U.S. Interpretation of the Canada-US Tax Treaty

7.3.2 [a] Taxation of the Business Profits of a Canadian Resident

Paragraph 1 of the Article VII of the Treaty provides that the business profits of a Canadian resident will only be taxed in the U.S. if such resident carries on business in the U.S. through a permanent establishment in the United States.

The determination as to whether a Canadian resident has a U.S. permanent establishment is discussed in Article V.

The permanent establishment is the first main threshold that must be crossed before business profits of a Canadian resident are taxed in the U.S. on a net income basis.

7.3.2 [b] Allowable Deductions under Paragraph (3) of Article VII

Paragraph (3) provides that deductions shall be allowed in determining the business profits of a permanent establishment, such that the business profits will be taxed on a net basis. These deductions may also include executive and administrative expenses.

The Technical Explanation to the U.S Model provides that the OECD Transfer Pricing Guidelines apply in determining the profits attributable to a PE. Hence, a PE may deduct payments made to its head office or another branch in compensation for services performed for the benefit of the branch.

7.3.2 [c] Purchasing, Executive, Managerial, or Administrative Services under Paragraph (4) of Article VII

Under paragraph (4), no business profits shall be attributable to a U.S. PE of a Canadian resident where the PE is used merely for purchasing goods or merchandise or merely providing executive, managerial or administrative services for the benefit of the Canadian resident.

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7.3.2 [d] Same Method of Attribution under Paragraph (5) of Article VII

Paragraph (5) requires that the method chosen to attribute business profits to the PE be the same every taxable period, absent a good reason to change it.

7.3.2 [e] Relationship to Other Articles under Paragraph (6) of Article VII

Paragraph (6) provides the coordination rules as between items of income that are dealt with under the business profits article and separately under other Articles of the Treaty.

7.3.2 [f] OECD revised Commentary on Article 7

Interpretation of Article 7(2) under the authorized OECD approach requires a two-step analysis.

Step 1

The attribution to the PE as appropriate of the rights and obligations arising out of transactions between the enterprise of which the PE is a part and separate enterprise;
The identification of significant people functions relevant to the attribution of economic ownership of assets, and the attribution of economic attribution of assets to the PE;
The identification of significant people functions relevant to the assumption of risks, and the attribution of risks to the PE;
The identification of other functions of the PE
The recognition and determination of the nature of those dealings between the PE and other parts of the same enterprise that can appropriately be recognized, having passed the threshold test; and
The attribution of capital based on the assets and risks attributed to the PE.

Step 2

Determining comparability between the dealings and uncontrolled transactions, established by applying the Guidelines’ comparability factors directly or by analogy in light of the particular factual circumstances of the PE; and

Applying by analogy one of the Guidelines’ traditional transactions methods, where such methods cannot be applied reliably, one of the transactional profit methods to arrive at an arm’s length compensation for the dealings between the PE and the rest of the enterprise, taking into account the functions performed by, and the assets and risks attributed to, the PE.

References:

Advisor’s Guide to Canada – U.S. Tax Treaty

By: Vitaly Timokhov, Raymond Montero, David Kerzner

Published by: Thomson Carswell