On May 16, 2008, the Tax Court of Canada released a landmark decision in Knights of Columbus v. The Queen, which addresses the fundamental issue of Canada's ability (or inability) to tax the business profits of a non-resident enterprise under a bilateral income tax convention.
The Income Tax Act (the “Act”) provides that any non-resident carrying on business in Canada is required to pay income tax on the profits attributable to its Canadian business activities. However, Canada has entered into numerous tax treaties with various countries that generally prohibit the taxation of a non-resident's business profits by a source country (i.e., the country in which the profits are derived) unless the non-resident has a “permanent establishment” in the source country. Generally, tax treaties contemplate two different types of permanent establishments: (1) “geographical permanent establishments” (i.e., a fixed place of business through which the business of the non-resident is carried out); and (2) “dependent agent permanent establishments” (i.e., a person who has, and habitually exercises, the authority to enter into contracts on behalf of the non-resident).
In this case, an insurance company (the “Knights”) resident in the United States sold insurance products to Canadians through the assistance of commission-based Canadian sales agents. Generally, the agents would solicit insurance applications from Canada and submit such applications to the Knights in the US for consideration. A limited form of temporary insurance was provided while the application for permanent coverage was under consideration. Sales agents generally worked out of home offices and visited the homes of prospective applicants in soliciting insurance applications.
The Crown argued that the Canadian sales agents constituted “dependent agent permanent establishments” of the Knights for purpose of the income tax convention between Canada and the US (the “Treaty”) on the basis that the agents solicited and received applications that were routinely approved by the Knights. Moreover, the agents contractually bound the Knights through the provision of the temporary insurance. Alternatively, the Crown argued that the agents' home offices were each a “geographical permanent establishment” of the Knights for purposes of the Treaty primarily on the basis that the agents carried on activities of significant importance to the business of the Knights through these premises.
The Tax Court heard the evidence of three expert witnesses: Mr. H. David Rosenbloom (an expert in US tax law and the chief negotiator of the Treaty at the time it was signed in 1980); Professor Brian Arnold (an expert in the interpretation of the OECD Model Income Tax Convention); and Professor Richard Vann (an expert in both the interpretation of the OECD and UN Model Income Tax Conventions).
The expert evidence generally supported the position that, in order for a non-resident to have a “geographical permanent establishment,” the non-resident must have some measure of control or disposal over that place (i.e., it is not sufficient that an agent conducts his or her agency activities in such a place).
The expert evidence further suggested that, due to the fundamental nature of their business, non-resident insurance enterprises are capable of conducting large-scale foreign insurance activities in a manner that does not create a permanent establishment for the purpose of most income tax treaties. If contracting states consider it appropriate to tax such insurance enterprises, they may include specific treaty provisions deeming the non-resident to have a permanent establishment. Many countries routinely include such provisions in their treaties and, in fact, both Canada and the United States have a history of including such provisions in certain treaties.
The Court found in favour of the Knights in respect of all issues. The Court concluded that the agents did not constitute “dependent agent permanent establishments” on the basis that the Knights concluded all contracts of insurance in the US after undertaking a comprehensive review of each application solicited by the agents. The provision of temporary insurance was viewed by the Court as being akin to a “gift,” which was outside the business proper of the Knights. Furthermore, the Court concluded that the Knights did not have sufficient control or disposal over the home offices to constitute “geographical permanent establishments.” In this respect, the Court found that the agents carried on their own agency businesses through such locations and not the business of the Knights.
This decision is extremely important from both a Canadian and international perspective due to the significance of the term “permanent establishment” to the international taxation of multinational enterprises. The Court provided clear guidance on the circumstances in which an agent may give rise to a taxable presence of a non-resident as well as the criteria that must be satisfied before a fixed place may be considered a geographical permanent establishment of a non-resident. Non-residents will undoubtedly benefit from these guidelines in structuring the administration and operation of their international business activities.
Another significant aspect of the case is the use of expert witnesses, which provided the Court with a wealth of relevant and necessary knowledge and background to the issues under consideration. It is anticipated that this type of evidence will become increasingly important in tax treaty litigation in the coming years.
The taxpayer, Knights of Columbus, was represented by William I. Innes, Chia-yi Chua and Brendan Bissell of Fraser Milner Casgrain LLP.
Her Majesty the Queen was represented by Marie-Thérèse Boris and Justin Kutyan of the Department of Justice.