Category Archives: International

Carrying on business in Canada

In the past 15 years, direct investment in Canada has more than tripled in value; more than 65% of that investment has come from the U.S. It is anticipated that this figure will continue to grow as U.S. corporations seek to expand their markets. This item discusses the basic Canadian tax issues facing U.S. corporations seeking to expand their businesses into Canada and the use of limited liability companies (LLCs) and unlimited liability companies (ULCs).

Taxation of Nonresident Corporations

Under Canadian law, nonresident corporations are subject to income taxes in Canada when they carry on a business there or dispose of taxable Canadian property (generally real estate, property used in a Canadian business and private company shares). These corporations will be subject to tax at ordinary rates, which range from 31% to 39% depending on the province to which the income is allocated.

In addition to income taxes, nonresident corporations are subject to a branch tax of 25% of the profits deemed to have been repatriated to the U.S. The amount is determined by formula and is designed to replicate the withholding tax that would have been imposed had those corporations carried on their Canadian business indirectly through a Canadian corporation that distributed its after-tax business earnings via dividends

Defining “Carrying on Business”

A question often asked is, “what level of Canadian business activity can a nonresident corporation engage in before being deemed to be carrying on business in Canada?” The term “carrying on business” is not specifically defined in the Canadian Income Tax Act (Act); rather, a common-law definition has evolved from the U.K. and Canadian courts. In addition, Act Section 253 provides an extended meaning of the term that deems a nonresident to be carrying on business in Canada if it:

1. Produces, grows, mines, creates, manufactures, fabricates, improves, packs, preserves or constructs anything in Canada;

2. Solicits orders or offers anything for sale there through an agent or servant, whether the contract or transaction is completed inside or outside of Canada; or

3. Disposes of certain resource properties or Canadian real estate.

Accordingly, the level of Canadian activity required to be deemed to be carrying on business there is very low. U.S. resident corporations can usually find relief in the Convention between the United States of America and Canada with respect to Taxes on Income and on Capital, signed September 26, 1980 (Treaty).

Treaty Provisions

The Treaty generally provides relief for U.S. residents via Article VII, Business Profits. This Article states that a U.S. resident will not be taxable in Canada on business profits unless it carries on a business there via a permanent establishment (PE) situated in Canada. When there is a Canadian PE, all business profits allocable to it may be taxed there.

Article V, Permanent Establishment, defines a PE to include:

1. Place of management, a branch, an office, a factory, a workshop and a mine or oil and gas well;

2. Building site or construction or installation project that lasts more than 12 months;

3. Person acting in Canada on behalf of a U.S. resident if that person has, and habitually exercises in Canada, the authority to conclude contracts.

A PE is deemed not to include a fixed place of business used solely for storage, display or delivery of goods or for the purchase of goods. In addition, the fact that a U.S. corporation has a Canadian subsidiary that carries on business there via a PE will not result in the U.S. parent having a PE in Canada.

Accordingly, when treaty protection is available, it is possible to carry on business in Canada, within these limits, without being subject to Canadian income taxes. Note: Canada requires a nonresident carrying on business in Canada, but exempt from Canadian tax because of Treaty provisions, to file an annual information return; see Act Section 150(1)(a).

Article 10, Dividends, also reduces (and in some case eliminates) various withholding taxes and exempts the first C$500,000 of branch profits from Canadian branch tax.

The LLC Trap

The popularity of U.S. LLCs in the last few years has led these entities to establish Canadian branches or subsidiaries. While an LLC may be disregarded or treated as a partnership for U.S. tax purposes, it will be treated as a corporation for Canadian tax purposes. This differing treatment generally does not cause any problems in inbound-to-Canada planning, and can provide some significant opportunities in the area of cross-border financing structures.

The LLC trap is caused by the fact that Canada does not consider a disregarded LLC, or an LLC treated as a partnership, to be a U.S. resident for Treaty purposes; thus, it does not afford treaty benefits to such an LLC. This is became Article IV, Residence, defines a resident of a contracting state as a person that is subject to tax in that state. Because a disregarded LLC or an LLC treated as a partnership is not subject to tax in the U.S., it is not deemed to be a U.S. resident. Thus, an LLC carrying on business in Canada:

* Will be taxable in Canada, whether or not it is operating through a PE;

* Will be subject to 25% withholding tax, if it receives interest, dividends and royalties from a Canadian resident;

* Will not be eligible for the C$500,000 branch tax exemption; further, the branch tax will be imposed at 25%, rather than the 5% Treaty rate.

