2014-0549621C6 Q.7 XXIX-A(3) Active Trade or Business Test

Principal Issues: Can the CRA provide its views on the active trade or business test in Article XXIX-A(3) of the Canada-US Treaty and in particular, in what circumstances the CRA would consider the US business to be "substantial" in relation to the Canadian business?

Position: General comments provided, comparative ratios are also summarized in the response.

Reasons: IT Rulings has issued several rulings confirming the availability of treaty benefits by virtue of Article XXIX-A(3) - for purposes of determining whether the US business was "substantial" in relation to the Canadian business, a number of factors were considered which included: (a) the relative amount of assets and revenues (b) number of employees (c) relative amount of income and (d) compensation expenses. It is highlighted however, that these factors were not considered in isolation and were applied in the context of all the facts and circumstances.

Author: Duval, Kimberly
Section: Article XXIX-A(3) of the Canada-US Treaty

CTF Annual Tax Conference
CRA Round Table – December 2, 2014

Article XXIX-A(3) of the Canada-US Tax Convention
Active Trade or Business Test

Question 7

Can the CRA provide its views on the active trade or business test in paragraph 3 of the Limitation on Benefits (LOB provisions) in Article XXIX-A of the Canada – US tax treaty and, in particular, in what circumstances the CRA would consider the US business to be “substantial” in relation to the Canadian business?

CRA Response

Where applicable, paragraph 3 of Article XXIX-A may extend benefits under the Treaty to a US resident that is not otherwise a qualifying person under paragraph 2.  In particular, paragraph 3 provides that treaty benefits may be available to a US resident with respect to income derived from Canada, provided that the income is derived in connection with, or is incidental to, the active conduct of a trade or business (other than certain investment businesses) carried on in the US by the US resident, or a person related to the US resident, and provided that the US trade or business is substantial in relation to the activity carried on in Canada giving rise to the income.

As highlighted in our response to a similar question at the 2013 CTF Annual Tax Conference, the Income Tax Rulings Directorate (“IT Rulings”) of the CRA has issued several advance tax rulings confirming the availability of treaty benefits by virtue of Article XXIX-A(3) to a person resident in the US that was not otherwise a qualifying person.  For the purpose of determining whether the US business was “substantial” in relation to the Canadian operations in the context of those rulings, a number of factors were considered which included, but were not limited to: the relative amount of assets and revenues, number of employees involved in each jurisdiction, and in certain circumstances the relative amount of income and compensation expenses.  These factors were not considered in isolation and were applied in the context of all the facts and circumstances of each particular case to determine whether the US business activities can be reasonably viewed as substantial in relation to the activities carried on in Canada. 

In considering these factors for purposes of applying Article XXIX-A(3), some of the more significant comparative ratios are summarized below:

Factor
(US vs Can)     Situation A      Situation B        Situation C       Situation D

Revenues         4.9 : 1             1.6 : 1               13.5 : 1              0.5 : 1

Assets               5.6 : 1             1.1 : 1               21.0 : 1             0.5 : 1i

# of                    4.0 : 1             1.6 : 1               38.8 : 1             0.1 : 1
Employees

To date, based on the situations that we have had opportunity to consider, IT Rulings has not denied the availability of treaty benefits under Article XXIX-A(3) on the determination that the US business was not substantial in comparison to the Canadian activities.  In addition, the US business has been equal to, or larger than, the Canadian operations in the majority of situations considered.

We note that these rulings were generally issued under the caveat that the US resident, or the person related thereto, continue to carry on its active business activities in the US, and that those US business activities remain substantial in relation to the activities carried on in Canada.  Any material change in the type, composition, or the size of either the businesses carried on by the US resident or person related thereto, or the relevant Canadian activities, would generally render such a ruling inapplicable.

Kim Duval
File 2014-054962

ENDNOTES
iComparison of relative average fixed asset base in US versus Canada.

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