2012-0457671I7 Treaty triangulation - Article 15

Principal Issues: Whether we look to the Canada-Employee treaty or to the Canada-Employer treaty for the definition of "permanent establishment" when applying subparagraph 2(c) of Article 15?

Position: The Canada-Employee treaty.

Reasons: For various reasons set out below and in document 2009-031995.

Author: Thomson, Sherry
Section: Article 15 of Canada's tax treaties

                                                                           July 20, 2015

      XXXXXXXXXX                                             HEADQUARTERS
      Large File Case Manager                             Income Tax Rulings
      XXXXXXXXXX TSO                                     Directorate
                                                                           S.E. Thomson
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                                                                            2012-045767

      Re:  Article 15 and Treaty Triangulation 

Dear XXXXXXXXXX:

This is in response to your query of July 2012 in which you ask for our comments on some additional considerations regarding document 2009-031995, which we issued on January 25, 2010.  We apologize for the lengthy delay in providing our response.

For purposes of illustration, we will assume that:

*     BCo is a resident of State B for treaty purposes.
*     Mr. X is a resident of State X for treaty purposes.
*     Canada has a tax treaty with both State B and State X
.*     Both the Canada-State B treaty and the Canada-State X treaty contain an Offshore Activities article.
*     BCo carries on business in Canada through a permanent establishment (“PE”) as defined in the Offshore Activities article in the Canada-State B treaty
.*     BCo does not have a PE in Canada under Article 5 of either the Canada-State B treaty or the Canada State-X treaty.

Document 2009-031995 dealt with a situation where BCo employed Mr. X (among others) to render services in BCo’s PE in Canada. The issue was whether we would look to the Canada-State B treaty or to the Canada-State X treaty for the definition of PE, in order to determine whether Mr. X was taxable in Canada on remuneration paid to him by BCo. 

Article 15 of each of the relevant treaties is similar to Article 15 [Income from Employment] of the OECD Model Convention.  Paragraph 1 of Article 15 of the OECD Model provides that remuneration paid to a resident of a contracting state is taxable only in the state of residence of the employee unless the employment is exercised in the other contracting state (the source state). Even if the employment is exercised in the source state, the remuneration is taxable only in the residence state if the three conditions in paragraph 2 of Article 15 are met.  The three conditions are as follows:

Notwithstanding the provisions of paragraph 1, remuneration derived by a resident of a Contracting State in respect of an employment exercised in the other Contracting State shall be taxable only in the first-mentioned State if:

a)    the recipient is present in the other State for a period or periods not exceeding in the aggregate 183 days in any twelve month period commencing or ending in the fiscal year concerned, and
b)    the remuneration is paid by, or on behalf of, an employer who is not a resident of the other State, and
c) the remuneration is not borne by a permanent establishment which the employer has in the other State.

We assumed that the conditions in subparagraphs 2(a) and 2(b) of Article 15 were met.  When determining whether BCo had a PE in Canada for purposes of subparagraph 2(c), we concluded that the better view was to look to the definition of PE in the Canada-State X treaty.

As noted above, we assumed that BCo did not have a PE in Canada under Article 5 of the Canada-State X treaty.  However, the Canada-State X treaty also had an Offshore Activities article.  Therefore, it was necessary to determine whether BCo had a PE in Canada under the Offshore Activities article of the Canada-State X treaty to see if the remuneration could be taxed in Canada.  Paragraph 3 of the Offshore Activities article in the Canada-State X treaty reads in part:

3. An enterprise of one of the States which carries on offshore activities in the other State shall, subject to paragraph 4, be deemed to be carrying on, in respect of those activities, business in that other State through a permanent establishment situated therein, unless the offshore activities in question are carried on in the other State for a period or periods not exceeding in the aggregate 30 days in any twelve month period.

The term “State” is defined in Article 3 of the Canada-State X treaty to mean either Canada or the State X.  The term “enterprise of one of the States” is defined in Article 3 of the Canada-State X treaty to mean an enterprise carried on by a resident of one of the States.  Since BCo was not “an enterprise of one of the States” under the Canada-State X treaty, paragraph 3 of the Offshore Activities article could not apply.  Therefore, BCo did not have a PE in Canada under subparagraph 2(c) of Article 15 of the Canada-State X treaty.

