2016-0655701E5 Article 5(3) - Demolition

Principal Issues: 1. Whether a “building site or construction or installation project” exists at a location where a structure is being dismantled or decommissioned, rather than being built, constructed or installed? 2. Whether the twelve month test in Article 5(3) of the Model Treaty applies to the fact pattern presented?

Position: 1. Yes. 2. Depends on the facts.

Reasons: 1. Due to the nature of the activities and other relevant factors, a “building site or construction or installation project” can include a site where a structure is being demolished rather than being created. 2. Two contracts may be considered a single unit if they form a coherent whole commercially and geographically but this can only be determined on a case by case basis after reviewing all relevant information.

Author: Ho, Judy
Section: Article 5(3) of the OECD Model Treaty

 XXXXXXXXXX                                                                                                                               2016-065570
                                                                                                                                                        Judy Ho, CPA, CA
January 16, 2017

Dear XXXXXXXXXX:

Re: Article 5(3) of the OECD Model Convention

We are writing in response to your letter dated June 27, 2016, wherein you requested our comments regarding whether “a building site or construction or installation project” could be considered to exist in the following hypothetical situation:

-     A Canadian resident company (“Customer”) is awarded a decommissioning contract for a number of offshore oil/gas platforms (the “Main Contract”);

-     Customer subcontracts certain portions of the work required under the Main Contract to an affiliated non-resident company (“Non-Resident”), a resident of a country that has a tax treaty with Canada that includes a provision which follows Article 5(3) (“Construction PE Provision”) of the Organisation for Economic Co-operation and Development (“OECD”) Model Tax Convention on Income and Capital (the “Model Treaty”);

-     Non-Resident has equipment and personnel present at a location in Canada (the “Location”) in year 1 for four months (the “First Segment”) under a contract with Customer (the “First Canadian Contract”);

-     After the First Canadian Contract is complete, the equipment and personnel leave the Location to go to another jurisdiction outside Canada for a period of time to work on a non-connected project under a contractual obligation to perform services for a different customer (the “Separate Project”);

After the Separate Project is complete, substantially the same equipment and same number of personnel return to the Location in year 2 for another four months (the “Second Segment”), under a different contract with Customer (the “Second Canadian Contract”) relating to the remaining elements of the Main Contract.

The two issues that you asked us to address is: (1) whether such decommissioning work (the First Segment and the Second Segment) can be considered to fall under the scope of the Construction PE Provision; and (2) whether the twelve month test (“Duration Test”) in Article 5(3) of the Model Treaty can be considered to apply in this situation.

Our comments

This technical interpretation provides only general comments. It does not confirm the income tax treatment of a particular situation but is intended to assist you in making that determination. The income tax treatment of transactions will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R7, Advance Income Tax Rulings and Technical Interpretations.

The determination of whether a permanent establishment exists generally involves an examination of specific facts and circumstances, and can only be made upon close consideration of an actual situation. However, as stated above, we can provide some general comments in respect of the hypothetical situation described above.

1.    Activities within the scope of a Construction PE Provision

Pursuant to Article 5(3) of the Model Treaty, a building site or construction or installation project constitutes a permanent establishment only if it lasts more than twelve months.

Paragraph 17 of the Commentary to Article 5 of the Model Treaty (“Commentary”) lists some examples of building sites and construction or installation activities, but the list is not an exclusive list. There is nothing in Article 5(3) that suggests that dismantling, commissioning, demolishing and similar activities (hereinafter referred to collectively as “demolition”) would not fall under the Construction PE Provision. Generally, we would expect that the equipment, personnel, expertise, etc. required for demolition are very similar to those required for what would traditionally be included in the type of construction activities that are listed in the Commentary. In some situations, demolition would precede some of the activities described in the Commentary, but in some other situations, demolition could be a standalone activity. As indicated by Klaus Vogel, “[t]he term ‘building site or construction project’ also covers demolition and clearing operations. Those operations need not be materially connected with subsequent building or construction work.” (footnote 1) 

Therefore, even though the Commentary does not specify that demolition would be considered a construction or installation project or that a site where demolition takes place would be considered a building site, it is our opinion that the decommissioning work described above (both the First Segment and the Second Segment) would likely be considered to fall under the scope of the Construction PE Provision.

2.    Duration Test

As indicated above, pursuant to Article 5(3) of the Model Treaty, construction activities would only result in a permanent establishment if the building site or construction or installation project lasts more than twelve months. As indicated in paragraph 18 of the Commentary to Article 5, the Duration Test applies to each individual site or project, but if they form a coherent whole commercially and geographically, they will be regarded as a single unit even if they are under separate contracts.

Since such determination of whether projects or sites form a coherent whole commercially and geographically would be a question of fact, it is impossible for us to assess the situation above based on the limited information. However, in the context of the provided information, even though each of the First Segment and the Second Segment are performed under separate contract (the First Canadian Contract and the Second Canadian Contract), it is still possible that they represent a coherent whole, given, among other things, that they are both performed under the scope of the Main Contract at the same Location (and also by the same personnel and using the same equipment).

With respect to the time between the First Segment and the Second Segment, the Commentary states that “ [a] site continues to exist until the work is completed or permanently abandoned. A site should not be regarded as ceasing to exist when work is temporarily discontinued.”

Based on the hypothetical fact situation above, even though the First Segment and the Second Segment are implemented in consecutive years, there would be a period of time between them during which Non-Resident will be working on the Separate Project. A longer period of time between projects could suggest that the projects are separate and should not be viewed as a single unit. However, other factors must also be considered. Given the fact that both the First Segment and the Second Segment are performed under the scope of the Main Contract, this could be a strong indication that the work is only temporarily discontinued.

Therefore, all relevant facts and circumstances will have to be examined to determine whether the First Segment and Second Segment should be viewed as a single unit for purposes of the Construction PE Provision. If they are, then in the hypothetical situation provided above, Non-Resident would be considered to carry on business in Canada through a permanent establishment in Canada if the time from the beginning of the First Segment to the completion of the Second Segment exceeds 12 months.

Lastly, as a general comment, in a situation where a taxpayer is involved in subcontracting or contract splitting arrangements in order to avoid having income taxed in Canada, the CRA may consider the application of the General Anti-Avoidance Rule to such arrangements.

We trust our comments will be of assistance.

Yours truly,

Vitaliy Anissimov
Section Manager
For Division 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 Klaus Vogel on Double Taxation Conventions, 3rd ed.(Cambridge, MA: Kluwer Law International), at 306. 

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