Canada: Canadian Tax @ Gowlings - May 20, 2011

Last Updated: May 23 2011

Edited by Laura Monteith and Henry Chong

Deemed Services PEs - Subcontractors vs Agents - CRA Adds Fuel to the Fire /H3>

By Jim Wilson and Pierre Alary

The Canada Revenue Agency's ("CRA") Income Tax Rulings Directorate recently released a technical interpretation 1 which may invite CRA auditors to continue this increasingly common and highly alarming trend.  There has been a trend by auditors to conclude with apparent ease that a parent-subsidiary or contract-subcontractor relationship is in fact an agent-principal relationship for purposes of Canada's bilateral tax treaties. As we discuss below, the agency threshold is not easily met under Canadian agency law, and the frequent jump by CRA auditors to conclude that an agency relationship exists, is creating significant tax uncertainty for Canadian and foreign entities.

The recent technical interpretation arose when a taxpayer requested the assistance of the CRA to determine whether Article V(9)(b) of the Canada-U.S. Tax Convention (the "Treaty") would apply to deem a US company to have a permanent establishment in Canada in the following hypothetical fact scenario.

USco1 [a US company] entered into a contract to provide services to Canco, a customer resident in Canada. USco1 engaged USco2 [another US company] to provide the services that USco1 was obligated to provide under the contract with Canco, on behalf of USco1 for Canco. The services are provided over a period more than 183 consecutive days. USco1 and USco2 are not residents of Canada; they are residents of the United States for the purposes of the Treaty. Many employees of USco2 will be involved in performing these consulting services. Canco, USco1 and USco2 are controlled by a common parent company.

Paragraph 9 of Article V was introduced by the Fifth protocol of the Treaty and is generally understood to be the governments' response to the Federal Court of Appeal decision in The Queen v. Dudney, 2000 DTC 6169 (F.C.A.)2. Article V(9)(b) deems a permanent establishment ("PE") to exist for cross-border service providers where the services are provided in the other State for at least 183 days in any twelve-month period with respect to the same or a connected project (commonly referred to as "deemed services PEs"). The services must be provided for customers who

  1. are either resident in the other State ("Option 1"); or
  2. have a PE in the other State in respect of which the services are provided ("Option 2").

The CRA concluded in this technical interpretation that USco1 and USco2 would both be deemed to have a PE.  While we understand why the CRA would interpret Article V(9)(b) in a manner that ensures that Canada maintains its taxing rights in this hypothetical scenario, it is the road travelled by CRA to arrive at its conclusion which we find concerning.

With respect to USco1, CRA opined that USco1 provided services to Canco through the agency of USco2. Thus, USco1 would be providing services to a customer resident in Canada (i.e. Canco) for more than 183 days in a twelve month period with respect to a single project. As a result, USco2 would also be deemed to have a PE in Canada as a result of providing services to a customer (i.e. USco1) that is deemed to have a PE in Canada (in addition to meeting the other factors listed in Article V(9)(b)).

It is important to note that the technical interpretation refers to the possible use of the general anti-avoidance rule ("GAAR") in the event that Article V(9)(b) is circumvented. The reference to GAAR would seem to indicate that CRA may have been concerned by the possibility of U.S. companies circumventing Article V(9)(b) of the Treaty by sub-contracting the work. This appears to be the "evil" CRA was trying to remedy in this case. To avoid such abuse of the provision, it is understandable why the CRA concluded that USco2 had a deemed PE in Canada.  However, it is unclear why CRA felt the need to establish an agency-principal relationship between USco1 and USco2. That is, while recognizing the obvious ambiguity within Article V(9)(b) in respect of subcontract scenarios, there would appear to have been a reasonable basis for CRA, based on a purposive approach to treaty interpretation, to conclude that USco2 had a deemed PE in Canada regardless of whether an agency relationship existed.  For example, an argument was available to CRA that USco1 "provides services" in Canada "for customers" who are resident in Canada even though they subcontracted with USco2 to have the latter entity physically perform the service in Canada. This would have resulted in USco1 having a deemed PE in accordance with Option 1 listed above.  Following this through, as USco2 provides services to its customer, USco1, who has a PE in Canada, USco2 would be deemed to have a PE in Canada pursuant to Option 2 listed above. 

