Corporate Tax Residency In Canada: The Legal Tests Explained

*Thompson Reuters considers the authors “leading tax experts and litigators”. The authors agreed to grant TR partial rights to this work. This article first appeared in TR’s, Practical Insights in May 2020.*

Overview

Canadian resident corporations pay Canadian tax on their worldwide income, whereas non-resident corporations pay Canadian tax only on their Canadian-source income. Clearly, determining whether a corporation is resident in Canada is material when projecting a corporation’s tax burden. However, the concept of corporate residence in Canada is nuanced and complex.

Individual residence focuses on whether an individual has familial, domiciliary, and social connections to Canada. Corporations do not have these types of connections. Instead, the ties between a corporation and a jurisdiction include the place of incorporation, the location of the head office, the location of management, the location of primary business operations, and the residence of the shareholders.

Consider the following scenario: a corporation is incorporated in Canada but has its office, operations, and employees outside of Canada and only provides services to foreign clients. Is the corporation resident in Canada and taxable on its worldwide income?

What about the opposite scenario, where a corporation is incorporated in a foreign jurisdiction but has an office, operations, and employees in Canada and provides services to Canadian clients (in addition to foreign clients)? Is the corporation resident in Canada and taxable on its worldwide income?

The answers turn on which factors Parliament and the courts identified as material for establishing corporate residence. Parliament has legislated that the place of incorporation determines corporate residence; i.e., incorporation in Canada is sufficient to establish Canadian residence (the statutory test). The courts have identified the location of the corporation’s central management and control as the determining factor for corporate residence; i.e., a corporation is resident in Canada if its central management and control is in Canada (the common-law test).

Generally speaking, “central management and control” refers to the corporation’s strategic management decisions rather than day-to-day operations. Strategic management has been described as the corporation’s “highest level of control”² and as “the functions of corporate governance that, in accordance with British and Canadian corporate law, are usually found where a majority or totality of the board of directors meets to exercise its powers pursuant to the corporation’s constitution”.³

In addition to the statutory test and the common-law test, the applicability and application of Canada’s international tax treaties have an impact in determining whether a corporation is resident in Canada. Specifically, if a corporation is resident in Canada under the statutory test or the common-law test, and if that corporation is also resident in another country with which Canada has a tax treaty, the tax treaty will deem the corporation to be resident in only one country. If the tax treaty deems the corporation to be resident in the foreign country, the corporation is not resident in Canada even if it meets the statutory test or the common-law test.

Corporate-Residence Tests in Canadian Law

Statutory Corporate-Residence Test

Subsection 250(4) of the Income Tax Act (ITA) contains the statutory test, which came into effect on April 27, 1965. Under subsection 250(4) of the ITA, a corporation is resident in Canada if it was incorporated in Canada at any time after April 26, 1965.⁴ A corporation incorporated in Canada before the statutory test came into effect is not considered resident in Canada unless, in any year ending after April 26, 1965, the corporation either satisfies the common-law test or carries on business in Canada.⁵ Note that the term “carrying on business” is a judicially defined term that Parliament expanded in section 253 of the ITA (see below for details).

As soon as a corporation incorporated in Canada before the statutory test came into effect either meets the common-law test or carries on business in Canada, the corporation will be considered resident in Canada for all subsequent fiscal years. In other words, as soon as a corporation incorporated in Canada before April 27, 1965, meets the statutory test, the ITA deems the corporation resident in Canada for all subsequent years regardless of whether the corporation meets the common-law test or carried on business in Canada in the subsequent years.

A corporation that satisfies the statutory test is deemed resident in Canada notwithstanding the corporation’s other circumstances; i.e., notwithstanding the location of the corporation’s office, business operations, clients, central management or control, or any other factor.

Carrying on Business in Canada – Judicial Interpretation

 Whether a corporation carries on business in Canada has a number of implications and consequences under the ITA. However, this Practical Insight focuses exclusively on the implications and consequences related to corporate residence.

 As set out above, a corporation incorporated in Canada before April 27, 1965, is not resident in Canada solely because of its incorporation in Canada. Instead, the ITA deems the corporation resident in Canada if the corporation meets the common-law test or if the corporation carried on business in Canada. Two elements determine whether a corporation carries on business in Canada: first, whether the corporation carries on business; second, whether that business is in Canada.

