7.2.2 [a] Article Vii[1]

Business Profits – Taxation of Profits Attributable to a permanent Establishment

Business profits of a U.S. resident carrying on a business in Canada are taxable only in the U.S, unless the U.S. resident carries on the business through a permanent establishment in Canada.

The business profits derived by a corporation resident in the U.S. through the permanent establishment in Canada may additionally be subject to the branch profits tax imposed under Part XIV of the Act on a non-resident corporation’s taxable income earned in Canada through a branch.

Relief for dividend, interest, and royalty income is generally found under Article X, XI and XII, respectively unless such income is effectively connected with a Canadian permanent establishment.

A U.S. resident may carry a business through a permanent establishment and the other through an independent agent that does not cause a U.S. resident to have a permanent establishment in Canada.

The losses incurred by a branch before it became a permanent establishment cannot be used by the permanent establishment to offset its business profits for the current year.

7.2.2 [b]  Article VII[2]

Business Profits – Methodology of the Attribution of Business Profits

Generally, the CRA accepts the attribution of profits to a permanent establishment by way of the permanent establishment adopting the separate accounting approach, which in its view is a fairer method offering a truer picture of the income of a permanent establishment comparing to other attribution methods, including various formulistic methods.

If the business profits attributable to a permanent establishment of a U.S. resident as determined under Article VII(2) are less than those determined under Canadian domestic law, the Treaty should prevail and restrict Canada’s right to tax the amount determined under Article VII.

Article VII(2) contemplates the symmetrical allocation of profits to a permanent establishment by both Canada and the U.S.

Under Article VII(2), a permanent establishment should compute its profits on the assumption that it deals at arm’s length not only with the head office, but also with related persons.

7.2.2[c] Article VII[3]

Business Profits – Allowable Deductions and Expenses

Article VII[3] provides that in determining the business profits of a permanent establishment, the expenses that were incurred for the purpose of the permanent establishment should be allowed including executive and general administrative expenses.

Article VII[3] prohibits the permanent establishment in Canada to claim as deduction from its business profits any expenses that would not be generally deductible under the act.

7.2.2[d] Article VII[4]

Business Profits – Exclusions for Certain Purchasing and Management Functions

According to article VII[4] if a U.S resident permanent establishment merely purchases goods or merchandise, or merely provides executive, managerial or administrative facilities or services for the resident, no deduction of expenses should be allowed.

7.2.2[e] Article VII[5]

Business Profits – Consistency of Determination

Article VII[5] requires the non-resident to continuously use the same method in computing the business profits attributable to the permanent establishment, unless there is good and sufficient reason to the contrary.

7.2.2[f] Article VII[6]

Business Profits – Allocation of other Income to Permanent Establishment

Article VII[6] provides that when business profits include items in income that are dealt with separately under other Articles of the Treaty, the provisions of those specific Articles will, except when they provide to the contrary, take precedence over the provisions of Article VII.

The following items of income are specifically dealt with in other Articles of the Treaty:

1 – Income from Real Property – Article VI

2 – Dividends – Article X

3 – Interest – Article XI

4 – Royalties – Article XII

5 – Gains – Article XIII

6 – Pension and Annuities arising in Canada – Article XVIII

7 – Other Income – Article XXII

In certain circumstances above income items may be included in the amount of business profits of a permanent establishment.

7.2.2[g] Article VII

Business Profits – Attribution Limited to Assets and Activities of a Permanent Establishment

According to Article VII[7], business profits are “attributable to” to a permanent establishment if they are derived from the assets or activities of the permanent establishment.

CRA suggests that the assets attributable to a permanent establishment may be located outside Canada, to the effect that the profits attributable to those assets could be attributable to the particular Canadian permanent establishment, even if such would not be the case under the domestic law.

7.2.2[h]

Additional Considerations

As a practical matter, given the complexities related to the computation of business profits attributable to a permanent establishment and potential tax costs arising from the imposition of branch tax under part XIV, a U.S resident may consider converting an existing and profitable permanent establishment in Canada into a Canadian corporation.

7.2.2[i]

Management Fee Paid to a U.S Resident

Generally, the payments by a person resident in Canada of a management or administration fee or charge to a non-resident person are subject to a withholding tax under Part XIII of the Act.

References:

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

By:  Vitaly Timokhov, Raymond Montero, David Kerzner

Published by: Thomson Carswell