The Organisation for Economic Co-operation and Development's ("OECD") Model Tax Convention on Income and on Capital ("OECD Model Treaty") does not contain a deemed services PE provision similar to Article V(9)(b) of the Treaty, but the OECD Commentary offers an alternative provision for the taxation of services, albeit slightly different from Article V(9)(b) of the Treaty.  Interestingly, applying paragraph (b) of the OECD alternative provision to the hypothetical scenario above, and assuming that USco2 was not an agent of USco1, dependent or independent, USco2 would be deemed to have a PE in Canada and USco1 would not be deemed to have a PE.3  However, given that Article V(9)(b) uses different wording 4 than the OECD alternative provision, and the Department of the Treasury Technical Explanation of the Fifth Protocol ("U.S. TE") is silent on the issue of subcontractors in this scenario, there seems to be plenty of room for CRA to support an interpretive policy that would protect source country taxation in these contractor-subcontractor scenarios. Furthermore, both the OECD Commentary to the alternative provision and the U.S. TE would seem to suggest that the intentions of the treaty negotiators were to maintain source state taxation rights provided that the ultimate customer resides in the source state and the services are physically performed in that state for more than 183 days. These three basic factors are met in the scenario above. 

Alternatively, and again by avoiding a literal or legalistic interpretation of Article V(9)(b), CRA could have argued that USco2 would be deemed to have a PE under Option 1 because the intention of the reference to services being provided by an enterprise (e.g. USco2) to "customers who are either residents of that State ..." was simply to ensure services were in fact physically provided to third party customers in Canada.  It is debatable whether the treaty negotiators intended for so much stock to be put on the fact that the subcontractor's "customer" is the general contractor and not the general contractor's Canadian resident customer. This interpretation approach would have been consistent with paragraph (b) of the OECD alternative provision described in paragraph 42.23 of the Commentary since the latter provision does not refer to services provided "for customers".

The use of the "agency" argument in this technical interpretation, when it was arguably not necessary to achieve the desired result, will simply add fuel to the fire of a growing trend we have encountered in our practice. In essence, certain CRA auditors are incorrectly employing the term "agent" to describe parent-subsidiary and contractor-subcontractor relationships. By doing so, CRA auditors are seemingly lifting the corporate veil, even though the courts have made it clear that an agency determination in such a case is not one that should be easily arrived at5. It is unclear to us how CRA could arrive at such conclusion in this technical interpretation because, generally speaking, a subcontractor simply enters into a contract of service with the contractor and not an agent-principal relationship.  While the technical interpretation issued by CRA provides a very brief description of the facts, we are concerned that there was nothing sufficient in those facts provided to create an agency-principal relationship. 

The OECD Commentary to Article 5 of the OECD Model Treaty does not define the term "agent", but instead attempts to describe what is meant by the terms "agent of a dependent status" versus "agent of an independent status" for the purposes of Article 5.  Oddly, the commentary regarding what conditions constitute an Independent Agent would seem to make it virtually impossible, under Canadian agency law, for that entity to be considered an agent at all.  Regardless of the confusion between the meaning of "agent" under Canadian agency law versus the OECD Commentary descriptions of these terms, attempting to describe a subcontractor as being an agent of a contractor, even under the broadest definition of agent, is a dangerous practice which should be halted immediately. A determination that an agency relationship exists should only be used as a method of last resort and was, arguably, not necessary in the hypothetical scenario above. Such a determination will only create tax uncertainty and encourage auditors to look through sub-contractors and captive service providers, when making PE determinations with respect to their foreign parent, in a more aggressive manner than they already are. 

Footnotes

1. 2010-0391541E5 E - Article V (9) of the Canada-US Tax Convention (Released April 13, 2011).

2. In Dudney, the FCA ruled that Mr. Dudney, a U.S. resident, was not subject to tax in Canada despite spending 300 days in Canada during the relevant taxation year because Mr. Dudney did not have a fixed base in Canada.

3. For example, if USco 2 is not a dependent agent of USco1, paragraph 42.32 of the Commentary states that paragraph (b) of the alternative provision does not apply to USco1. Furthermore, if USco1 did not direct or control the manner in which the services are performed by USco2, which would be consistent with a non-agency relationship, USco1 would again be exempted from the deemed PE rule (see paragraph 42.43 of the Commentary).

4. For example, Article V(9)(b) uses the words "provides services" instead of "performs services" and also includes the words "to customers".

5. See United Geophysical Company of Canada v. Minister of National Revenue, 61 DTC 1099.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

 
In association with
Related Topics
 
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions