For Canadian tax purposes, services provided by a foreign affiliate in connection with the purchase or sale of its Canadian parent’s real property inventory would be treated differently from movable property, on the basis that real property is not considered to be “goods”. Finance could consider replacing the term “goods” with “property” in relevant legislations for equitable outcome.
The article was originally published in the Canadian Tax Focus, Volume 12, Number 3 in August of 2022.
At the 2022 IFA CRA round table, held on May 17, 2022, the CRA stated that real property is not considered to be “goods” for the purpose of paragraph 95(3)(b) in the foreign affiliate (FA) regime. This interpretation expands the sparse guidance on this provision but does not appear to be consistent with its policy intent.
Paragraph 95(2)(b) provides a deemed service-FAPI rule: certain services provided by an FA are deemed to be a separate business other than an active business carried on by the FA. Any income earned from the deemed business is therefore FAPI. For example, clause 95(2)(b)(i)(A) stipulates that this rule applies if the amounts paid in consideration for the services provided by an FA are deductible by its Canadian parent or certain related entities in computing income from a business carried on in Canada. This clause is intended to prevent erosion of the Canadian tax base through Canadian taxpayers shifting Canadian income offshore by creating a service FA in a low-tax jurisdiction.
Subsection 95(3) provides exceptions to the “services” referred to in paragraph 95(2)(b). Specifically, paragraph 95(3)(b) provides an exception for services performed in connection with the purchase or sale of goods.
The term “goods” is not defined in the Act. Furthermore, it appears that no court cases have addressed how to interpret this term for the purposes of applying the FA rules. There is also limited previous guidance from the CRA on this subject. CRA document no. 5-7563 (August 23, 1985) states that the provision of services as a foreign sales representative for a Canadian broadcaster would not meet the exception in paragraph 95(3)(b) because the Canadian broadcast is not considered to be “goods.” At the 2022 round table, the CRA stated that real estate inventory (such as a residential condominium) is not considered to be “goods,” because the term should generally include only tangible, movable, personal property intended for sale.
The policy intent of the exception to the paragraph 95(2)(b) service-FAPI rule for services performed in connection with the purchase or sale of goods appears to be to protect activities closely connected with the processes of selling goods and transferring property that are required, by their nature, to be performed outside Canada. These activities are likely driven by valid business reasons and are not structured for the purposes of shifting income offshore. For instance, an FA may be created to provide marketing services to facilitate Canco’s sales in a foreign country. The arrangement is driven by legitimate business reasons and should not erode the Canadian tax base.
The question then becomes why services provided in connection with the purchase or sale of Canco’s real property inventory would be treated differently from movable property in this regard. Perhaps the CRA’s policy is simply a question of statutory interpretation, based on its belief that the term “goods” would imply non-movable property. However, the policy arguments noted above seem to apply equally to movable and non-movable property.
In recognition of these policy arguments, Finance could consider amending paragraph 95(3)(b) to replace “goods” with “property” —the term used in a somewhat related provision, paragraph 95(2)(a.1). This is the “property FAPI” rule that deems certain income from the sale of property to be FAPI, including income from the performance of services as an agent in relation to the purchase or sale of property.