gst/hst and electronic commerce...customs and revenue agency (ccra) of the administration of the...

GST/HST andelectronic commerce

GST/HST and Electronic Commerce

A discussion paper for public comment on the administration of the Goods and Services Tax/Harmonized Sales Tax in an

electronic commerce environment

Excise and GST/HST Rulings Policy and Legislation

November 2001

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TABLE OF CONTENTS 1 INTRODUCTION_________________________________________________________________ 1

Overview_________________________________________________________________________ 1

The electronic commerce environment _______________________________________________ 2

The CCRA’s strategy_______________________________________________________________ 3

2 SUMMARY OF RECOMMENDATIONS_______________________________________________ 7

The meaning of “carrying on business in Canada” for GST/HST purposes__________________ 7

Determining what constitutes a permanent establishment for GST/HST purposes ___________ 8

Characterization of a supply that is delivered electronically ______________________________ 8

Determining whether a supply is a telecommunication service or merely provided by means of telecommunications _______________________________________________________________ 9

Determining the place of supply in an electronic commerce environment _________________ 10

Methods of tax collection__________________________________________________________ 10

3 CARRYING ON BUSINESS IN CANADA ____________________________________________ 12

Introduction _____________________________________________________________________ 12

Background _____________________________________________________________________ 12

Interpretative issues for electronic commerce ________________________________________ 14

Options for carrying on business ___________________________________________________ 16

Analysis and recommendation _____________________________________________________ 19

Application of recommended approach ______________________________________________ 21

4 PERMANENT ESTABLISHMENT __________________________________________________ 23

Introduction _____________________________________________________________________ 23

The OECD on permanent establishment for electronic commerce ________________________ 24

Background _____________________________________________________________________ 25


Analysis ________________________________________________________________________ 27

Recommendation ________________________________________________________________ 29

5 CHARACTERIZATION ISSUES FOR GST/HST PURPOSES ____________________________ 30

Introduction _____________________________________________________________________ 30

Background _____________________________________________________________________ 30


Options for characterization _______________________________________________________ 32

Analysis and recommendation _____________________________________________________ 34

Application of recommended approach ______________________________________________ 35

6 TELECOMMUNICATIONS________________________________________________________ 48

Introduction _____________________________________________________________________ 48

Background _____________________________________________________________________ 48

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Indicators for characterization______________________________________________________ 50

Examples _______________________________________________________________________ 50

7 PLACE OF SUPPLY ____________________________________________________________ 54

Introduction _____________________________________________________________________ 54

Background _____________________________________________________________________ 54


Intangible personal property _______________________________________________________ 57

Services ________________________________________________________________________ 59

8 TAX COLLECTION MECHANISMS_________________________________________________ 63

Introduction _____________________________________________________________________ 63

Background _____________________________________________________________________ 63

Options_________________________________________________________________________ 63

APPENDIX A_______________________________________________________________________ 65

APPENDIX B_______________________________________________________________________ 69

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1 INTRODUCTION

OVERVIEW

This discussion paper contains the results of a review carried out by the Canada Customs and Revenue Agency (CCRA) of the administration of the Goods and Services Tax/Harmonized Sales Tax (GST/HST) in an electronic commerce environment. This review has been undertaken to ensure that the CCRA will be in a position to effectively administer the GST/HST without placing an unreasonable burden on taxpayers, while contributing to a favourable international environment for the continued growth of the electronic commerce sector.

This review was conducted with the assistance of the Electronic Commerce Technical Advisory Group on Consumption Taxes (the “GST TAG”), a group of private sector tax experts and industry representatives selected to provide expert advice to the CCRA on electronic commerce consumption tax issues.

This paper discusses the following issues in the context of the current legislation (i.e., Excise Tax Act1).

• the meaning of “carrying on business in Canada” for GST/HST purposes;

• determining what constitutes a permanent establishment for GST/HST purposes;

• characterization of a supply that is delivered electronically;

• determining whether a service is a telecommunications service or merely one provided by means of telecommunications;

• determining the place of supply for supplies made by electronic means ; and

• methods of tax collection.

A summary of the CCRA’s recommendations with respect to the above issues can be found in section 2 of this paper.

Release of the discussion paper

This paper does not replace the law found in the Excise Tax Act and Regulations. It represents the CCRA’s proposed administration of the GST/HST with respect to electronic commerce transactions.

