Copyright 2008, Blake, Cassels & Graydon LLP
Originally published in Blakes Bulletin on Tax, September 2008
On May 16, 2008, two significant decisions of the Tax Court of Canada (the Court) dealing with the interpretation of the meaning of permanent establishment under the Canada–United States Tax Convention (the Convention) were released: Knights of Columbus v. R., and American Income Life Insurance Company v. R., (the latter discussed later in this bulletin). The same judge, the Honourable Justice C. J. Miller, presided over both cases and both were decided in favour of the taxpayers. The decisions are important because of the lack of judicial guidance in Canada on the topic of permanent establishment in an international context. The decisions also make some interesting comments on tax treaty interpretation in general.
Knights Of Columbus
A non-resident of Canada that carries on business in Canada is subject to Canadian tax unless it is exempt under the Convention by virtue of not having a permanent establishment in Canada. The issue in Knights of Columbus was whether the taxpayer was subject to Canadian tax in respect of business profits from its insurance business carried on in Canada. In this regard, Miller J. considered whether the Knights of Columbus had a permanent establishment as a result of:
- using agents, other than independent agents acting in the
ordinary course of their business, who habitually exercised
in Canada authority to conclude contracts in the name of the
Knights of Columbus (Article V(5) and (7) of the Convention);
- carrying on its business through a fixed place of
business in Canada (Article V(1) of the Convention).
Agency Permanent Establishment
Pursuant to Articles V(5) and (7) of the Convention, a taxpayer will have a permanent establishment in Canada if it has an agent in Canada that habitually exercises a general authority to conclude contracts in the name of the taxpayer, other than an agent of independent status who acts in the ordinary course of its business. It follows from this definition that if an agent does not have the authority to bind the taxpayer, it will not constitute a permanent establishment of the taxpayer. The Knights of Columbus carried on its insurance business in Canada through agents of varying levels, a Chief Agent, General Agents and Field Agents.
The Court found that the Chief Agent and General Agents were independent agents of the Knights of Columbus but did not come to a final determination with respect to the status of the Field Agents. The Court decided that such a determination was unnecessary because none of the Chief Agent, General Agents or Field Agents habitually exercised an authority to conclude contracts on behalf of the Knight of Columbus. Although the Field Agents solicited permanent insurance contracts in Canada, such contracts were finalized and approved in the U.S. The Court rejected the argument that the Field Agents could be considered to "conclude contracts" because they were involved in the negotiation process, even though they did not actually sign the final agreements. Although the Court did not rule out that involvement in the negotiation of a contract could be enough to constitute concluding contracts (referring to comments to this effect in the commentary to the model treaty of the Organization for Economic Cooperation and Development (the OECD Commentary)), the Court did not think that the actions of the Field Agents were extensive enough to come within the type of negotiation contemplated by the OECD Commentary. The terms of the insurance contracts were set in the U.S. The Field Agents simply presented these terms to potential customers and this did not constitute real negotiation.
Fixed Base Permanent Establishment
The Court then considered whether the Knights of Columbus could be considered to have a permanent establishment in Canada by virtue of Article V(1) of the Convention. Article V(1) states that a permanent establishment is a fixed place of business through which the business of a taxpayer is wholly or partly carried on. This test requires that there be a place of business, that the place of business is fixed, and that it is the Knights of Columbus' business that is carried on through the fixed place of business. The Minister of National Revenue (the Minister) argued that the home offices of the Field Agents could be considered fixed places of business of the Knights of Columbus. The Court found that the home offices were permanent and were places of business. However, with regard to whose business was being carried on through the home offices, Miller J. made the following comments:
"For the Field Agents' residences to be considered fixed places of business of the Knights of Columbus, the Knights of Columbus must have a right of disposition over these premises. A right of disposition is not a right of the Knights of Columbus to sell an agent's house out from under him. The Knights of Columbus might be viewed as having the agents' premises at its disposal, for example, if the Knights of Columbus paid for all expenses in connection with the premises, required that the agents have that home office and stipulate what it must contain, and further required that clients were to be met at the home office and in fact that Knights of Columbus' members were met there. In such circumstances, although the Knights of Columbus may not have a key to the premises, the premises might be viewed as being at the disposal of the Knights of Columbus.
Once it had been determined that the Field Agents are independent contractors, which it has been agreed, that is, that they are in business on their own account, then it is illogical to find that all the organizing and recordkeeping that they conduct at home is anything other than business activities of their own business..."
The Court found that the home offices did not constitute fixed places of business through which the Knights of Columbus' business was carried on. The Knights of Columbus, therefore, did not have a permanent establishment in Canada pursuant to Article V(1) of the Convention.
The Court then considered the importance of the absence of a provision in the Convention dealing explicitly with the insurance business. Other Canadian and international treaties contain such a provision that deems a company to have a permanent establishment in a country where it collects premiums or where it insures risks through an agent other than an agent of independent status. The Convention has no such provision and the Court found that it was reasonable to draw certain inferences from this fact. In particular, the Court concluded that the parties to the Convention – Canada and the U.S. – were familiar with this type of provision and deliberately left it out of the Convention and that this supported the Court's finding that the Knights of Columbus were not subject to Canadian tax, regardless of the fact that they carried on extensive business operations in Canada.
The Knights of Columbus were found not to have a permanent establishment in Canada and therefore not subject to Canadian tax on its business profits derived from its Canadian operations.
Although Knights of Columbus and American Income Life Insurance Company dealt with the unique business of insurance, and so may be distinguished from other fact patterns, the Court made some general comments regarding the permanent establishment issue that were, for the most part, favourable to the taxpayer. With so little Canadian jurisprudence in this area, such cases are very welcome. It is our understanding the Minister does not intend to appeal the cases.
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.