The Directorate confirmed the position in 9408985 that in light of the branch profits limitation under Ar. X(6) of the Canada-US Treaty of 10% of cumulative untaxed "earnings," a two-step process should be followed under which branch tax is first computed in accordance with Part XIV, then the upper limit is computed under Art. X(6) which, if applicable, reduces the branch tax computed under the first step.
Regarding the effect on “earnings” under Art. X(6) where a non-resident corporation applied a loss carryback to reduce its taxable income earned in Canada in the prior year, the Directorate noted that, in contrast to the Part XIV rules, the Art. X(6) earnings for a particular year are not reduced by the carryback of losses to that year from a subsequent year, so that such loss only reduces the cumulative earnings for Art. X(6) purposes in the loss year. Furthermore, although Art. X(6)(b) contemplates the deduction of Part I federal, and provincial income tax in computing earnings, when there is a loss carryback to a prior year which reduces such taxes for that year, the impact of such tax reduction on earnings for Art. X(6) purposes should be to reduce the loss for the current year rather than to increase earnings for the prior year.
The Directorate further stated:
[T]he amount of Allowance for Investment Property in Canada claimed in the prior year and that is being added back to the branch tax base under paragraph 219(1)(g) should not be added back in the same manner in computing “earnings” under Article X(6). Instead, the amount of Allowance for Investment Property in Canada for the current year, calculated under Regulation 808, would be deducted in the “earnings” calculation in accordance with subparagraph (c) of Article X(6).