As a general rule, a non-resident is prima facie liable to pay Canadian income tax on business income earned in Canada if the non-resident carries on business in Canada.The term “carrying on business” is a broad concept and is generally understood that the threshold for carrying on business in Canada is fairly low.The determination of whether or not a non-resident is carrying on business in Canada must first be decided on the basis of common law.There is a large body of case law that assists in determining whether a non-resident person is carrying on business in Canada.
Section 253 of the Income Tax Act (Canada) provides for an extended meaning of carrying on business in Canada under which a non-resident person will be deemed to be carrying on business in Canada if the non-resident person:
- produces, grows, mines, creates, manufactures, fabricates, improves, packs, preserves, or constructs anything in Canada, whether or not the person exports that thing without selling it before exportation;
- solicits orders or offers anything for sale in Canada through an agent or servant, whether the contract or transaction is to be completed inside or outside Canada or partly in and partly outside Canada; or
- disposes of certain types of property, including Canadian resource property, timber resource property, and real property situated in Canada.
If it is found that the non-resident person is not carrying on business in Canada, then the non-resident person will not (aside from Part XIII withholding on Canadian source income, the disposition of taxable Canadian property or the earning of employment income in Canada) be liable for tax in Canada.If it is found that the non-resident person is carrying on business in Canada, the non-resident person will be liable for tax in Canada unless the non-resident person is resident in a country with which Canada has a tax treaty and the business of the non-resident is not conducted through a “permanent establishment” in Canada.In such event, the profits of the business are taxable in Canada to the extent that they are attributable to the “permanent establishment”.Profits are to be calculated in the normal course in that revenue and expenses attributable to the Canadian business are taken into account.Non-residents will also be subject to provincial tax on income earned in a province to the extent that they are carrying on business through a “permanent establishment” in that province.
A “permanent establishment” is defined in most tax treaties to mean a “fixed place of business” through which the business of the non-resident is wholly or partly carried on.A “permanent establishment” can include a place of management, a branch, an office, a factory a workshop and a mine, an oil or gas well, a quarry or any other place of extraction of natural resources and a building site or construction or installation projects lasting more than 12 months.It would also include a person (other than an independent agent acting in the ordinary course of its business) acting in Canada on behalf of a non-resident and who habitually exercises authority to conclude contracts on behalf of the non-resident.
The commentary to the OECD Model Tax Convention indentifies the following conditions for a “permanent establishment”arising from a fixed place of business:
- the existence of a “place of business” (i.e., a facility such as premises or, in certain instances, machinery or equipment);
- which place of business must be“fixed” (i.e., it must be established at a distinct place with a certain degree of permanence); and
- the carrying on of the business of the enterprise through this fixed place of business. This means usually that persons, who, in one way or another, are dependent on the enterprise (personnel), conduct the business of the enterprise in the state in which the fixed place is situated.
Paragraph 4 of the OECD Commentary further states:
4. The term “place of business” covers any premises, facilities or installations used for carrying on the business of the enterprise whether or not they are used exclusively for that purpose.A place of business may also exist where no premises are available or required for carrying on the business of the enterprise and it simply has a certain amount of space at its disposal.It is immaterial whether the premises, facilitates or installations are owned or rented by or are otherwise at the disposal of the enterprise.A place of business may thus be constituted by a pitch in a market place or by a certain permanently used area in a customs depot (e.g. for the storage of dutiable goods).Again the place of business may be situated in the business facilities of another enterprise.This may be the case for instance where the foreign enterprise has at its constant disposal certain premises or a part thereof owned by the other enterprise.
In Knights of Columbus v. R., and American Income Life Insurance Company v. R., the Tax Court of Canada commented upon when a place of business will be considered a “permanent establishment” for purposes of paragraph 1 of Article V of the Canada – U.S. Tax Treaty and when the activities of an agent will give rise to a “permanent establishment” under paragraph 5 of Article V.In respect of whether a place of business would constitute a “permanent establishment”, the Court concluded that there must be a place of business, the place must have some degree of permanence, and the business of the non-resident must be carried on through the place (meaning that the non-resident must have the place “at its disposal”).In commenting on whether a fixed place of business constituted a “permanent establishment”, the Court considered the following:
- A “permanent establishment”requires a fixed place of business meaning:
- existence of a place of business;
- degree of permanence to such place;
- the carrying on of the business of the enterprise through such fixed place.
- The enterprise need not own or lease property for it to be a fixed place of business.
- The premises need not be used exclusively by the non-resident.
- To determine if the non-resident’s business is being carried on from the fixed place of business, the following factors should be considered:
- use of premises by the non-resident;
- control by the non-resident over the premises;
- legal right to exercise control over premises;
- degree to which premises identified with the non-resident’s business;
- who paid for expenses of premises;
- who paid for equipment used at premises;
- who made management decisions;
- what contracts were concluded from the premises;
- what products of the non-resident were kept on the premises;
- did the non-resident have any Canadian employees;
- who bore the risk of the operation from premises;
- how many principals were represented by the agent; and
- were agents subject to detailed instructions or comprehensive control.
A “permanent establishment” will not be established by virtue of having a fixed place of business, independent of other factors, if the fixed place of business is used solely for any one or more of the following:
- the storing, displaying or delivering of goods or merchandise belonging to the non-resident;
- the maintenance of a stock goods or merchandise belonging to the non-resident for the purposes of storage, display or delivery;
- the maintenance of a stock of goods or merchandise belonging to the non-resident for the purpose of processing by another person;
- the purchasing of goods or merchandise, or the collecting of information, for the non-resident; or
- advertising, the supply of information, scientific research or any similar activities that have a preparatory or auxiliary character for the non-resident.
