country in imposing its income tax allows a similar credit to persons in receipt of income derived from sources within Canada. Such deductions, however, may not exceed the amount of the tax which would otherwise be payable under the Canadian Act, in respect of the income derived from sources within Great Britain, or any of its self-governing colonies or any foreign country.

In other words, the maximum credit that may be taken is the difference between the results obtained by calculating the Canadian tax on the total income from all sources, without any deduction for foreign taxes paid and then by calculating the tax on the total income minus the amount which has been subject to foreign income taxes. Before these deductions can be allowed, the taxpayer must furnish evidence satisfactory to the Minister proving the amount of the tax paid and the particulars of income derived from foreign

sources.

A Canadian taxpayer receiving dividends from a foreign corporation is not entitled to any tax credit for the tax paid to the foreign government by the corporation, but if he himself has paid any tax on the dividend as such, he is entitled to the credit. However, under the provisions of section 4 (o) dividends received by an incorporated company from a company incorporated outside of Canada are exempt from Canadian tax to the extent that the latter corporation has earned income in Canada and actually paid the Canadian tax in respect to such income.

An amendment designed to remedy the condition whereby Canada bears the burden in times of loss and receives no tax in times of profit under the reciprocal tax relief provisions was made by the 1935 Amendments Act as paragraph (j) of section 6, which provides that deductions from income are not allowed for: net losses sustained in the 1934 or any subsequent taxation period in the United Kingdom of Great Britain and Northern Ireland or any of the British Dominions other than Canada or any British possessions or dependency, or in any foreign country, after the taxpayer has in respect of any such period once elected to claim, and has received, reciprocal tax relief under this act for taxes paid to any such country in respect of profits earned therein: Provided, however, that this provision shall not apply to companies incorporated in Canada and carrying on any class of insurance business other than life insurance for which such companies are registered or licensed under the laws of the Dominion of Canada or any Province thereof.

UNITED STATES TAX CREDIT PROVISIONS

Foreign tax-credit provisions under the United States Revenue Act (sec. 131) and the rules and regulations of the Bureau of Internal Revenue in relation thereto should be examined by American firms subject to Canadian income tax on their Canadian profits. Tax credit, within the limits prescribed by the act, may be taken not only for income taxes paid to the government of a sovereign State, such as the Dominion of Canada, but to all political entities included therein, as for example the Provinces of Canada.59

50 Burnet, Commissioner of Internal Revenue v. Chicago Portrait Company, 285 U, S. 1.

TAXATION OF CORPORATIONS

Whether the American exporter or manufacturer operates through a registered Canadian branch or through a subsidiary company incorporated either under the company law of one of the provinces or under the Dominion Companies Act, the same rate of 15 percent will apply to its profits. The extent of the liability of corporations, however, depends on residence as in the case of individuals.

Companies incorporated under a Dominion or Provincial charter and resident in Canada, and companies incorporated under the laws of a foreign country but resident in Canada are liable to the Canadian tax on their income, whether derived from Canadian or foreign sources. Whether a corporation has a "residence in Canada" creating unlimited tax liability is determined upon the basis of principles established by English court decisions interpreting the application of the United Kingdom Income Tax Act. If a company, although incorporated abroad, has its actual "head, seat, or governing power," within Canada, its real business is carried on within Canada. The primary test of residence has been summarized as follows: "A company resides, for income-tax purposes, 'where it really keeps house and does business,' 'where its real business is carried on, and 'the business is carried on where the central management and control actually abides'."

"960

If a foreign company has a branch establishment or sales agency, or is deemed to be carrying on business in Canada, it would be liable for Canadian income tax on its profit derived from its Canadian business. Thus an American company registered and licensed to do business as an extra-Provincial company under the law of a Canadian Province would be taxed only on the profits of the branch in Canada.

