23 May 2013 Roundtable, 2013-0483801C6 - Pars IV(6), IV(7), and V(9) of Canada-US Treaty

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: Update on CRA's position on paragraphs IV(6), IV(7), and V(9) of Canada-US Treaty.

Position: Highlight recent positions issued by the Rulings Directorate, including comments on treaty shopping concerns in situations involving circumvention of IV(7)(b).

Reasons: See response.

International Fiscal Association (IFA) Conference
Canada Revenue Agency Roundtable
May 23, 2013

Treaty Protocol and Hybrid Entities

Are there any new issues with respect to Article IV(6) and (7) of the US treaty that have been raised with Rulings and would be of interest? It seems most rulings are becoming repetitive in this area. Similarly, are there any new issues that have arisen with respect to the services PE provision in the US treaty?

Response:

New issues with paragraphs IV(6) & IV(7)

Since the 2007 signing of the Fifth Protocol to the Canada-United States Tax Convention (the "Treaty"), the Canada Revenue Agency (the "CRA") has been asked to consider many strategies designed to ensure that either paragraph (6) of Article IV does apply to a particular amount, or that paragraph (7) of that Article does not apply to a particular amount, along with the possible application of the general anti-avoidance rule. In these instances, it has been recognized that some structures may be utilized for legitimate reasons without engaging in potentially abusive transactions. (endnote 1) As your question suggests, where we have considered it appropriate to do so in the circumstances, we have issued favourable rulings in response to these requests.

Among the strategies previously considered, the CRA is aware of some structures designed to avoid the application of paragraph (7) of Article IV through the introduction of an interposing entity located in a third jurisdiction. In this regard, the CRA has previously expressed its long-standing concerns over the practice of abusive "treaty shopping". More recently, we note that the Department of Finance bolstered these concerns in Budget 2013, announcing consultations on possible measures designed to "protect the integrity of Canada's tax treaties" from these practices. In addition, the GAAR Committee has recently approved the application of the GAAR to a treaty shopping case.

Accordingly, we will continue to consider ruling requests involving the application of paragraph (7) of Article IV on a case-by-case basis. However, in light of the significant concerns outlined above, taxpayers should not expect the Income Tax Rulings Directorate to look favourably upon a ruling request involving an interposing entity located in a third jurisdiction designed to avoid the application of paragraph (7) of Article IV of the Treaty.

New issues with paragraph V(9)

The last conference in which we spoke at length about paragraph (9) of Article V of the Treaty was the 2011 Canadian Tax Foundation Annual Conference. In addition to those views, the Income Tax Rulings Directorate has also recently provided an advance ruling on the applicability of Article V of the Treaty to a specific proposed transaction. (endnote 2) The facts of that ruling involved a US resident corporation ("USco") carrying on a web-based business. USco's business included Canadian residents among its users, and provided for the sale of advertising space on its websites to Canadian-resident businesses, and the sale of digital content by Canadian resident software developers.

Under the proposed transactions, a Canadian resident subsidiary of USco ("Canco") was to build and operate a data centre consisting of numerous servers in Canada, and use that data centre to provide website and data hosting services to USco. USco would pay Canco an arm's length fee for these services. Canco would not have the authority to legally bind USco or create any legal obligation for USco, and would not provide any services to Canadian resident users, advertisers or software developers. Employees of USco would not have unsupervised access to the servers, although they would be able to manage the software and data resident on the server by remote access.

In our analysis, we considered the fixed base PE provision in paragraph (1), the agency PE provision in paragraph (5) of Article V, and the services PE provision in subparagraph (9)(b). On the facts provided, we ruled that the application of Article V of the Treaty would not result in USco being considered to carry on a business through a permanent establishment in Canada.

While considering this situation, we noted that USco also had another Canadian subsidiary providing services to USco in connection with marketing and sales support activities for USco's development and expansion of its user, advertiser and software developer base in Canada. However, as it specifically states in the ruling, we were not asked to and did not address how these facts may have affected our determination of whether USco would have a permanent establishment in Canada.

Jeffrey Johns
2013-048380

ENDNOTES

1 Joint Committee on Taxation, Explanation of Proposed Protocol to the Income Tax Treaty Between the United States and Canada, JCX-57-08 (Washington, DC: Joint Committee on Taxation, July 8, 2008), paragraph VI(B).
2 Ruling 2012-0432141R3