There are also negative consequences for an LLC that forms a Canadian subsidiary. While the subsidiary will still be taxed at regular Canadian rates, the withholding tax on dividend distributions will be 25%.

It is widely anticipated that the next protocol to the Treaty will resolve the LLC trap; however, it is not known when it will be completed. Accordingly, if an LLC is considering expansion into the Canadian market, it is vital that a Canadian tax adviser be consulted before commencing operations there.

ULCs

A special type of Canadian corporation, the ULC, has become very popular with cross-border planners over the last few years, due to the opportunities presented by its hybrid classification. It is treated as a corporation for Canadian tax purposes and may be treated as a disregarded or flowthrough entity for U.S. tax purposes. In the past, this type of corporation could only be formed in the province of Nova Scotia; very recently, the province of Alberta passed legislation allowing ULC formation there, too; compare the Nova Scotia Companies Act to the Alberta Business Corporations Amendment Act (Bill 16, 5/17/05). Some of the advantages “of using a Canadian ULC include:

1. When an S corporation carries on business in Canada through a PE, the use of a ULC can reduce the effective tax rate, by allowing the S shareholders access to foreign tax credits that would not be available if the S corporation had used a regular Canadian corporation. A qualified subchapter S subsidiary is often used to shield the parent S corporation from liabilities arising from the Canadian operations, as a ULC does not provide liability protection.

2. The use of a ULC allows losses to flow through to the U.S. parent.

3. When a ULC is disregarded for U.S. purposes, transfer pricing issues are simplified; only the Canadian authorities must be satisfied, as the transfer price does not affect U.S. taxation.

4. A ULC instead of a Canadian branch also simplifies Canadian transfer pricing issues, as there is more guidance available on establishing transfer prices between two corporations than on determining the profits that should be allocated to a PE under the Treaty.

5. The use of a ULC instead of a regular Canadian corporation avoids the complexities of the U.S. controlled foreign corporation and passive foreign investment company rules.

6. The ULC can be very useful in developing cross-border financing structures that can significantly reduce the effective cost of capital.

7. In an acquisition, it may be possible to step up the basis of the assets of a Canadian target corporation by “converting” it to a ULC.

The cost of incorporating and maintaining a ULC has risen over the past several years, due to increased fees being charged by Nova Scotia; however, with the competition provided by Alberta’s ULC legislation, it is anticipated that these costs will now decrease.

Conclusion

While this item has discussed some of the basics of Canadian taxation of nonresidents and some issues surrounding the use of LLCs and ULCs, there are many more considerations for a U.S. corporation seeking to expand into the Canadian marketplace; it will be vital for U.S. and Canadian tax planners to work together to find the most effective structure for both sides of the border

Chinese Tax

Chinese Tax Developments Re-draw the Map for

Canadian Investors

Canadians doing business in China may have a hard time keeping up with the country’s rapid pace of tax reform. Over the past year, China has introduced a host of changes to its tax laws and administration that aim to increase compliance and eliminate tax avoidance by non-resident investors. A new protocol to the China-Barbados tax treaty could also affect companies investing into China through Barbados by eliminating relief that was previously available to dividends and capital gains. On a brighter note, China has also announced a series of Business Tax exemptions for certain foreign business activities.

Companies with business investments or operations in China may need to review their activities and business structures in light of these reforms. The following recent Chinese tax developments of interest to Canadian investors:

  • Changes to the China-Barbados tax treaty
  • New anti-avoidance rules for non-residents
  • Enterprise Income Tax on representative offices in China
  • New exemptions from China’s Business Tax.

Protocol to the China-Barbados tax treaty

Access to reduced dividend withholding tax rate restricted

Under the protocol to amend the China-Barbados tax treaty signed on February 10, 2010, access to the reduced five-percent withholding tax rate on dividend payments between China and Barbados is only available if a beneficial owner company directly holds at least 25 percent of the dividend payer’s capital. If not, the withholding tax rate under the treaty is 10 percent.

The five-percent withholding tax rate on dividends is still competitive compared with other China treaties. Among popular holding company jurisdictions, only China’s treaties with Luxembourg, Ireland, Singapore and Hong Kong currently provide a five-percent withholding rate on dividends. Each of these treaties also includes a 25-percent ownership test as a condition for the reduced withholding tax rate.

