Principal Issues: Whether CRA should take administrative position on paragraph 9 of Article V.
Position: Yes
Reasons: In cases where services are subcontracted to a Canadian resident entity for an arm's length fee, the correct amount of income will be taxable in Canada, without creating an undue administrative burden on US resident.
2011 CTF November 2011
Question 25 Canada-US Tax Convention - Permanent establishment
Part A
A US company ("USCo") enters into a contract to provide consulting services to Canco, an arm's length customer resident in Canada. USCo subcontracts part of the contract to related corporation resident in the United States ("USCo 2"). Employees of USCo 2 perform all of the required Canadian-situs services and spend over 183 days in Canada on the project in a 12 month period.
Under subparagraph 9(b) of Article V of the Canada-US Tax Convention (the "Convention"), would USCo be deemed to have a permanent establishment ("PE") in Canada? In your response, please comment on the impact of paragraph 42.43 of the OECD Commentary to Article 5 of the Model Convention on the CRA's views.
CRA Response
In the above circumstances, subparagraph 9(b) of Article V of the Convention will deem services to have been provided by USCo to Canco through a PE in Canada if it can be concluded that USCo "provided" those services to Canco. In the above circumstances, it is CRA's view that USCo "provides" services to Canco. It does not matter that the services are performed by the employees of USCo2 rather than USCo's own employees. As a result, USCo is deemed by subparagraph 9(b) of Article V of the Convention to have performed the services through a PE of USCo in Canada.
In the above circumstances, subparagraph 9(b) of Article V will also apply to deem the services provided to USco by USco2 to have been provided through a permanent establishment of USco2 in Canada.
Our views as set out above are not influenced by paragraph 42.43 of the Commentary to Article 5 of the OECD Model Tax Convention. That paragraph pertains to the interpretation of a provision (the "alternative provision") described in paragraph 42.23 of the OECD Commentary. Subparagraph 9(b) of Article V of the Convention is materially different from the corresponding paragraph of the alternative provision to Article 5 of the OECD Model Tax Convention, referred to in the OECD Commentary. The most substantial difference is that the alternative provision in the OECD Commentary refers to the performing of services through one or more individuals who are present and performing services in the other contracting state while the subparagraph 9(b) of Article V of the Convention refers simply to the providing of services by an enterprise of a contracting state. In our view, the determination of whether an enterprise is performing services through individuals in a state is different from the determination of whether an enterprise is providing services in a state. In addition, the alternative provision includes a sentence dealing specifically with circumstances where services performed by an individual on behalf of one enterprise can be considered performed by another enterprise through that same individual and when they cannot. There is no such sentence in subparagraph 9(b) or Article V of the Convention. In sum, as the discussion in paragraph 42.43 of the Commentary pertains to the interpretation of wording that is materially unlike the wording of subparagraph 9(b) or Article V of the Convention, we are of the view that it is not of assistance in interpreting the latter provision.
Part B(a)
A US company ("USCo") enters into a contract to provide consulting services to Canco, an arm's length customer resident in Canada. USCo subcontracts a portion of this work to an arms' length Canadian company, ("Canco 2"). Employees of Canco 2 perform all of the required Canadian-situs work and spend over 183 days in Canada on the project in a 12 month period. USCo performs all of its services under the contract solely in the US.
Under subparagraph 9(b) of Article V of the Convention, would USCo be deemed to have a permanent establishment in Canada?
CRA Response
CRA will not consider USco to have a PE in Canada, provided Canco 2 is paid an arm's length fee for the work performed.
Part B(b)
Would the CRA's views expressed relating to Part B(a) change if Canco 2 did not deal at arm's length with USCo (for example, Canco 2 was the Canadian subsidiary of USCo)?
CRA Response
No
Part C
A US professional services partnership ("USFirm") enters into a contract to provide consulting services to Canco, an arm's length customer resident in Canada. USFirm subcontracts part of the contract to an arm's length Canadian professional services partnership ("CanFirm"). USFirm and CanFirm are part of a global network, but are independently owned and controlled. Employees of CanFirm perform all of the required Canadian-situs work and spend over 183 days in Canada on the project in a 12 month period. USFirm does not exercise supervision or control over CanFirm or CanFirm's employees.
Under subparagraph (9)(b) of Article V of the Convention, would USFirm be deemed to have a permanent establishment in Canada?
CRA Response
CRA will not consider USFirm to have a PE in Canada provided Canfirm is paid an arm's length fee for the work performed.
Part D
If Regulation 105 withholding is deducted by Canco on payments made to USFirm in the facts presented in Part C, would the CRA require every partner of USFirm that is allocated (under USFirm's partnership agreement) income pertaining to the activities in Canada to file a Canadian tax return to claim their share of the withholding?
Would the CRA require every partner that is a corporation to file a Canadian corporate income tax return under the "carrying on business in Canada" criteria? Is there any relief from this burdensome process?
CRA Response
Regulation 105 withholding does not represent a final tax of the non-resident. Rather, it is a payment on account of the non-resident's potential Part I tax liability to Canada. The ultimate tax liability is determined after the assessment of the non-resident's Canadian income tax return. Non-resident partners of a partnership are required to file a Canadian income tax return to calculate their tax liability and to obtain a refund. There is currently no administrative procedure whereby a refund can be issued in respect of a particular non-resident partner's share of the Regulation 105 withholding without that partner filing a tax return. However, where a partnership can demonstrate, based on treaty protection, that the normally required withholding is in excess of the ultimate tax liability, the partnership can make an application for a treaty-based waiver of Regulation 105 withholding on behalf of the partnership.
Corporate members of a partnership must file an income tax return pursuant to paragraph clause 150(1)(a)(i)(B) if they carry on business in Canada (i.e. including through a partnership). Individual partners are excepted under subparagraph 150(1.1)(b)(i) of the Act if no tax is payable by the relevant partner for the year. Where there exists an obligation under section 150 to file a return, there are currently no administrative procedures that relieve a non-resident partner of a partnership from such obligation.
2011-042659
Olli Laurikainen