 The courts established a low threshold for what constitutes “carrying on business”. Specifically, in Backman v. R.,⁶ the Supreme Court of Canada interpreted “carrying on business” as follows:

[i]n law, the meaning of “carrying on a business” may differ depending on the context in which it is used. Provincial partnership acts typically define “business” as including “every trade, occupation and profession”. The kinds of factors that may be relevant to determining whether there is a business are contained in the existing legal definitions. One simple definition of “carrying on trade or business” is given in Black’s Law Dictionary (6th ed. 1990), at p. 214: “To hold one’s self out to others as engaged in the selling of goods or services.” Another definition requires at least three elements to be present: (1) the occupation of time, attention and labour; (2) the incurring of liabilities to other persons; and (3) the purpose of profit: see Gordon v. The Queen, [1961] S.C.R. 592, per Cartwright J., dissenting but not on this point, at p. 603.

Courts consider various factors when determining whether the business is carried on “in Canada”. The place in which a business enters into contracts is one such factor. British courts consider this the primary factor in determining the location of business operations.

On the other hand, Canadian courts agree that the location of contracts is relevant, but is not the lone determining factor. Canadian courts have identified the following factors as relevant for determining whether a corporation carries on business “in Canada”:

• where the corporation delivers services,
• where the corporation receives payment,
• where the corporation manufactures or produces products,
• from where the corporation solicits orders,
• where the corporation maintains its inventory,
• the location of the corporation’s bank account,
• the location of the corporation’s branch office (if any), and
• the location of the corporation’s agents.⁷

In Procter & Gamble Co., Re,⁸ the Saskatchewan King’s Bench addressed whether the appellant was carrying on business in Saskatchewan. The appellant maintained its head office in Ontario but advertised in Saskatchewan, maintained a warehouse in Saskatchewan, and employed salespeople who solicited orders in Saskatchewan. The orders the employees solicited stated that the orders were not final or binding until the appellant’s head office accepted the orders, which occurred in Ontario. The appellant argued that it was not carrying on business in Saskatchewan because it entered into sales contracts in Ontario only.

However, the Court held that the appellant was carrying on business in Saskatchewan because, although technically the appellant completed contracts with its Saskatchewan clients in Ontario, the Court held that the appellant did not do anything of significance to accept the orders. In this circumstance, the Court cited the appellant’s operations and activities in Saskatchewan to support the Court’s finding that the appellant was carrying on business in Saskatchewan.

 In Gurd's Products Co. v. R.,⁹ the Federal Court of Appeal (FCA) held that Gurd’s Products was carrying on business in Canada because it generated its profits in Canada. Gurd’s Products was incorporated in Canada in 1932. Its parent corporation was resident in the United States and sold products worldwide. Gurd’s Products operated for several years, but was inactive between 1946 and 1969.

During that time, the US parent corporation conducted the corporate group’s business without using Gurd’s Products. In 1969, the US parent corporation sought to begin operations in Iraq, but due to the political conflict between the United States and Iraq, the US parent corporation wanted to appear to be a Canadian corporation. Therefore, the US parent corporation revived Gurd’s Products so that it could use Gurd’s Products to continue to sell products to Iraq. The Agency assessed Gurd’s Products as Canadian resident on the basis that it carried on business in Canada. Gurd’s Products did not advertise in Canada, did not sell products to Canadian customers, did not enter into contracts in Canada, and did not have products in Canada. Gurd’s Products argued that it intended to create the impression of operating in Canada so that it could sell to Iraq, but that, in fact, it carried on business in the United States only. The FCA held that Gurd’s Products was carrying on business in Canada because it had a Canadian bank account, profited from the sale of products to Iraq, and generated profits for the corporate group. In these circumstances, Gurd’s Products was carrying on business in Canada and, therefore, was deemed resident in Canada under paragraph 250(4)(c) of the ITA.

The following factors are relevant in determining whether a corporation is carrying on business in Canada:

• where the corporation delivers services,
• where the corporation receives payment,
• where the corporation manufactures or produces products,
• from where the corporation solicits orders,
• where the corporation maintains its inventory,
• the location of the corporation’s bank account,
• the location of the corporation’s branch office (if any),
• the location of the corporation’s agents or employees, and
• where the corporation is listed in a business.¹⁰

Carrying on Business in Canada – Expanded Legislative Definition

The ITA, at section 253, expands the meaning of “carrying on business” in Canada. In these circumstances, a corporation incorporated in Canada before April 27, 1965, is deemed resident in Canada if, in any year after April 26, 1965, it meets the expanded definition of “carrying on business”. Section 253, set out below, provides that a person (including a corporation) is carrying on business in Canada if the person

