Canadian Tax @ Gowlings

Corporate Income Tax Rate Reductions in Canada: 2009 Provincial Budgets
By: Laura Monteith

In recent years there has been a trend of aggressive corporate tax cuts across the globe as countries compete for foreign direct investment to stimulate economic growth. Since 2000, the average corporate income tax rate among OECD countries has dropped from 34.1% to 26.7% in 2008.

In response to these global pressures, the Canadian Federal government, beginning in 2006, has introduced significant reductions in corporate tax rates. The reductions have included a change to the general corporate income tax rate from 22.12% in 2007 (including the 1.12% corporate surtax, which was eliminated January 1, 2008) to the current rate of 19%, but which is to be reduced to 15% by 2012.

In the fall of 2007, the Federal Minister of Finance publicly challenged the provinces to lower their general corporate income tax rates to 10% by 2012 to achieve a combined rate of 25%, which would be the lowest corporate income tax rate among the G7 nations. In December 2008, the Advisory Panel on Canada’s System of International Taxation released its final report, "Enhancing Canada’s International Tax Advantage." The report agreed that Canada must lower its domestic corporate tax rates in order to stimulate foreign direct investment and for Canadian companies to remain competitive in the international markets.

Despite the global financial crisis and decreasing fiscal revenues, in the 2009 Federal Budget the Federal government stated that it is committed to moving ahead with its corporate income tax rate reductions. The general corporate income tax rate will be decreased as follows: 18% for 2010, 16.5% for 2011 and 15% for 2012. Once again, the Federal Minister of Finance called on the provinces and territories to join Alberta and British Columbia to reduce their corporate income tax rates to 10%.

In the recently announced provincial budgets, some of the provinces have committed to reducing corporate income tax rates despite the current fiscal challenges, while others have demonstrated reluctance to sign on.

Maritime Provinces

In March 2009, the New Brunswick Department of Finance released "The Plan to Lower Taxes in New Brunswick." According to the Plan, the 2008 corporate income tax rate of 13% will be reduced to 12% in 2009, 11% in 2010, 10% in 2011 and 8% in 2012 (effective July 1 of the particular year). The Plan provides the largest one-time tax reduction package ever introduced in the Province of New Brunswick. The measures will reduce New Brunswick’s general corporate income tax rate from one of the highest rates in 2001 (16%), to the lowest by 2012.

The general corporate income tax rate for the Province of Nova Scotia will remain unchanged from 2008 at 16% in 2009 and 2010. However, the Nova Scotia Department of Finance is currently conducting a review of its tax system to determine how it can best be used to achieve its long-term fiscal and economic objectives.

The Province of Prince Edward Island forecasts a provincial deficit for the 2008/09 and 2009/10 fiscal years. Prince Edward Island's general corporate income tax rate is 16% for 2009 and no corporate income tax rate reductions have been announced for the future. Instead, the 2009 Prince Edward Island Budget focused on infrastructure and capital spending.

Newfoundland & Labrador’s corporate income tax rate remains unchanged at 14% for 2009. There is no mention in the 2009 Budget of rate reductions going forward.

Central Canada

The Province of Québec expects deficits in the 2009/10 and 2010/11 fiscal years. The corporate income tax rate in Québec was increased from 11.4% in 2008 to 11.9% in 2009. This is an increase from 8.9% in 2005. Québec has not announced any plans to further increase corporate tax rates in the province.

The corporate income tax rate in the Province of Ontario remains unchanged at 14% for 2009. The corporate income tax rate will be reduced to 12% in 2010, 11.5% in 2011, 11% in 2012 and 10% in 2013 (effective July 1 of the particular year). Ontario has no plans to cancel the proposed corporate income tax rate reductions because of any increase in the provincial deficit as a result of the current economic crisis.

Prairies

In the 2008 Budget, the Province of Manitoba reduced its corporate income tax rate from 14% to 13%, effective July 1, 2008. In its 2009 Budget, Manitoba confirmed a further rate reduction from 13% to 12%, effective July 1, 2009. Subject to having a balanced budget, Manitoba plans to reduce its general corporate income tax rate to 11% in the future; however, no date has been released for the proposed reduction.