1 The Excise Tax Act contains the legislation for the GST/HST. All statutory references in this paper are to provisions of the Excise Tax Act, unless otherwise noted.

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This discussion paper is being distributed by the CCRA for public comment. Please refer your comments, by March 1, 2002 to:

Mr. Ed Gauthier, Deputy Assistant Commissioner Excise and GST/HST Rulings

15th Floor, Tower A, Place de Ville 320 Queen Street

Ottawa ON K1A 0L5

Submissions can also be made electronically to [email protected]

The CCRA would like to thank the members of the GST TAG and others participating in this review for their dedication and invaluable contribution throughout the past two years.

THE ELECTRONIC COMMERCE ENVIRONMENT

Electronic commerce can simply be defined as conducting business with the assistance of telecommunications and telecommunications-based tools. It includes transactions that take place by telephone, facsimile, automated banking machine, television shopping, secure private computer networks (Electronic Data Interchange) and by Internet with payment made by credit card, debit card or similar means. 2 For purposes of this paper, references made to “electronic commerce” are meant to include only supplies made over the Internet.

The Internet or the World Wide Web (the “Web”) is a decentralized, global, public network of computers over which digital information and products can be distributed.3 A person who is connected to the Internet can communicate quickly, cheaply, and efficiently with other people such as employees, suppliers and customers, can access data such as credit and market information and can buy and sell products and services electronically.4

There are a variety of ways to access the Internet. Generally a person obtains access through a commercial Internet Service Provider (ISP). Once connected, the user can access a document (Web page) on the Web either by using a unique Web page address (a Uniform Resource Locator or URL), or by conducting a search for Web pages with one of the various Internet search engines.

A Web page or collection of linked Web pages is referred to as a “Web site.” A Web site is a collection of files or programs which are stored on a server. A server is a computer that holds the files for one or more Web sites. A very large Web site may be spread over a number of servers in different geographic locations. The information stored on a Web site may include product listings, links to digitized products, databases, multimedia files (e.g., games or movies), and links by e-mail or Electronic Data Interchange (EDI) to a supplier or to third party service providers to permit on-line ordering, payment processing and various other business functions.

2Electronic Commerce and Canada’s Tax Administration: A Report to the Minister of National Revenue from the Minister’s Advisory Committee on Electronic Commerce, April 1998, available at: http://www.ccra-adrc.gc.ca/tax/business/ecomm/index-e.html 3 Ibid. 4 What is Electronic Commerce?, Industry Canada, available at: http://e-com.ic.gc.ca/english/index.html

http://www.ccraadrc.gc.ca/tax/business/ecomm/index-e.html

http://e-com.ic.gc.ca/english/index.html

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Web sites range from basic (i.e., those containing only a catalogue of products or services with no interactive features), to fully interactive sites. Where a Web site simply displays products, purchases are usually made by a consumer at a vendor’s physical premises, or by telephoning the vendor to place an order. More advanced, interactive Web sites enable consumers to view, order, and pay for the products they purchase through the sites.

The technology underlying electronic commerce facilitates the delivery of products and services by suppliers to customers located throughout the world. A business will often have no physical presence in the jurisdiction of its customers. In other cases, the only physical presence it may have in that jurisdiction is a server. As well, products that could previously only be supplied in a tangible format can now also be supplied electronically in a digitized format, and services that once required the physical presence of personnel at the location of the customer may now be performed from a remote location by electronic means. This fundamentally alters the way business is conducted and presents challenges to consumption tax administrators throughout the world.

THE CCRA’S STRATEGY

In April 1997, the Minister of National Revenue established the Advisory Committee on Electronic Commerce to address tax issues identified in conjunction with the growth of electronic commerce. The Committee’s objective was to ensure that the CCRA is able to collect appropriate revenues from domestic and international electronic commerce activities.5

In its April 1998 report entitled Electronic Commerce and Canada’s Tax Administration, the Committee recommended that the CCRA and the Government of Canada take steps to clarify and communicate the application of existing tax policies and practices to electronic commerce transactions.

In September 1998, the Minister responded to the Committee’s report by committing the CCRA to explore issues identified in the report. With respect to the application of the GST/HST this work was to be carried out in consultation with a new advisory group comprising tax experts and representatives of industry involved in electronic commerce. The mandate of this group -- the Electronic Commerce Technical Advisory Group on Consumption Taxes (the “GST TAG”) -- was to advise on the interpretation of the GST/HST legislation, compliance, and administrative matters in an electronic commerce environment.

