2014-0558661I7 Application of Article V(9) to a partnership

Principal Issues: How to compute the thresholds in Article V(9) of the Canada-U.S. Tax Convention when the services are provided through a partnership?

Position: The thresholds are computed at the partnership level.

Reasons: Canadian law. Accords with the OECD approach.

Author: Thomson, Sherry
Section: Subsection 96(1) of ITA; Paragraph 9 of Article V of Canada-U.S. Tax Convention

                                                                                                      December 14, 2015

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                                                                                                      2014-055866

Re:  Paragraph 9 of Article V of the Canada-U.S. Tax Convention and Partnerships

We are responding to your email of November 26, 2014 in which you ask how to compute the time and revenue thresholds in paragraph 9 of Article V [Permanent Establishment] of the Canada-U.S. Tax Convention (the “Treaty”) when the services are rendered in Canada through a partnership.  To illustrate the issue, we have assumed the following set of facts, and provide our views on how paragraph 9 of Article V of the Treaty would apply on these facts.

Mr. A and Mr. B, both U.S. resident individuals, are partners of a U.S. partnership that provides consulting services in Canada to customers resident in Canada.  The partnership is a fiscally transparent entity in the U.S. (i.e. the tax is levied at the partner level, not at the partnership level).  Neither Mr. A nor Mr. B provides services in Canada otherwise than through the partnership.

Example 1

Mr. A is present in Canada throughout the period from January 1, 2015 to May 31, 2015 (151 days).  Mr. B is present in Canada throughout the period from August 1, 2015 to December 31, 2015 (153 days).  Neither Mr. A nor Mr. B is present in Canada for 183 days or more in any twelve-month period.

Mr. A and Mr. B work 5 days per week, including statutory holidays, but do not work on the weekends.  Therefore, of the aggregate of 304 days (151 days by Mr. A and 153 days by Mr. B) that the individuals are present in Canada, only 216 days are work days.

Example 2

Mr. A is present in Canada throughout the period from January 1, 2015 to July 31, 2015 (212 days).  Mr. B does not provide services in Canada.  Mr. A’s services in Canada generate $200,000 of income, and the partnership’s gross active business revenue during those 212 days is $350,000.

Mr. A works 5 days per week, including statutory holidays, but does not work on the weekends.  Therefore, of the 212 days that Mr. A is present in Canada, only 152 days are work days.

Our Comments

We assume that there would not be a permanent establishment in Canada under any of the other paragraphs in Article V on these facts. 

Under Canadian law, it is the partners, whether limited partners or general partners, who carry on the business in common through the partnership. (footnote 1)  A non-resident person who carries on business in Canada is taxable in Canada on his incomes from businesses carried on in Canada under subsection 2(3) and subparagraph 115(1)(a)(ii) of the Income Tax Act (the “Act”).  The benefits, if any, of an income tax treaty between Canada and the non-resident partner’s country of residence would be applied at the partner level. (footnote 2)

However, for purposes of computing the income (or in this case, the taxable income earned in Canada) of a particular partner, the partnership is considered to be a separate person resident in Canada pursuant to paragraph 96(1)(a) of the Act.  Income is computed at the partnership level, and the income of the partnership is then allocated to the partners to be included in the partners’ income for tax purposes.  The nature and source of the income from the partnership is retained when allocated to the partners. (footnote 3)

Paragraph 9 of Article V of the Treaty reads as follows:

“9. Subject to paragraph 3, where an enterprise of a Contracting State provides services in the other Contracting State, if that enterprise is found not to have a permanent establishment in that other State by virtue of the preceding paragraphs of this Article, that enterprise shall be deemed to provide those services through a permanent establishment in that other State if and only if:

(a)   Those services are performed in that other State by an individual who is present in that other State for a period or periods aggregating 183 days or more in any twelve-month period, and, during that period or periods, more than 50 percent of the gross active business revenues of the enterprise consists of income derived from the services performed in that other State by that individual; or

(b)   The services are provided in that other State for an aggregate of 183 days or more in any twelve-month period with respect to the same or connected project for customers who are either residents of that other State or who maintain a permanent establishment in that other State and the services are provided in respect of that permanent establishment.”

Paragraph 9 of Article V applies where an “enterprise of a contracting state” provides services in Canada, and the other conditions in the paragraph are met.  The terms “enterprise” and “enterprise of a contracting state” are not otherwise used or defined in the Treaty or the Act. (footnote 4)  However, the terms are used and defined in the OECD Model Tax Convention on Income and on Capital (the “OECD Model”).

In the OECD Model, the term “enterprise of a contracting state” is defined to mean “an enterprise carried on by a resident of a contracting state,” and the term “enterprise” applies to the carrying on of any business.  However, the term “enterprise” appears to be used in the OECD Model in two senses: at times it appears to refer to the taxpayer and at other times it appears to refer to the business carried on by the taxpayer.