Capital gains exemption narrowed

The China-Barbados protocol restricts the current exemption for capital gains on the disposition of shares in Chinese companies, eliminating one of the advantages of the China-Barbados treaty and bringing it in line with other Chinese treaties. Once the protocol takes effect, China’s capital gains tax will apply to gains realized on the disposition of shares deriving more than 50 percent of their value from immovable property in China. Further, if a Barbados company holds at least 25 percent of a Chinese corporation, any gains realized on the disposition of shares are also taxable in China.

The changes to the China-Barbados treaty eliminate opportunities for foreign shareholders to avoid the Chinese capital gains tax on shares in land-rich Chinese companies and significant interests in Chinese investees.

New anti-avoidance rules for non-residents

The Chinese tax authority recently issued three circulars with guidance that aims to prevent cross-border tax planning that the government perceives as abusive.

Pre-approval of treaty benefits

Starting October 1, 2009, non-residents must request pre-approval to obtain benefits under one of China’s tax treaties on Chinese-source dividends, interest, royalties and capital gains. In a circular dated August 24, 2009, China’s tax authority clarified existing procedures and documentation requirements for non-residents to apply for pre-approval. The process requires extensive disclosure of the non-resident’s operations and group structure.

Intermediate holding companies

In a circular issued on December 10, 2009, China’s tax authority announced plans to eliminate traditional tax planning approaches involving intermediate holding companies. Specifically, the circular targets the “indirect” transfer of an interest in a Chinese company through the transfer of shares in a foreign-incorporated holding company. If the transfer of the intermediate holding company has no commercial purpose, avoids tax liabilities, and is undertaken in an “abusive” manner, the tax authorities can use the substance over form principle to recharacterize the transaction as a sale of the Chinese company and levy capital gains tax accordingly. These changes are retroactive to January 1, 2008.

The December 2009 circular does not define “abusive reorganisation planning”. However, if the shares of the Chinese resident corporation are transferred indirectly and the capital gains tax paid by the ultimate transferor is less than 12.5 percent of the gain, detailed information on the transaction and the parties’ relationship must be submitted to China’s tax authority within 30 days of the transfer. The documentation requirements include questions relating to the substance of the intermediary holding company and its function within the group.

Based on these information requirements, it appears that the Chinese tax authorities may consider the transfer of an intermediate holding company to be abusive where the transfer occurs tax-free and the intermediary company has no assets or activities other than its investment in the Chinese company.

Beneficial ownership of interest, dividends, and royalties

Another new circular sets out guidance on determining whether a non-resident is eligible for beneficial owner status and thus able to claim treaty relief on dividends, interest, and royalties. This circular took effect on October 27, 2009.

The Chinese tax authorities will take a “substance over form” approach in making these determinations. The circular distinguishes a “beneficial owner”, who owns or controls property in substance and “generally” carries on business in substance, from a “conduit company”, which is only registered to satisfy legal requirements but does not manufacture, trade or manage any commercial activities in substance. The circular lists seven factors that constitute unfavourable evidence:

1.      The entity applying for beneficial owner status is liable to distribute all or most (e.g., more than 60 percent) of its income to a resident of a third country within a specified time period (e.g., 12 months).

2.      The entity has no commercial activities other than holding property or shares that generate dividends, interest or royalties.

3.      Where the entity does carry on a business, the assets, number of employees and scale of the business are so small that the business’s size cannot match the revenues earned by the entity.

4.      The entity has little or no control over the property or shares that generate the dividend, interest or royalty income.

5.      The entity pays little or no tax on income earned in the treaty country.

6.      Where the entity seeks treaty benefits for interest income on a loan, the entity has a third-party loan that is similar in amount, interest rate and issuance date.

7.      Where the entity seeks treaty benefits for royalty income from an underlying right regarding patent, franchise or intellectual property, there is a similar underlying right with a third party.

Factors 1 to 4 focus on whether the recipient has substantial activities in its residence country to justify the revenue received. Factor 5 focuses on the amount of tax paid on income earned in the treaty company. Factors 6 and 7 address situations where the loan, patent, franchise or intellectual property is provided via a back-to-back arrangement through an intermediate holding company in a favourable treaty jurisdiction.  

