On May 16, 2008, the Tax Court of Canada released two important decisions dealing with the concept of permanent establishment ("PE") under treaty law: American Income Life Insurance Co. v. R., 2008 D.T.C. 3631 and Knights of Columbus v. R., 2008 D.T.C. 3648. In both cases, the Canada Revenue Agency ("CRA") had assessed insurance companies based in the US on the basis that the companies (1) had a fixed place of business in Canada and (2) were using dependent agents in Canada pursuant to paragraphs V(1), (5) and (7) of the Canada-US tax treaty.
American Income Life Co. ("AIL") and Knight of Columbus ("KC") are both insurance companies headquartered in the US. Both AIL and KC conducted business in Canada through a sophisticated network of agents. Their business was legally structured in a way that the agents could be viewed as independent contractors (as opposed to employees). The underwriting process was performed in the US and the agents had no authority to alter the insurance agreements proposed to clients. The agents were commission agents without exclusivity and were free to develop their own business as a distinct cell from AIL and KC.
Both cases were heard by the same judge, C.J. Miller J., and were released on the same day. In each of these cases the CRA assessment was vacated on the basis that the taxpayer in question, AIL or KC, did not carry on business in Canada through a PE either on the basis of the fixed place of business concept or through a dependent agent.
Fixed Place of Business
On the issue of whether an agent's place of business (generally the agent's home office) was "at the disposal" of AIL and KC, the Court simply concluded that AIL and KC could not be considered to have geographical fixed places of business at their disposal in Canada through the offices of the agents. The Court came to that conclusion on the basis that the agents' business was distinct from the business of AIL and KC. In other words, because the facts demonstrated that the agents were independent contractors bearing the associated entrepreneurial risk, an agent's place of business could not be considered to be "at the disposal" of AIL and KC.
On the issue of whether AIL and KC had a dependent agent PE, the Court concluded that the agents had no authority to contract on behalf of AIL and KC. The Court found that the directing mind behind the acceptance or refusal of the insurance agreements entered into did not lie with the agents but with the principals in the US. Accordingly, the agents could not be considered to be PEs of AIL or KC in Canada.
The Court, arguably by way of obiter dictum, provided a complete analysis on whether the agents were dependent from AIL and KC. In effect, the Court hypothesized that if it were to be found that the agents would have had the authority to bind the principals, then the relevant question to consider would have been to determine whether the agents were independent from AIL and KC. Relying mostly on the inherent principles found in Taisei Fire and Marine Insurance Co., Ltd. v. Commissioner of Internal Revenue, (1995), 104 T.C. 535 (Taisei), a US Tax Court decision dealing with insurance underwriters, the Court concluded that the agents were both legally and economically independent from AIL and KC.
The PE concept is one of the most important concepts covered in treaty law. These decisions are therefore very important as they provide valuable insight in establishing the existence of a PE. At the very least, these cases certainly will be essential references to be considered when dealing with Canadian PE issues.
However, an important area of the AIL decision should be considered. Referring to the arguments presented on the issue of economic dependency in the Taisei case, the Court explicitly concluded that the agents were economically independent of AIL. In doing so, the Court found that the fact that the agents dealt only with AIL products was not determinative of economic dependency. In fact, the Court found that the dependence was one of AIL on the agents rather than vice versa. The question of economic dependency is a thorny one. If, as in the case of the AIL agents, an agent decides to act strictly for one principal rather than for several given that doing so would prove to be more profitable, the intuitively attractive view would be that the agent would be economically dependent on the principal with respect to such activity. However, it would seem that the Court decided otherwise and, therefore, to the advantage of the principals.
Although these two cases are very welcomed news in the tax community, a clear-cut definition of the agency type PE, especially the concept of economic dependency, is still very questionable. Structuring one's affairs in Canada through the use of agents still requires a very thorough understanding of the treaty provisions and their interpretation and most importantly awareness of judicial interpretation and precedents.