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Deemed Services PEs - Subcontractors vs. Agents - CRA Adds Fuel To The Fire


The Canada Revenue Agency's ("CRA") Income Tax Rulings Directorate recently released a technical interpretation which may invite CRA auditors to continue this increasingly common and highly alarming trend. There has been a trend by auditors to conclude with apparent ease that a parent-subsidiary or contract-subcontractor relationship is in fact an agent-principal relationship for purposes of Canada's bilateral tax treaties. Taxand Canada discusses how the agency threshold is not easily met under Canadian agency law and that there is a tendency by CRA auditors to conclude that an agency relationship exists, which in turn is creating significant tax uncertainty for Canadian and foreign entities.

The recent technical interpretation arose when a taxpayer requested the assistance of the CRA to determine whether the Canada-U.S. Tax Convention (the "Treaty") would apply to deem a US company to have a permanent establishment in Canada in the following hypothetical fact scenario.

In essence, certain CRA auditors are incorrectly employing the term "agent" to describe parent-subsidiary and contractor-subcontractor relationships. By doing so, CRA auditors are seemingly lifting the corporate veil, even though the courts have made it clear that an agency determination in such a case is not one that should be easily arrived at. It is unclear how the CRA could arrive at such conclusion in this technical interpretation because, generally speaking, a subcontractor simply enters into a contract of service with the contractor and not an agent-principal relationship. While the technical interpretation issued by CRA provides a very brief description of the facts, we are concerned that there was nothing sufficient in those facts provided to create an agency-principal relationship.

Taxand's Take

The OECD Commentary in the OECD Model Treaty does not define the term "agent", but instead attempts to describe what is meant by the terms "agent of a dependent status" versus "agent of an independent status". Oddly, the commentary regarding what conditions constitute an Independent Agent would seem to make it virtually impossible, under Canadian agency law, for that entity to be considered an agent at all. Attempting to describe a subcontractor as being an agent of a contractor, even under the broadest definition of agent, is a dangerous practice which should be halted immediately.

A determination that an agency relationship exists should only be used as a method of last resort. Such a determination will only create tax uncertainty and encourage auditors to look through sub-contractors and captive service providers, when making PE determinations with respect to their foreign parent, in a more aggressive manner than they already are.

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Your Taxand contacts for further queries are:
Jim Wilson
T. +1 613 786 0196

Pierre G Alary
T.+1 613 786 0132

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