The Province of Saskatchewan has already implemented a number of reductions to its general corporate income tax rate. The rate was reduced from 17% to 14% in 2006, 13% in 2007 and 12% in 2008 (effective July 1 of the particular year). In its 2009 Budget, Saskatchewan stated that its economy remains strong and that growth is forecasted for the 2009/10 fiscal year. However, no further corporate income tax rate reductions have been announced.

Western Canada

The Province of Alberta has had the lowest corporate income tax rate since 2006 at 10%. The rate was gradually reduced over several years from 15.5% in 2000. In its 2009 Budget, Alberta announced that its corporate income tax rate will remain at 10% for 2009 and was silent on any future rate reductions, but did state that a changing revenue outlook requires the government to be cautious before making any additional tax reductions.

The corporate income tax rate in the Province of British Columbia was decreased from 12% to 11%, effective July 1, 2008. The rate will remain at 11% for 2009, but will be further reduced to 10.5% in 2010 and 10% in 2011 (effective January 1 of the particular year). This follows a gradual reduction over several years from 16.5% in 2001. In its 2009 Budget, British Columbia announced that, rather than reducing spending or increasing taxes, it will run its first deficit in five years.

Territories

With respect to the Territories, the Yukon’s corporate income tax rate of 15% for 2008 remains unchanged for 2009. The Yukon’s 2009 Budget is silent on any future changes. The Northwest Territories’ corporate income tax rate of 11.5% for 2008 remains unchanged for 2009. This is a reduction from 14% in 2005. Nunavut’s corporate income tax rate is 12% for 2009. The Nunavut Budget is silent on any future changes.

Conclusion

Based on the proposed changes as they stand today, the combined federal-provincial general corporate income tax rates in 2012 will be as follows: 23% New Brunswick; 31% Nova Scotia; 31% Prince Edward Island; 29% Newfoundland & Labrador; 26.9% Québec; 26% Ontario; 27% Manitoba; 27% Saskatchewan; 25% Alberta; 25% British Columbia; 30% Yukon; 26.5% Northwest Territories; 27% Nunavut. With only three provinces meeting the Federal government’s challenge by 2012 (Ontario will meet it by 2013), it will be interesting to see which provinces emerge from the current recession stronger and more prosperous.

Permanent Establishment in Canada: Why Multinationals Should Be Concerned
By: Mathieu Champagne & Pierre-Marc Gendron

On January 1, 2010, the new service provision of the 5^th Protocol to the Canada-US tax Convention (the "Convention") will come into force.

New paragraph V(9) of the Convention reads as follows:

Subject to paragraph 3, where an enterprise of a Contracting State provides services in the other Contracting State, if that enterprise is found not to have a permanent establishment in that other State by virtue of the preceding paragraphs of this Article, that enterprise shall be deemed to provide those services through a permanent establishment in that other State if and only if:

(a) Those services are performed in that other State by an individual who is present in that other State for a period or periods aggregating 183 days or more in any twelve-month period, and, during that period or periods, more than 50 percent of the gross active business revenues of the enterprise consists of income derived from the services performed in that other State by that individual; or

(b) The services are provided in that other State for an aggregate of 183 days or more in any twelve-month period with respect to the same or connected project for customers who are either residents of that other State or who maintain a permanent establishment in that other State and the services are provided in respect of that permanent establishment.

Subparagraph V(9)(a) targets enterprises that earn their income through the personal services provided by a small number of individuals. It requires the presence of only a single individual in the other Contracting State for a total of 183 days or more during the same 12-month period. In order to meet this test, the enterprise must also derive at least a minimum of 50% of its gross active revenues from the activities of that individual in the other Contracting State.

Subparagraph V(9)(b) is aimed at the overall activities of an enterprise with regards to the same or connected project. For the purpose of this subparagraph, the threshold to be met is the presence of any employees for a minimum of 183 working days in aggregate in the same 12-month period (non-working days such as weekends or holidays do not count in the test as long as no services are actually being provided on these days). For the purpose of meeting the time threshold, time will be computed on a calendar-day basis, independent of the number of employees working in the other Contracting State. This means that even if a resident of a Contracting State sends many individuals simultaneously to provide services in the other State, their collective presence during one calendar day will count for only one day of the company’s presence in that State.

