The Canadian tax reach

Some time back, I posted about the extent to which the US tax authorities can tax the income of foreign corporations. There are similar considerations at hand for when foreign corporations operate in Canada, albeit on different principles. The most important questions are:

• Is a corporation resident in Canada?
• Is it carrying on business in Canada?

These must be read together with the basic requirements of s.2 of the Income Tax Act, where liability to tax arises where:

• a person is resident in Canada, or otherwise
• a person is employed in Canada, carries on a business in Canada, or disposes of a taxable Canadian property.

This is reinforced by the requirement in s. 150(1)(a) to file the appropriate returns, which also covers other circumstances where tax is payable, or the income is exempt is exempt as provided under the provisions of an applicable tax treaty. In the latter case, a return must be filed together with the specified declaration claiming treaty protection.

Who is a Canadian resident?

We must first deal with where persons are deemed to have such status or not:

• s. 250(4) deems any corporation incorporated in Canada after 26 April 1965 to be a Canadian resident, as well as any similar corporation formed before 27 April 1965 that was a Canadian resident or carried on business in Canada.
• if an applicable tax treaty so provides, s. 250(5) will deem a corporation to be resident in the other country and not resident in Canada.

Otherwise, common law principles govern whether a corporation is resident in a jurisdiction or note. This is said to be "where the central management and control resides." This is said to be the place where the board of directors holds its meetings, but that cannot be said to automatically apply. A recent case in the High Court of Australia held several foreign corporations to be resident there, as the meetings of the board acted only as a rubber stamp to actions undertaken by a principal in Sydney. This was held to be distinct from a previous case where the board did not blindly accept the actions of others, as it actively discussed whether such moves would indeed be appropriate to accept. Tax treaties with the UK and Switzerland did not act to shield the taxpayers in the recent case, as the act of incorporating within those jurisdictions was insufficient to override where the actual management and control were taking place. The impact of this decision could be huge, and it will be interesting to see if the CRA picks up on it.

Who carries on business in Canada?

Common law principles govern whether business is carried on, and s. 253 deems certain activities undertaken by a non-resident as constituting such activity. Applicable tax treaties will usually specify that income earned by a non-resident is taxable only where it can be attributable to a permanent establishment.

The most important factor in determining where a business is being carried on is the place where the contract is made. Other factors such as the place of delivery and the place of payment (among others) may also play a role, but the analysis can be quite complicated.

The definition of a permanent establishment is generally left up to the tax treaties, but the following situations can arise:

• a fixed place of business will constitute a PE
• an agent authorized to conclude contracts on behalf of the foreign corporation can also be said to be a fixed place
• in some circumstances, office space made available by a subsidiary to a parents' employees can be a fixed place
• executives who can act on behalf of both a parent and subsidiary are problematic, as their presence in the other country's office can also constitute a PE
• similarly, it can be argued that a foreign corporation that is constantly seeking guidance from a manager in a Canadian parent can be said to possess a Canadian PE
• certain tax treaties (such as the one with the US) can specify that, where services are being provided, days spent in the other country will trigger a PE when the total passes a specified threshold
• there can be other complications, such as in the manner that e-commerce platforms are structured

This is not an exhaustive list, and discussions are taking place at the international level as to whether such scope should be widened. That is an area that should be watched closely.

Summary

This is a very short article on a very complex topic, and I have known of many companies that did not get this right. Foreign corporations must consider the various issues carefully before proceeding to enter the Canadian market. Similar issues also arise in assessing whether foreign entities are subject to GST/HST, but the rules are slightly different and must be assessed separately.