Previously, a non-resident of China generally only had to provide a certificate of tax residency from its state of residence to obtain benefits under one of China’s tax treaties. These new administrative measures require extensive disclosures on the holding company and related tax planning arrangement. The measures reflect the Chinese government’s intention to tighten its enforcement of the taxation of non-residents and strengthen the tax authority’s ability to scrutinize and challenge tax planning strategies that are perceived to be abusive.

If the measures are applied and interpreted strictly, many current investment structures into China may have difficulty sustaining treaty benefits. KPMG in China is aware of cases where non-residents have failed to have their previous treaty entitlements renewed under the new rules.

Canadian companies with Chinese interests should review their holding, financing and intellectual property structures in light of these rules. Structures that do not meet these substance requirements could be restructured to increase the level of activity in the intermediary company (such as by transferring additional functions, assets and resources to the relevant country). Companies intending to set up new structures should account for these substance requirements in their planning. For example, such structures could be set up in countries in which the corporate group has or plans to establish a substantial business operation with its own third-party revenue, employees and physical assets, or substantial head office management functions.

Enterprise Income Tax on representative offices

On February 20, 2010, China’s tax authority announced new rules for calculating China’s Enterprise Income Tax (EIT) and related filing requirements. The EIT applies to non-resident companies that carry on business in China through a “representative office” in China. The changes apply retroactively from January 1, 2010.

Before 2010, Chinese domestic law provided an EIT exemption for representative offices on their market research, marketing communication, and auxiliary activities in China in support of the manufacture and sale of their products. Under the new rules, the relevant tax treaty must be reviewed to determine whether the representative office has a permanent establishment in China. If it does, China has the authority to tax the activities of the representative office. Treaties based on the OECD model treaty typically exclude certain auxiliary activities from their “permanent establishment” definitions; however, the specific treaty should be consulted.

Further, unless a representative office can provide complete and accurate financial records, it must calculate its income tax liability based on the cost-plus method. The new rules raise the mark-up rate to not less than 15 percent (from 10 percent).

Representative offices in China that do not meet the new requirements for exemption should consider the potential benefits of converting the entity to a wholly-foreign-owned corporation.

New exemptions from China’s Business Tax

On September 27, 2009, the Chinese government announced that certain foreign business activities are exempt from China’s Business Tax.

Background

China’s Business Tax is a turnover tax that applies to individuals and entities providing services, transferring intangible assets or selling immovable property in China. The tax rate on the transaction ranges from three to 20 percent depending on the type of transaction. At the end of 2008, the scope of the Business Tax was significantly broadened. Previously, the tax only applied to services that were physically carried out in China. The current regime applies to companies or individuals that either provide or receive services that are located in China

Under the recent changes, Chinese companies and individuals that render services outside China are exempt from Business Tax with respect to construction, cultural and sporting activities. Also exempt are services provided to Chinese recipients outside of China by non-resident individuals and corporations in certain areas, including cultural and sporting services, entertainment, catering, hotels and warehousing services.

Since China’s Business Tax applies to any business services provided to or received by a Chinese resident, the tax can be a significant cost for Canadian companies investing or providing services in China. For example, the tax applies not only to transfers of intangible assets from a foreign entity to a resident of China but also to any future royalties paid by the Chinese resident with respect to the intangible assets, even though the withholding tax also applies to the royalties.

China Business Tax also represents an additional cost for interest payments made by a Chinese borrower to a foreign lender as the five-percent tax is charged in addition to the 10-percent withholding tax. Further, this additional tax is beyond the scope of China’s tax treaties and no treaty protection is available. In effect, for all jurisdictions other than Hong Kong, the effective tax burden on interest payments is now 15 percent (12 percent for Hong Kong).

Further, where a Chinese resident makes service payments to a foreign entity through an intermediate Chinese resident, the Business Tax would apply to both transactions. Foreign entities investing in China should be aware of the potential adverse application of China Business Tax and structure their transactions accordingly.

Since the active business income of foreign affiliates is exempt from Canadian tax, this change does not affect income earned through Chinese subsidiaries of Canadian companies. However, if the Canadian company carries on business in China directly, the change may jeopardize the company’s ability to offset the tax by claiming foreign tax credits for Canadian purposes since the Business Tax is not a tax on income or profit. As a result, Business Tax payments only qualify for an ordinary tax deduction for Canadian purposes, instead of a foreign tax credit or grossed-up deduction under the foreign affiliate rules.