BUSINESS AND ASSETS SITUATED ABROAD

Certain types of companies, frequently described as (section) 4k companies, incorporated in Canada whose business is not only carried on, but whose assets, also, are situated entirely outside of Canada are exempt from income tax in Canada, provided that such companies file annually a fully completed return on the form prescribed, and also pay a filing fee of $100, within 4 months from the close of their fiscal period. However, if any such company without reasonable cause, of which the Minister is the judge, fails to file such annual return or to pay the filing fee, within the time prescribed, it is liable to the rates of tax applicable to corporations and the filing fee of $100. The companies entitled to this exemption upon compliance with the above requirements are defined by paragraph (k) of section 4 as follows:

(k) The income of incorporated companies (except personal corporations), I. whose business operations are of an industrial, mining, commercial, publicutility or public-service nature, and are carried on entirely outside of Canada, either directly or through subsidiary or affiliated companies, and whose assets (except securities acquired by the investment of accumulated income and such bank deposits as may be held in Canada) are situate entirely outside of Canada, including wholly owned subsidiary companies which are solely engaged in the prosecution of the business outside of Canada of the parent company; or

Plaxton & Varcoe, p. 36.

71518-387

II. whose business operations are of an investment or financial nature and carried on entirely outside of Canada, and whose shares have been offered for public subscription or are listed on any recognized stock exchange in Canada or elsewhere, and whose assets (except such bank deposits as may be held in Canada and except shares of other companies conforming to the requirements of this paragraph (k) are situate entirely outside of Canada. Shares, stocks, or bonds of Canadian companies shall, for the purposes of this paragraph (k), be deemed to be assets within Canada notwithstanding that they may be or have been transferred on any register outside of Canada.

APPORTIONMENT OF INCOME

Where the accounts of the Canadian branch or subsidiary show the true profits, the tax is levied without reference to the profits or losses of the foreign parent company. However, if the tax authorities are of the opinion that the profits are not truly reflected, they may ask to examine the accounts of the foreign enterprise.

61

Under the provisions of sections 26, 27, and 27Ă, the Minister is given full discretion as to the manner of determining the proportionate part of income derived from operations in Canada, and under section 23, he may determine the fair market price of commodities sold in intercompany transactions. According to the Canadian Commissioner of Income Tax 1 no specific rules or regulations have been issued as to the method of allocating income between a local branch or subsidiary and the foreign parent company, as each case is decided on its own merits. Should the Canadian organization report a loss while the entire operations of the foreign company produced a profit, then a part of the profit may be considered to have been made in Canada because the Canadian branch contributed indirectly to the profit from total operations through volume output.

INTER-COMPANY TRANSACTIONS

In determining the income of a Canadian subsidiary which purchases manufactured goods from a foreign parent company, the tax officials may examine the invoice price, and to ascertain its fairness request from the parent company data regarding the cost of manufacture.

Section 23 dealing with inter-company transactions states: "Where any corporation carrying on business in Canada purchases any commodity from a parent, subsidiary, or associated corporation, in excess of the fair market price, or where it sells any commodity to such a corporation at a price less than the fair market price, the Minister may, for the purpose of determining the income of such corporation, determine the fair price at which such purchase or sale shall be taken into the accounts of such corporation."

Where no agreement can be arrived at between the taxpayer and the authorities as to what is a fair price and the foreign enterprise fails to supply information requested, the authorities may apportion income on the basis of the ratio of sales in Canada to total sales.

61 Taxation of Foreign and National Enterprises, vol. III, pp. 66–70.

EXPENSES PAYABLE TO FOREIGN CONTROLLING COMPANY

The amounts charged by a company or organization outside of Canada to Canadian companies in respect of management fees, services, use of patents, processes, or formulae used in Canada are not allowed as a deduction if the nonresident controls the Canadian company, through the holding of shares, by affiliation with other companies, by agreement, or in any other manner. The Minister, however, may allow a portion of such charges as a deduction if he is satisfied that such charges are reasonable for services actually rendered or for the use of anything actually used in Canada (sec. 6-i). The purpose of this provision is to prevent, as a deduction from Canadian profits, payments abroad to parent or controlling organization, which are not subject to Canadian tax.

NONRESIDENT-OWNED INVESTMENT CORPORATIONS

A new category of companies for tax purposes, described as nonresident-owned investment corporations, was created by the Amendment Act of 1936.

A nonresident-owned investment corporation is defined by paragraph (p) of section 2 as:

A company incorporated in Canada, at least 95 percentum of the aggregate value of whose issued shares and all of whose bonds, debentures, and other securities or evidences of funded indebtedness are beneficially owned by persons who are nonresidents of Canada or are owned or held by trustees for the benefit of nonresident persons or their unborn issue, or by a corporation whether incorporated or domiciled in Canada or elsewhere but in all other respects conforming to the foregoing requirements of this paragraph (p), the gross income of which is derived from one or more of the following

Sources:

(I) from the ownership of or the trading or dealing in bonds, stocks, or shares, debentures, mortgages, hypothecs, bills, notes or other similar property, or any interest therein;

(II) from the lending of money with or without security, or by way of rent, annuity, royalty, interest, or dividend;

(III) from or by virtue of any right, title, or interest in or to any estate or trust.

RATE OF TAX

Such nonresident-owned investment corporations which elect within the time and manner prescribed by regulations will not be taxed at the usual corporate rates, but at one-half the ordinary corporate rate-that is, 7.5 percent. These new rates are applicable to the year 1935 and fiscal periods ending therein, and to subsequent periods. In the future such companies will not have to deduct the 5-percent tax on dividends paid to their nonresident shareholders, nor on interest payable and falling due after the effective date of election.

TAXABLE INCOME AND TAX CREDITS

In determining the taxable income of a nonresident-owned investment corporation (sec. 22A) after the effective date of election and so long as it is subject to tax at one-half the ordinary corporate rate, it is not allowed to deduct interest payable on its bonds, debentures, and other securities and evidence of funded indebtedness, nor taxes

paid abroad. Dividends and interest received from another nonresident-owned investment corporation, and one-third of the dividends (less carrying charges if any) received from any other company incorporated in Canada are deductible.

Whereas other Canadian taxpayers are allowed tax credits for income taxes paid to other parts of the British Empire and to foreign countries allowing similar credits up to an amount not exceeding that which would otherwise be payable under the Canadian Act, nonresident-owned investment corporations which have made the election may deduct from the tax only one-third of the amount of tax (i. e., of the 7.5 percent tax), or one-third of the tax paid abroad, whichever is the less.

The tax payable in respect of the income of the fiscal periods 1935 and 1936 by such corporations which have made the election will be reduced by the amount of 5-percent tax on payments to nonresident shareholders which may have already been deducted during these fiscal periods, or the tax paid at the rates applicable to corporations. However, these companies will be required to pay the 5-percent nonresident tax on income accumulated but not distributed between 1932 and up to the coming into effect of the new tax.

REGULATIONS RELATIVE TO ELECTION

The regulations issued by the Department of National Revenue provide the manner in which nonresident-owned investment corporations must make the election. Such companies in respect of the 1935, 1936, and 1937 periods or fiscal periods ending therein, desiring to elect, must elect within 12 months from June 23, 1936. Thereafter, in respect of all subsequent periods, an election made within the first 6 months of any fiscal period may be made effectively in respect of the period in which the election takes place, or any succeeding fiscal period, while an election made in the last 6 months of any fiscal period applies only in respect to the next or any succeeding fiscal period.

Once an election is made, the company will continue to be taxed under paragraph E of the tax schedule (one-half ordinary corporate rate), while it remains a nonresident-owned investment corporation as defined by the act, and without power of revocation thereafter; with this proviso, that the company, upon request in writing to the Commissioner of Income Tax at Ottawa, made at least 6 months before the end of the fiscal year, may become subject, from the beginning of the succeeding fiscal year, to the tax payable at the rate applicable to corporations under either paragraph C or D of the tax schedule (15 or 17 percent) instead of at the rate provided for in paragraph E (7.5 percent). Should any such company subsequent to election cease to be nonresident-owned, it will be taxed at the ordinary corporate rates.

DOCUMENTS REQUIRED

Election must be made by forwarding by registered mail to the Commissioner of Income Tax at Ottawa the following documents in duplicate:

(a) An affidavit setting forth all the necessary facts to show conclusively that the company is in fact technically a nonresident-owned investment corpora