of the corporation is nil, that proportion of its taxable income for the year that the aggregate of the salaries and wages paid in the year by the corporation to employees of the permanent establishment in the province is of the aggregate of all salaries and wages paid in the year by the corporation; and
(c) in any case where the aggregate of the salaries and wages paid in the year by the corporation is nil, that proportion of its taxable income for the year that the gross revenue for the year reasonably attributable to the permanent establishment in the province is of its total gross revenue for the year.
(6) For the purposes of subsection (3), where part of the corporation’s operations were conducted in partnership with one or more other persons
(a) the corporation’s gross revenue for the year, and
(b) the salaries and wages paid in the year by the corporation,
shall include, in respect of those operations, only that proportion of
(c) the total gross revenue of the partnership for its fiscal period ending in or coinciding with the year, and
(d) the total salaries and wages paid by the partnership in its fiscal period ending in or coinciding with the year,
respectively, that
(e) the corporation’s share of the income or loss of the partnership for the fiscal period ending in or coinciding with the year,
is of
(f) the total income or loss of the partnership for the fiscal period ending in or coinciding with the year.
6) Summary of the Position of the Taxpayer and its Representatives:
The Taxpayer and its representatives indicate that the determination of taxable income earned in a taxation year in a province pursuant to section 402 of the Regulations must be made in two stages. The first is the determination of the existence of a permanent establishment in a corporation's taxation year in accordance with subsection 402(1) of the Regulations. The wording of this subsection provides that the corporation must have had a permanent establishment in a province "in" its taxation year. They argue that the fact that a partnership had permanent establishments outside Quebec before the corporation's taxation year is irrelevant because this subsection refers only to the corporation's year.
Subsection 96(1) of the Act provides for computing the income from a partnership and provides inter alia that the income of a partnership preserves its nature as to its source and as to where it was earned. However, this subsection does not in any way determine the existence of permanent establishments for the purpose of allocating taxable income earned between provinces. Instead, the rules for determining permanent establishments and allocating taxable earned income are provided for in sections 400 et seq. of the Regulations and, according to the taxpayer and the taxpayer’s representatives, are independent of subsection 96(1) of the Act.
In the event that there are permanent establishments in more than one province, the second step is to allocate taxable income pursuant to subsection 402(3) of the Regulations.
However, since, in their view, the Partnership did not have a permanent establishment outside the province of Quebec in the Taxpayer's taxation year ending October 16, 2006 and since subsection 402(6) of the Regulations applies only for the purposes of subsection 402(3), they conclude that subsections 402(6) and 402(3) of the Regulations do not apply in this situation and that the taxable income earned did not have to be allocated between the provinces pursuant to subsection 402(3) of the Regulations.
7) Our Comments:
Given the circumstances of this case, the relevant legislation and the tax policy underlying the provincial income allocation rules, it appears to us that the better position is your position that the Taxpayer should allocate its taxable income for the taxation year ended October 16, 2006 to the provinces in which it had a permanent establishment including permanent establishments that the Partnership had during its taxation year ended October 31, 2005.
Pursuant to paragraph 96(1)(f), the income of a partnership for a particular taxation year from any source or sources in a particular place is the partner's income from that source or sources in that particular place for the partner's taxation year in which the partnership's taxation year ends.
Consequently, since the income a corporation earns through a partnership in a particular taxation year is deemed to come from the same sources in the same provinces in which the partnership's income was earned, the corporate partner must allocate its taxable income for a particular taxation year to the provinces in which the corporation had a permanent establishment in the taxation year including the provinces in which the partnership had permanent establishments in its taxation year that ended in the particular taxation year.
Furthermore, by virtue of the Act, the applicable federal corporate tax rate on a corporation's taxable income is reduced by 10 per cent if the same income is earned in the year in a province. The term "taxable income earned in the year in a province" is defined in subsection 124(4) of the Act and refers to Part IV of the Regulations determining whether taxable income is earned in a province. Section 401 of the Regulations states that the computation of the amount of a corporation's taxable income earned in a taxation year in a particular province must be made in accordance with Part IV of the Regulations. To that end, subsection 402(3) of the Regulations provides the formula for allocating taxable income earned in the year in a province. That federal allocation formula is used by the provinces to determine the amount of corporate tax payable to them based on the gross revenue and wages paid attributable to a permanent establishment in their province.
That formula is intended to protect the amount of tax payable in a particular province. This will indeed be the case where a new partnership is created in a particular taxation year and the new partnership has a permanent establishment in a province where a corporate partner did not have one before the partnership was created. For example, consider a situation where a corporation with a permanent establishment only in Quebec becomes a partner in a new partnership in a particular taxation year. Suppose that the first fiscal period of the new partnership will end after the particular taxation year and that the new partnership has only a permanent establishment in Ontario. In this example, although the corporation would have a permanent establishment in Ontario through the partnership during its particular taxation year, since the partnership's income is included only in the corporation's income in the taxation year following the particular taxation year, no portion of the corporation's taxable income for the particular taxation year will be allocated to the province of Ontario under subsection 402(6) of the Regulations.
That protection of the provincial tax base should also be applied in cases such as this one. In computing a corporation's taxable income earned in a province for a taxation year under section 402 of the Regulations, permanent establishments that a partnership had during its taxation year that ended in the corporation's taxation year must be considered.
For your information, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should the taxpayer request a copy of this memorandum, they may request a severed copy using the Privacy Act criteria, which does not remove taxpayer identity. Requests for this latter version should be made by you to Ms. Celine Charbonneau at (613) 957-2137. In such cases, a copy will be sent to you for delivery to the taxpayer.
We hope that our comments will be of assistance.
Best regards,
Guy Goulet CA M. Fisc.
Manager
for the Director
Ontario Corporate Tax Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch.
c. c. Ms. Jeannine Leroux-Lafontaine, Director
International, Provincial and Strategic Policy Division
Legislative Policy and Regulatory Affairs Branch
FOOTNOTES
Due to our system requirements, footnotes contained in the original document are reproduced below:
1 See in particular No 630 v. MNR, 59 DTC 300 (TAB) and Robinson (Trustee of) v. R., [1998] 1 CTC 272, 98 DTC 6065.