Canada: Permanent Establishments - Canadian Update

Last Updated: December 7 2012
Article by Jim Wilson, Pierre G. Alary and Sandra Mah

Most Read Contributor in Canada, October 2018

The determination of whether a permanent establishment (PE) exists in Canada has always been the subject of confusion and uncertainty for non-resident taxpayers doing business or contemplating doing business in Canada. While the introduction of paragraph 9 of Article V of the Canada-U.S. Tax Convention (Treaty) in the Fifth Protocol clarified some PE issues involving Canada and U.S. service providers, much confusion and uncertainty still exists with many everyday inbound business activities.

On October 12, 2011 the Centre for Tax Policy and Administration of the Organisation for Economic Co-operation and Development (OECD) released a discussion draft entitled Interpretation and Application of Article 5 (Permanent Establishment) of the OECD Model Tax Convention (PE Discussion Draft and OECD Model). On October 19, 2012, the OECD released a revised version of the PE Discussion Draft based on feedback from the international tax community. The PE Discussion Draft proposes revisions to the OECD Model's Commentary (Commentary) to Article 5 that will help clarify the application and interpretation of certain OECD principles and guidelines regarding several contentious PE issues within the international tax community, including Canada. The proposed additions and changes to the Commentary on Article 5 of the OECD Model will be considered for inclusion in the next update to the OECD Model and Commentary, which is currently planned for 2014.

The PE Discussion Draft identifies 25 key PE issues and proposed changes to the Commentary with respect to most of those issues. The proposed changes to the Commentary should be extremely helpful and save considerable time and resources for taxpayers and tax authorities alike when they are finalized and implemented. As the proposed Commentary will be, for the most part, clarifying in nature, once implemented, it should have immediate impact as a tool for interpreting existing tax treaties. It is trite law in Canada that the OECD Model and its Commentary are of "high persuasive value" in the interpretation of the tax treaty in issue. Therefore, taxpayers and their advisers should pay special attention to these proposals, even while they are still in draft discussion format, as many of the most contentious PE issues are being clarified.

A complete analysis of the PE Discussion Draft is beyond the scope of this update. However,the following are some examples of contentious PE issues that have been addressed in the PE Discussion Draft and proposed Commentary to Article 5 of the OECD Model:

Business Restructuring: The PE Discussion Draft makes it clear that no distinction should be made in the application and interpretation of Article 5 based on whether or not the facts and arrangements relevant to the determination of a PE resulted from a business restructuring. Whether or not a PE exists in a state during a given period must be determined on the basis of the circumstances applicable during that period. In addition to this clarification, the proposed Commentary states, in the context of the general rule in paragraph 1 of Article 5 (General PE Rule) and the space at the disposal concept: "it cannot be considered that a plant that is owned and used exclusively by a supplier or contract-manufacturer is at the disposal of an enterprise that will receive the goods produced at that plant merely because all these goods will be used in the business of that enterprise."

Space at the Disposal:  The proposed Commentary states, in part, that space will be considered to be at the disposal of the enterprise (and thus a PE) where the enterprise has "the effective power to use that location." It goes on to state that, as an example, where "an enterprise is allowed to use a specific location that belongs to another enterprise or that is used by a number of enterprises and performs its business activities at that location on a continuous basis during an extended period of time," that enterprise may have a PE.

Seconded Employees: The proposed Commentary provides that "there may be cases where individuals who are formally employed by an enterprise will actually be carrying on the business of another enterprise and where, therefore, the first enterprise should not be considered to be carrying on its own business at the location where these individuals will perform that work." It is possible for the seconded employee to establish a PE of another enterprise if such employee is carrying on the business of the other enterprise.

Activities of a Recurrent Nature:  Under the General PE Rule, PEs normally have not been considered to exist in situations where a business has been carried on in a country through a place of business that was maintained for less than six months. Exceptions to the six-month time requirement include activities of a recurring nature. The proposed Commentary introduces an example to shed some much needed guidance on the matter.

Time Spent by Subcontractors (General PE Rule - Space at the Disposal): The proposed Commentary states "Whether a fixed place of business where subcontractors perform work of an enterprise is at the disposal of that enterprise will be determined on the basis of the guidance in paragraph 4.2; in the absence of employees of the enterprise, however, it will be necessary to show that such a place is at the disposal of the enterprise on the basis of other factors showing that the enterprise clearly has the effective power to use that site, e.g., because the enterprise owns or has legal possession of that site and controls access to and use of the site."

Time Spent by Subcontractors (Construction Site PEs): The proposed Commentary states: "the site should be considered to be at the disposal of the general contractor during the time spent on that site by any subcontractor where circumstances indicate that, during that time, the general contractor clearly has the construction site at his disposal by reason of factors such as the fact that he has legal possession of the site, controls access to and use of that site and has overall responsibility for what happens at that location during that period."

Joint Ventures versus Partnerships: Much helpful clarification of PE issues has been added through the proposed Commentary regarding the approach to members of joint ventures versus members of partnerships and other fiscally transparent entities. The PE Discussion Draft discusses the reasoning behind these clarifications by stating that "whilst members of a partnership would each have a permanent establishment if the partnership had one, the situation would be different, for many countries, in the case of a joint venture that did not constitute a partnership or other type of entity under their domestic law." The PE Discussion Draft acknowledges, however, that the meaning of joint venture would depend on domestic law, and that in some countries a "joint venture" could refer to a distinct enterprise. In addition, the proposed Commentary clarifies that there are different treaty implications at the partner level when the partners in a partnership are from different countries and the applicable treaties provide for different PE rules.

In conclusion, the tax community was in great need of further guidance from the OECD on core PE issues and welcomes any clarification. Even though the PE Discussion Draft is only a start, and many outstanding PE issues will remain, the attempt to clarify key areas of PE controversy is appreciated and will ultimately be of great benefit to taxpayers and their advisers in avoiding or resolving PE disputes.

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.

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