Due to the general nature of the bulletin, it should not be relied upon as legal or tax advice.

International Taxation

Non-residents who conduct business in Canada, earn Canadian income or own taxable Canadian property are required to report and file Canadian income tax returns. Failure to file the required withholding taxes and remittances to CRA can result in severe tax penalties, significant amounts of interest on back taxes, increased accounting and legal costs, and could even tie up proceeds from the sale of Canadian property for extended periods of time.

We have experience in preparing and filing NR4, NR6 and Section 216 tax returns with Canadian tax authorities for non-residents and obtaining Clearance Certificates from CRA.

We have also helped many non-residents obtain favourable results under Voluntary Disclosure rules for waiving CRA penalties.

Luxembourg

Luxembourg Foreign Investment

The Luxembourg government actively encourages foreign investment. There are no formalised legal regimes aimed at foreign investment as such (other than the tax-exempt ‘holding’ companies and collective investment funds ) but on an ad hoc basis the government offers a variety of types of assistance including guarantees, cash, tax incentives, subsidised loans, assistance with development and construction projects etc.

Luxembourg has a wide range of customised investment incentives specifically for new ventures to the principality. This includes the offer of land with favourable conditions at one of the country’s municipal business parks or national industrial parks which are equipped with the infrastructure necessary to support a successful business.

In addition, there are incentives for investment available to Luxembourg and foreign investors alike under the laws of 28th July 1923 and 27th July 1972.

 
Luxembourg Tax Treatment of Offshore Operations.

Offshore companies are taxed as follows :

  • Holding companies formed under the law of 31st July 1929 are exempt from income taxes (the IRC and the Municipal Business Tax on Profits) and from the Fortune Tax. No tax is levied on the transfer of shares, and there are no taxes due on the liquidation of a 1929 Holding Company. No withholding tax is due on dividends payable to a 1929 Holding Company. (NB 1929 holding companies can no longer be formed.)
  • 1929 Holding Companies are subject instead to the capital contribution tax (droit d’apport) of 1% of subscribed capital, either on formation or on a later capital increase, and to the subscription duty (taxe d’abonnement) which amounts to 0.20% of the value of the shares issued by the Holding Company, payable annually in four equal instalments. If shares are quoted, the value is the current market value; if there is no quotation, the paid-in value is used. There are adjustments if dividends are paid out during the year, if profits are written to reserves, or if losses are incurred. Under legislation which came into effect in 2004, in order to satisfy the EU’s ‘harmful tax practices’ initiative:

    A 1929 holding company loses its tax-exempt status if at least 5% of its dividends received relate to foreign participations that are not subject to tax at a rate comparable to the Luxembourg corporate income tax rate. An effective tax rate is considered to be comparable if it is at least 11%, equating to approximately one-half of the current corporate income tax rate that applies to regular resident taxpayers and is in line with the tax rate generally applicable to dividends received from participations that do not qualify for a full exemption.

    Further, the taxable base needs to be determined under a method similar to the methods used in Luxembourg. An auditor or accountant is required to certify annually that the eligibility requirements have been met. A 1929 holding company that loses its tax-exempt status is subject to the normal corporate income tax regime.

    For newly incorporated 1929 holding companies, the amendment applied as from 1 January 2004. For existing 1929 holding companies (i.e. those incorporated under the law applicable before 1 January 2004), the new rules will not apply before they are terminated in 2010.

