Outdated Provision of Canadian Income Tax Act Taxes Foreign Service Providers

This article was originally published in Practical International Tax Strategies, January 2012, Volume 16, No. 2 and is republished with the permission of the publisher.

Tax is constantly evolving, and sometimes obsolete provisions need to be pruned. While the Federal government regularly amends the Income Tax Act (Canada) (Act) in an effort to preserve the tax base and curb abuse of the Act by taxpayers, impetus for changing or abolishing provisions of the Act may come from taxpayers and their tax advisors who perceive such provisions to be obsolete, outdated or unfair.

Paragraph 212(1)(a) of the Act1 is a section that is obsolete, outdated and unfair and has lost its raison d’être with the introduction of the transfer pricing and other anti-avoidance rules. In fact, as will be illustrated further below, with no judicial limits imposed on the application of the section, the Canada Revenue Agency (CRA) feels entitled to take a rather cavalier approach to applying this paragraph to tax payments made by a resident of Canada to a non-arm’s length non-resident party.

Background

Paragraph 212(1)(a) generally imposes Part XIII withholding tax at a rate of 25 percent of the gross amount of “management or administration fee or charge” paid or credited by a Canadian resident to a non-resident. Subsection 212(4) excludes certain payments for services performed by an arm’s length service provider. Also excluded are reimbursements of specific expenses incurred by a service provider (whether arm’s length or non-arm’s length). The key factor rendering a fee for services taxable is the fact that the foreign recipient does not deal at arm’s length with the Canadian payor—regardless of whether the recipient is otherwise in the business of providing the very services to third parties and whether the price charged to the Canadian payor reflects an arm’s length arrangement.