Useful Background

The introduction of this "service PE" provision seems clearly to be a reaction to the Dudney ¹ case, in which a computer expert based in the U.S., who stayed in Canada for 300 days to perform his work, was found not to have a permanent establishment in Canada on the basis that his ties with Canada where not sufficiently fixed and permanent to meet the permanent establishment threshold under the Convention.

Similar wording to paragraph V(9) has recently been included in the OECD’s Commentaries on the Articles of the Model Convention ("OECD Commentaries"). Arguably this addition was made in an effort to satisfy countries reluctant to adopt the fixed and permanent place of business test with respect to services performed in their territory.

It is interesting to note that this provision is not included in the current version of the OECD’s Model Convention (the "OECD Model") nor in the United States Model Income Tax Convention (the "US Model").

The Issue

The Technical Explanation of the 5^th Protocol (the "TE") prepared by the United States Department of Treasury and subscribed to by the Government of Canada states that (emphasis added):

Paragraph 9 applies only to the provision of services, and only to services provided by an enterprise to third parties. Thus, the provision does not have the effect of deeming an enterprise to have a permanent establishment merely because services are provided to that enterprise.

In a recent publication², the Canada Revenue Agency ("CRA") concluded that the term "third party" should be given a liberal interpretation and that it should include any person other than the person operating the enterprise. Moreover, the CRA concluded that a related person in reference to a particular person is considered a "third party" for purposed of paragraph V(9) of the Convention.

This may lead to situations where a related party which is a member of a multinational group may be considered a "third party" for that purpose. As a consequence, a U.S. subsidiary of a multinational group providing services in Canada to a related Canadian subsidiary of the same group could be considered to have a permanent establishment in Canada.

One may question whether this CRA position correctly reflects the intention of the parties to the Convention and the language used in new paragraph V(9) and in the TE.

Conflicting Views

Ambiguity in the application of new paragraph V(9) results mostly from the following comments from the United States Joint Committee on Taxation in its explanation of the 5^th Protocol (emphasis added):

According to the [TE], paragraph 9 applies only to services provided by the enterprise to third parties, and not to services provided to that enterprise (i.e. intercompany services).

Many practitioners consider these comments to be in total contradiction with CRA’s view. This position seems to be based on the assumption that the term "enterprise" should be given a wide meaning and should therefore be understood to mean the "enterprise" of a multinational group as a whole. This position appears to be reinforced by the importunate use of new and undefined terms in both the Convention and the TE which appear to be referring to dealings with unrelated parties (such as references to "third parties" and "customers").

At the other end of the spectrum, some argue that "intercompany", as referred to by the U.S. Joint Committee, was meant to mean within the same company or entity or, in other words, "intra-company". They also suggest the terms "enterprise" and "enterprise of a contracting state" should be given a narrow meaning and, therefore, be limited to the business activities of a resident of a Contracting State on a stand-alone basis only.

On the last point, it should be noted that the terms "enterprise" and "enterprise of a contracting state" are defined under the US Model and match the exact wording of the OECD Model. The term "enterprise" is defined to apply to the carrying on of any business. While the term "enterprise of a Contracting State" mean an enterprise carried on by a resident of a Contracting State. Interestingly, the US Model specifies that "the terms also include an enterprise carried on by a resident of a Contracting State through an entity that is treated as fiscally transparent in that Contracting State."

Should a wide meaning to the term "enterprise" had been intended, one could question why such specification would have been required since the enterprise of such a fiscally transparent entity would have been viewed as the same enterprise as its owner in any case under a wide-meaning approach anyway.

Where Do We Stand?

Without doubt, new paragraph V(9) raises important interpretative concerns as it introduces new and undefined terminology to the Convention. The use of the terms "enterprise", "enterprise of a Contracting State" and "customers" in these contexts is new to the Convention and no definition of such terms have been added to the Convention.

The ambiguity created by this new language has been expanded by the conflicting views described above. With CRA recently affirming its aggressiveness on the issue, the Canadian judicial system will probably be called to settle this ambiguity. In the meantime, multinational groups must be aware of the risk of Canadian taxation associated with a deemed permanent establishment in Canada and should plan the allocation of their human resources accordingly.

1. Canada v. Dudney, (2000), 54 D.T.C. 6169.
2. CRA Views 2008-0300941C6, dated December 9, 2008.