  • Milliardaire Holding Companies are taxed on the basis of various percentage rates applied to interest paid out and dividends distributed by the company, and on the remuneration and fees paid to directors, auditors and liquidators residing less than six months of the year in Luxembourg. The minimum annual tax liability of a Milliardaire Holding Company is much less than an equivalent 1929 Holding Company would pay. (NB Milliardaire holding companies can no longer be formed.)
  • Financial Holding Companies are taxed on the same basis as 1929 Holding Companies. (NB Financial Holding Companies can no longer be formed.)
  • The replacement for the 1929 holding company, the Family Private Assets Management Company, or SPF is intended to be exempt from corporate income tax, municipal business tax and net-worth tax, and from withholding tax on distributions. These new vehicles are prohibited from commercial activity, and will be limited to private wealth management activity, for example the holding of financial instruments such as shares, bonds and other debt instruments, in addition to cash and other types of bankable asset. If the SPF is used to hold voting rights in other companies, it must ensure that it does not involve itself in the running of those companies, and it is prohibited from providing any kind of service. The SPF’s exemptions can be affected by participation in non-resident, non-listed companies, if those companies are located in a country not subject to a roughly equivalent corporate tax regime.
    A subscription tax at a rate of 0.25% is payable on share capital.
  • SOPARFI companies, which were created under the law of 24th December 1990, are subject to the normal regime of income taxes etc but do receive the benefit of Double Taxation Treaties, and in many circumstances are exempt from taxation on dividends received from or paid to resident and non-resident companies in which they have a significant participation. The EU Parent-Subsidiary Directive also provides some withholding tax exemptions (improved as from 2004), but the SOPARFI benefits are more extensive. The rules are complex; there are conditions; and there are limitations on the deductibility of expenses.
  • The various forms of UCI are all exempt from all Luxembourg taxation, and pay only a small capital duty on start-up, plus an annual tax on net assets which (at the time of writing) varies between 0.01% and 0.06% depending on the type of fund. In June, 2004, the Luxembourg government announced that pension funds would be exempt from the 0.01% ‘subscription’ tax, in order to encourage the transnational pooling of pensions assets.
  • In 2004, Luxembourg introduced the SICAR, which may take one of a number of corporate forms, including that of a limited partnership. A fixed capital duty of Euro 1,250 applies to equity capital injections upon incorporation or thereafter. SICARs that are in corporate form are fully taxable and should in principle, unlike 1929 holding companies, be eligible for benefits under Luxembourg’s tax treaties as well as benefits under EC directives. Investment income and realized gains are not considered taxable income, and realized losses and write-downs are not deductible. All other income and expenses are taxable in the normal way. Distributions are exempt from withholding tax, as are redemptions by nonresident investors, regardless of the amount or holding period. SICARs are exempt from wealth tax, and there is an exemption from VAT for management charges. SICARs are excluded from the benefits of fiscal consolidation. Investors seeking tax transparency will opt for a SICAR in the form of a limited partnership (SeCS). An SeCS is not liable to corporate income tax or net wealth tax, and is exempt from the municipal business tax. Income from the partnership and capital gains realized on units by nonresident partners will not be taxed in Luxembourg.


Luxembourg The EU’s Parent/Subsidiary Directive

Changes to the parent/subsidiary directive in 2004 have reduced the holding requirement to 20% for 2005-06; to 15% for 2007-08; and to 10% for 2009 onward. Under the EU’s Directive on Interest and Royalties, which also came into effect in 2004, both types of payment will be exempt from withholding tax if they are between associated companies (rules as for the participation exemption).

Luxembourg has actually gone even further, meaning that there is no withholding tax on royalties paid to non-resident companies, and Luxembourg holding companies incorporated according to the terms of the law of 1929 are not subject to such withholding tax either. In line with the directive, the laws came into force retrospectively, with effect from January 1st 2004.

Luxembourg Taxation of Foreign and Non-Resident Employees In Luxembourg the taxation of individuals is based entirely on the concept of residence, regardless of nationality.  Generally, individuals are considered to be resident when they maintain a residence in Luxembourg with the intention of remaining other than temporarily. A stay of six months is deemed to be residence. Most types of compensation and benefit paid to employees are taxable; there are no special privileges or exemptions for expatriate workers.Non-residents are liable to pay Luxembourg taxes only on certain types of income arising in Luxembourg or from Luxembourg sources. These types of income are very precisely defined in Luxembourg legislation. Nationals of countries with which Luxembourg has double taxation treaty also need to be aware that the relevant treaty may well affect their tax treatment. The main types of taxable income for non-residents are: 

  1. income from trade or business carried on in Luxembourg or arising there;
  2. income from dependent services (ie employment income) performed or arising in Luxembourg;
  3. pension income resulting from former activity in Luxembourg;
  4. investment income arising or paid from Luxembourg;
  5. income from leasing of goods etc situated in Luxembourg or exploited by a Luxembourg entity;
  6. capital gains on the sale of property or substantial participations in Luxembourg companies.

Each of these categories is further defined in considerable detail in the legislation.

Luxembourg eventually signed up to the compromise on the European Savings Tax Directive reached in January, 2003, and has imposing a withholding tax on non-residents’ investment returns, like Switzerland, as from July, 2005 (initially at a rate of 15%, rising to 20% in 2008, and 35% in 2011).