At the December 2008 Tax Executives Institute round table, in respect of paragraph 9 of Article V of the Treaty, we said:

“Our view is that the term “enterprise” refers to a resident of a contracting state but only in reference to a particular line of business carried on by such resident.” (footnote 5)

In the context of a fiscally transparent partnership, the term “enterprise”, in our view, refers to a business carried on by each partner through the partnership. It is the CRA’s longstanding position that the determination whether such business is carried on through a permanent establishment is made at the partnership level (footnote 6).  If a partnership is found to have a permanent establishment in Canada, each partner will also be found to have a permanent establishment in Canada (footnote 7).

The OECD takes the same approach to applying the duration test involving partnerships under paragraph 3 of Article 5, the building site or construction or installation project article.  Paragraph 19.1 of the OECD Commentary on Article 5 of the OECD Model says:

“In the case of fiscally transparent partnerships, the twelve month test is applied at the level of the partnership as concerns its own activities.  If the period of time spent on the site by the partners and the employees of the partnership exceeds twelve months, the enterprise carried on by the partnership will therefore be considered to have a permanent establishment.  Each partner will thus be considered to have a permanent establishment for the purposes of the taxation of his share of the business profits derived by the partnership regardless of the time spent by himself on the site.”

In addition, the OECD published a discussion draft on October 19, 2012 entitled OECD Model Tax Convention:  Revised Proposals Concerning the Interpretation and Application of Article 5 (Permanent Establishment) (footnote 8) proposes to add the following new paragraph 10.4 to the Commentary on paragraph 1 of Article 5:

“10.4 In the case of an enterprise that takes the form of a fiscally transparent partnership, the enterprise is carried on by each partner and, as regards the partners’ respective shares of the profits, is therefore an enterprise of each Contracting State of which a partner is a resident.  If such a partnership has a permanent establishment in a Contracting State, each partner’s share of the profits attributable to the permanent establishment will therefore constitute, for the purposes of Article 7, profits derived by an enterprise of the Contracting State of which that partner is a resident (see also paragraph 19.2 [previously 19.1] below).”

Therefore, in applying the duration test or the gross active business revenue test in paragraph 9 of Article V of the Treaty to the examples above, we would examine the activities and revenue of the partnership.

Example 1

Subparagraph 9(a) of Article V would not deem the partnership to provide services through a permanent establishment in Canada because no one individual is present in Canada for 183 days or more in any twelve-month period.

Since the partnership has provided services in Canada for 216 days in a twelve-month period, subparagraph 9(b) of Article V will deem the partnership to provide services through a permanent establishment in Canada if they are provided with respect to the same or connected projects.  In that case, both Mr. A and Mr. B would be taxable in Canada on the profit attributable to the partnership’s permanent establishment and allocated to them in accordance with the terms of the partnership agreement.

If the projects are not connected, the 183 days test in subparagraph 9(b) of Article V would have to be done for each project.

Example 2

Subparagraph 9(a) of Article V will deem the partnership to provide services through a permanent establishment in Canada.  Mr. A is present in Canada for 212 days in 2015, and the income of the partnership derived from his services is more than 50% of the gross active business revenue of the partnership ($200,000 / $350,000 = 57.14%) during those 212 days.

Subparagraph 9(b) of Article V will not deem the partnership to provide services through a permanent establishment in Canada since the partnership has provided services in Canada for only 152 days in a twelve-month period.

Since the thresholds in subparagraph 9(a) of Article V have been met, the partnership has a permanent establishment in Canada and the profit attributable to the permanent establishment will be allocated to the partners.  Both Mr. A and Mr. B will be considered to carry on business in Canada through a permanent establishment, even though Mr. B was not present in Canada. (footnote 9)

We trust that we have been of assistance.

Yours truly,

Julia Belova
Manager
For Director
International Division
Income Tax Rulings Directorate

FOOTNOTES

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

1  The Queen v. Mary Robinson and Evelyn Gertrude Robinson, Trustees of the Percival Samuel Robinson Trust, 98 DTC 6065 (FCA)
2  2000-0028475
3  Paragraph 96(1)(f) of the Act.  See also IT-81R, Partnerships — Income of Non-Resident Partners
4  Pursuant to paragraph 2 of Article III of the Treaty, unless the context otherwise requires, an undefined term shall have the meaning which it has under the domestic law of the country imposing the tax.
5  E 2008-0300941C6
6  9708705
7  9716735; 9801445; No. 630 v. MNR, 59 DTC 300 (TAB)
8  http://www.oecd.org/ctp/treaties/PermanentEstablishment.pdf
9  Gordon Grocott v The Queen, 96 DTC 1025 (TCC)

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