Under paragraph 5 of Article V of the Canada – U.S. Tax Treaty, if a resident of one state maintains an agent in the other state who has and regularly exercises the authority to enter into contracts in that other state in the name of the resident, the resident agent will be deemed to constitute a “permanent establishment” in the other state with respect to the activities the agent undertakes.A “permanent establishment” will not be deemed to exist simply because a non-resident corporation carries on business in Canada through a broker, general commissions agent or any other independent agent, provided that such persons are acting in the ordinary course of their own business.
Extended Meaning of “Permanent Establishment”
Article XIV of the Canada – U.S. Tax Treaty had previously provided that independent personal service providers resident in one state may be taxed in the other state to the extent that the service provider has or had a fixed place of business regularly available in that other state.The Fifth Protocol removes Article XIV and introduces a special rule for services in paragraph 9 of Article V, under which services performed by an “enterprise” of either Canada or the United States in the other state may give rise to a “permanent establishment” in that other state.The removal of Article XIV on independent personal services was due to the fact that no practical distinction could be made between a “fixed base”, as the term is used in Article XIV to provide taxing nexus, and a “permanent establishment”.However, the result of the changes to Article V will be that more non-resident enterprises that provide services in Canada will be considered to have a “permanent establishment”, which will give rise to Canadian tax liability.
New paragraph 9 of Article V of the Canada– U.S. Tax Treaty deems an enterprise of a state to be providing services through a “permanent establishment” in the other state, even though it may not otherwise have one, if and only if the enterprise meets one of two tests:
the “Single Individual Test”;and
the “Enterprise Test”.
The “Single Individual Test”
Subparagraph 9(a) of Article V of the Canada – U.S. Tax Treaty is referred to as the “Single Individual Test”.This test is generally aimed at enterprises that earn most of their income through the personal services of a small number of individuals.
Under the Single Individual Test, a “permanent establishment” is deemed to exist if the following conditions are met:
services are performed in the other state by an individual who is present in that other state for at least 183 days in any 12-month period; and
during such time, more than 50% of the “gross active business revenue” of the enterprise consists of income derived from the services performed in that other state by that individual.
The term “gross active business revenue”means gross revenue attributable to active business activities of the enterprise that has been (or should be) charged to its customers, regardless of when actual billings occurs and of domestic tax laws concerning when such revenue should be taken into account.
The “Enterprise Test”
Subparagraph 9(b) of Article V of the Canada – U.S. Tax Treaty is referred to as the “Enterprise Test”.Under the Enterprise Test, a “permanent establishment” is deemed to exist if an enterprise of a state meets the following conditions:
it provides services in the other state for at least 183 days in any 12-month period with respect to the same or connected projects; and
such services are provided for customers who are either residents of that other state or maintain a “permanent establishment” in that other country and the services are provided to that “permanent establishment”.
Projects are considered “connected” if they constitute a coherent whole, both commercially and geographically.The concept of connected projects attempts to address artificially divided projects undertaken to frustrate the 183-day threshold.This determination is to be made from the perspective of the enterprise, not the customer.
Factors to be considered when determining commercial coherence include:
whether the projects would, in the absence of tax planning considerations, have been concluded pursuant to a single contract;
whether the nature of the work involved under different projects is the same; and
whether the same individuals are providing the services under the different projects.
Commercial and geographical coherence must be considered together.For example, in a case in which an enterprise is hired to execute separate auditing projects at different branches of a bank located in different cities pursuant to a single contract, the projects may be commercially coherent, but not geographically coherent.Thus, each separate auditing project would be considered separately for the purpose of the Enterprise Test.
Physical Presence and Day-Counting
Under the Single Individual Test, physical presence on an individual during a day is sufficient to count as one day toward the 183-day threshold, regardless of whether the individual actually performs any work on that day.
By contrast, under the Enterprise Test, physical presence only includes days when work is actually performed.This means that weekends or holidays in most cases do not count for the purposes of the 183-day threshold.Also, because paragraph 6 of Article V of the Canada – U.S. Tax Treaty applies notwithstanding paragraph 9, days spent on preparatory or auxiliary activities described in paragraph 6 are not to be taken in account for purposes of applying the Enterprise Test.
Collective presence of more than one individual providing services during one calendar day will only count for one day of physical presence by an enterprise in the other state.
Since the period for measuring the 183-day threshold is not tied to any specific year, it is a rolling 12-month period in which no services are provided.
Paragraph 9 only applies to services provided to third parties.The Canadian tax authorities have expressed the view that the term “third party” should be interpreted to mean any person other than the person operating the enterprise in question, and that a related person is considered a third party for the purposes of this paragraph.The changes to Article V of the Canada – U.S. Tax Treaty introduced by the Fifth Protocol are effective for the third taxation year after the Fifth Protocol enters into force (ignoring any days of presence, services rendered and gross active business income earned before January 1, 2010).If paragraph 9 applies, then services are taxed on a net basis under Article VII which deals with the treatment of business profits.This means that taxation is limited to the profits attributable to the activities carried on in performing services in the other state. Neither “services” nor “enterprise” are defined for the purposes of paragraph 9; however, commentary issued by the Competent Authorities of both Canada and the United States have defined “enterprise” as an “individual or other entity carrying on a business”.