Due to the general nature of the bulletin, it should not be relied upon as legal or tax advice.

 

Regulation 105

Paragraph 153(1)(g) of the Act makes provision for withholding from a payment of fees paid for services on account of the payee’s potential liability for tax under the Act. 

Section 105 of the Income Tax Regulations gives effect to paragraph 153(1)(g) in the context of payments to non-residents.  The purpose of paragraph 153(1)(g) is to ensure that if the non resident recipient of a payment is liable to pay income tax in Canada, then there will be funds available in the form of a percentage withheld and remitted, to satisfy the obligation. R105 withholding is not the final tax amount. It is only a tax instalment, contrary to Part XIII (Tax on Income from Canada of Non-Resident Persons).

Subsection 164(2) allows for this instalment to be applied against any income tax owed by the taxpayer

What is Permanent establishment (PE)?

Definition of PE may vary from different jurisdictions, since each jurisdiction have different provincial, state and/or federal laws therefore permanent establishment treatment for Domestic Law various from the international laws. However the objective may be the same, which is to allow the taxation authorities to exercise their power by relying on a guide to determine which authority may have the legal right to tax the produced income. These rules determine, when and how much another province/state or country may tax an enterprise which carries out a business on their soil. Canada and USA have negotiated tax treaties with each other and other countries (some reasons) in order to resolve conflict and elimination of double taxation when taxpayers are operating in two countries.

Most of the time in order to determine if a PE exists it is required to understand the nature of the business – what functions, operations and activities are carried out, and what individual employees are doing on behalf of their employer.

A permanent establishment should not be confused with a subsidiary. A subsidiary is a separate legal entity. A permanent establishment is not, it is merely a branch and as such an extension of the head office

Tax law, tax treaties, jurisprudence and administrative practices have has been evolving over time. The concept of the PE has been adapted to incorporate new ways of doing business and more in particular internet sales.

Furthermore, filing requirements may result from having a permanent establishment in Canada or in another country.

Domestic law

 

  • ITA 2(1) – Canadian residents are subject to Canadian tax on world-wide income

 

  • ITA 124(1) and ITR 400-402 – Permanent establishment concept applicable in the allocation of provincial income

 

  • IT-177R2 – Permanent Establishment means a fixed place of business

 

–       The principal place at which business is conducted

–       The place where a business is carried on through an employee or agent with general authority to contract or who has a stock of merchandise from which orders are filled

–       Corporation which otherwise has a permanent establishment in Canada owns land in a province – the land is the permanent establishment

–       Place where a corporation uses substantial machinery or equipment

  • ITA 2(3) covers non-residents

 

–       Where a person is not subject to income tax under subsection 2(1) (not resident in Canada) subsection 2(3) provides that if that person

–       Was employed in Canada;

–       Carried on a business in Canada, or

–       Disposed of a taxable Canadian property

Any income tax will be payable upon taxable income determined under division D (sec 115 and 116)

Note that the words “business” is defined in subsection 248(1) and extended meaning of “carrying on business in Canada” in Section 253.

Tax treaties

Once it has been established that a business is being carried on in Canada by a resident of the US, it is necessary to refer to the treaty to determine if its provisions override the Canadian law, as it otherwise applies.  The treaty would only be invoked to provide relief.  A tax treaty will not create an obligation if the obligation does not exist under domestic law.

The main use of the concept of a PE is to determine the right of a Contracting State to tax the profits of an enterprise of the other Contracting state.

The provisions of Article 5 (of OECD Model Tax Convention) also apply in determining whether any person has a PE in any State.  These provisions would determine whether a person other than a resident of Canada or the US has a PE in Canada or the US, and whether a person resident in Canada or the US has a PE in a third state. The key determinants of a PE is defined in Article V – (1) must be a place of business (2) the place of business must be fixed; and (3) the carrying on of the business of the enterprise through this fixed place of business

Under Article 7 of the Canada-US Tax treaty, a contracting state cannot tax the profits of an enterprise of the other contracting state unless the profits are attributable to the PE situated therein.

Article V of the Canada – US tax treaty is for a great part similar to Article 5 of the OECD model tax convention.

Due to the general nature of the bulletin, it should not be relied upon as legal or tax advice.