You have asked some additional questions regarding this conclusion.  You ask why we would not make the assumption that BCo is resident in State X for purposes of the Offshore Activities article of the Canada-State X treaty.  You say that it is necessary to assume that BCo is a resident of State X under Article 1 of the Canada-State X treaty in order to even apply the Canada-State X treaty, so why would we not continue with that assumption for purposes of the Offshore Activities article.  You suggest that if BCo must be resident in either Canada or State X under the Canada-State X treaty in order for paragraph 3 of the Offshore Activities Article in that treaty to apply, residents of State X who are employed in Canada for less than 183 days will never be taxed in Canada unless BCo also happens to be resident in Canada or State X.

In our opinion, it is not necessary to make the assumption that BCo is resident in State X under Article 1 of the Canada-State X treaty.  Article 1 of the OECD Model says,

This Convention shall apply to persons who are residents of one or both of the Contracting States.

In applying Article 15 of the Canada-State X treaty, we are determining whether the remuneration paid to Mr. X can be taxed in Canada.  Paragraph 1 of Article 15 says that remuneration derived by a resident of State X may be taxed only in State X unless the employment is exercised in Canada.  Mr. X is the resident of State X, and we are applying the treaty to Mr. X, not to BCo.  Article 15 says that the employment only has to be exercised in Canada; it does not say it has to be paid by a resident of Canada.  Therefore, the Canada-State X treaty applies, but not because we assume BCo to be a resident of Canada or State X.

In addition, paragraph 2 of Article 15 seems to contemplate that employers can be resident in a third country.  Subparagraph 2(b) refers simply to “an employer who is not a resident of the other state”, and it would seem that paragraph 2(c) contemplates such employers potentially having a PE in a contracting state despite not being resident in either contracting state.

We also note that in paragraph 1 of Article 5 of the OECD Model, the term “permanent establishment” is defined as follows:

For purposes of this Convention, the term “permanent establishment” means a fixed place of business through which the business of an enterprise is wholly or partly carried on.

Under this definition, the employer does not have to be a “resident” of a particular state in order to have a PE there.  Many of Canada’s treaties define PE with this wording.  When we test whether Article 15 can apply, we are merely looking to see if the employer has a PE in Canada under the definition of PE in the Canada-State X treaty.

On the other hand, some of Canada’s treaties depart from the standard OECD definition of PE in Article 5.  For example, the Canada-U.S. Tax Convention treaty defines PE as follows,

For the purposes of this Convention, the term “permanent establishment” means a fixed place of business through which the business of a resident of a Contracting State is wholly or partly carried on.

On a strict reading of this definition, the employer must first be a resident of a Contracting State (i.e. either Canada or the U.S.) in order to apply the definition of PE in the Canada-U.S. Tax Convention.  However, the Canada-U.S. Tax Convention has added paragraph 10 to Article V.  It reads,

For the purposes of the Convention, the provisions of this Article shall be applied in determining whether any person has a permanent establishment in any State.

We interpret this to mean that, for purposes of the Canada-U.S. Tax Convention, including subparagraph 2(c) of Article XV, any person will have a PE in any country if it has a fixed place of business there through which its business is wholly or partly carried on, even if the person is not resident in Canada or the U.S.  The U.S. has similar articles in its treaties with Poland, Australia and Argentina, and Canada has a similar article in paragraph 8 of Article 5 of the Canada-Australia Income Tax Convention. 

We understand that on a purposive reading, one would expect that Canada (i.e. where the PE is located) should be able to tax Mr. X’s remuneration for employment exercised through the PE since BCo is allowed a deduction from the profits taxable in Canada attributable to the PE for the remuneration.  However, we doubt that, when applying subparagraph 2(c) of Article 15 of the Canada-State X treaty, it was intended that Canada or State X should look for a definition in a treaty between Canada and a third country to find out if the remuneration can be taxed in Canada.  We note that there is some recent academic commentary that comes to the same conclusion (footnote 1).

We trust that we have been of some assistance.

Yours truly,

Olli Laurikainen, CPA, CA
Director
International Division
Income Tax Rulings Directorate

cc:  XXXXXXXXXX, Regional International Tax Advisor, XXXXXXXXXX

FOOTNOTES

Note to reader:  Because of our system requirements, the footnotes contained in the original document are shown below instead:

1  Bilateralism of tax treaties versus triangular cases:  is there a conflict? Elo Madiste, Lund University School of Economics and Management, Chapters 3.5 and 4.6, May 2012.  See  http://lup.lub.lu.se/luur/download?func=downloadFile&recordOId=2544520&fileOId=2544552.  Also, Income from International Private Employment, Frank Potgens, IBFD Doctoral Series, Volume 12, Section 4.3.3, January 2007. 

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