1. produces, grows, mines, creates, manufactures, fabricates, improves, packs, preserves or constructs, in whole or in part, anything in Canada whether or not the person exports that thing without selling it before exportation,
2. solicits orders or offers anything for sale in Canada through an agent or servant, whether the contract or transaction is to be completed inside or outside Canada or partly in and partly outside Canada, or
3. disposes of
   • Canadian resource property, except where an amount in respect of the disposition is included under paragraph 66.2(1)(a) or 66.4(1)(a),
   • property (other than depreciable property) that is a timber resource property, an option in respect of a timber resource property or an interest in, or for civil law a right in, a timber resource property, or
   • property (other than capital property) that is real or immovable property situated in Canada, including an option in respect of such property or an interest in, or for civil law a real right in, such property, whether or not the property is in existence.

 Common-Law Corporate-Residence Test

The common-law test provides that a corporation is resident in the location of the corporation’s central management and control. Central management and control refers to the decisions that drive the corporation’s business. In other words, central management and control refers to the corporation’s top-level management decisions.¹¹

The origin of the central management and control test is De Beers Consolidated Mines Ltd. v. Howe,¹² a decision from the British House of Lords. De Beers was a South African corporation that operated diamond mines in South Africa. However, De Beers held its board of directors’ meetings in the United Kingdom and made all major business decisions related to the mining business in the United Kingdom. The House of Lords held that De Beers was resident in the United Kingdom because its central management and control was in the United Kingdom.

In De Beers, the House of Lords laid out the following principles related to corporate residence:

• A company resides in the place where its real business is carried on, and the real business is carried on where the central management and control actually abides.
• The answer in any given case was a pure question of fact to be determined upon a scrutiny of the course of business and trading.
• Factors to be considered in determining residence include the location of the principle business office, the location of the director’s meetings, residence of a majority of the directors, the place of incorporation and registered office, and the location of the policy and decision-making process of the entire corporate activity.¹³

 The Impact of Tax Treaties on Corporate Residence

As set out above, under the common-law corporate-residence test, a corporation incorporated in a foreign jurisdiction will be resident in Canada if its central management and control is in Canada. However, the corporation is also likely to be resident in the foreign jurisdiction in which it was incorporated. In this situation, a single corporation will be resident in two separate jurisdictions under the domestic law of each jurisdiction. If Canada has a tax treaty with the other country, however, the treaty sets out a tiebreaker so that the corporation will only be resident in one country. Canada’s tax treaties are modelled after the Organisation for Economic Co- operation and Development’s Model Tax Convention on Income and on Capital (OECD Model Treaty). The OECD Model Treaty, at Article IV.3, provides that the corporation is deemed resident only in the country “in which its place of effective management is situated”.

Citations:

¹ With assistance from Jennifer Mak, Articling Student at Counter Tax Lawyers.

² Geoffrey Loomer, “The Disjunction Between Corporate Residence and Corporate Taxation: Is Improvement Possible?” (2015) 63:1 Can. Tax J. 111, citing United Kingdom, Inland Revenue, Statement of Practice 1/90, at para. 11 (reproduced in United Kingdom, HM Revenue & Customs, International Manual (London: HMRC, 2014), online at: https://www.gov.uk/hmrc-internal-manuals/international-manual/intm120200), at section 120200).

³ Ibid. at 111.

⁴ Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.) as amended [ITA], para. 250(4)(a).

⁵ Ibid., para. 250(4)(c).

⁶ 2001 CSC 10, 2001 SCC 10, 2001 CarswellNat 246, 2001 CarswellNat 247 (S.C.C.), para. 19.

⁷ See Constantine A. Kyres, “Carrying on Business in Canada” (1995) 45:5 Can. Tax J. 1642.

⁸ 1937 CarswellSask 71, (sub nom. Income Tax Act, 1932, Re) [1938] 2 D.L.R. 597 (Sask. K.B.).

⁹ 1985 CarswellNat 310, (sub nom. R. v. Gurd's Products Co.) [1985] 2 C.T.C. 85 (Fed. C.A.) [Gurd’s Products].

¹⁰ Kyres, supra note 7 at 1642.

¹¹ Robert Couzin, Corporate Residence and International Taxation (Amsterdam: IBFD Publications BV, 2002).

¹² [1906] A.C. 455, 5 T.C. 198 (U.K. H.L.) [De Beers].

¹³ Ibid. at 213.