The GST TAG was chaired by Ed Gauthier, Deputy Assistant Commissioner, Excise and GST/HST Rulings, CCRA. The members of the GST TAG were:

• Pierre Bocti, CGA, Director, Tax (Toronto), Hewlett-Packard (Canada) Ltd.;

• Michel Ducharme, CGA, Director, Planning and Shareholder Value Management, Bell Canada;

• Carol Felepchuk, Government Programs Executive, IBM Canada;

• Bruce B. Flexman, CA, Partner-in-Charge of Tax (Vancouver), KPMG;

5 Electronic Commerce and Canada’s Tax Administration: A Report to the Minister of National Revenue from the Minister’s Advisory Committee on Electronic Commerce.

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• Teresa W. Ma, Senior Manager, Commodity Tax, TD Canada Trust;

• Richard Mount, Federation of Canadian Municipalities (Chair – Taxation Committee), City of Calgary;

• D. Blair Nixon, CA, LLB, Partner, Felesky Flynn;

• Taz Pirmohamed, Business Strategy Consultant, Boston Consulting Group;

• Glen S. Pye, CA, CMA, Director of Taxation (Toronto), Nortel Networks;

• Tony Roziere, Supervisor, Commodity Tax and Transportation, City of Winnipeg; and

• Munir A. Suleman, CA, Vice President, Domestic Taxation, Scotiabank.

Representatives from the CCRA, Industry Canada, the Department of Finance, and a number of provincial governments also participated in the GST TAG meetings as observers.

The Minister’s September 1998 response recognized that the growth of electronic commerce would create new challenges and opportunities for the administration of all consumption taxes. Since the impact of electronic commerce is international in scope, and a “Canadian” approach in isolation would not be viable, the Minister committed the CCRA to working with revenue authorities in other countries in addressing the challenges posed by electronic commerce.

At an Organization for Economic Co-operation and Development (OECD) Ministerial Conference held in Ottawa in October 1998, Ministers of the OECD member countries (including Canada) agreed that widely accepted general tax principles that apply to traditional commerce should also apply to electronic commerce. These tax principles are as follows.

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Broad Taxation Principles

1) Neutrality − Taxation should seek to be neutral and equitable between different forms of electronic commerce, and between conventional and electronic forms of commerce. Business decisions should be motivated by economic rather than tax considerations. Taxpayers in similar situations carrying out similar transactions should be subject to similar levels of taxation.

2) Efficiency − Compliance costs for taxpayers and administrative costs for tax authorities should be minimized as far as possible.

3) Certainty and simplicity − The tax rules should be clear and simple to understand so that taxpayers can anticipate the tax consequences in advance of a transaction, including knowing when, where and how the tax is to be accounted for.

4) Effectiveness and fairness − Taxation should produce the right amount of tax at the right time. The potential for tax avoidance should be minimized, while keeping counter-acting measures proportionate to the risks involved.

5) Flexibility – The systems for the taxation should be flexible and dynamic, to ensure that they keep pace with technological and commercial developments.6

In order to implement these broad taxation principles, governments agreed to a framework to assist in developing an internationally consistent approach to the consumption taxation of electronic commerce transactions. The elements of this framework are as follows:

Elements of a taxation framework with respect to consumption taxes

• Rules for the consumption taxation of cross-border trade should result in taxation in the jurisdiction where consumption takes place and an international consensus should be sought on the circumstances under which supplies are held to be consumed in a jurisdiction.

• For the purpose of consumption taxes, the supply of digitized products should not be treated as a supply of goods.

• Where business and other organizations within a country acquire services and intangible personal property from suppliers outside the country, countries should examine the use of reverse charge, self-assessment or other equivalent mechanisms where this would give immediate protection of their revenue base and of the competitiveness of domestic suppliers.

• Countries should ensure that appropriate systems are developed in co-operation with the World Customs Organization (WCO) and in consultation with carriers and other interested parties to collect tax on the importation of physical goods, and that such systems do not unduly impede revenue collection and the efficient delivery of products to consumers.7

The CCRA and the GST TAG were guided by the principles and the Taxation Framework noted above in carrying out their work.

6 Electronic Commerce: Taxation Framework Conditions, A Report by the Committee on Fiscal Affairs as presented to Ministers at the OECD Ministerial Conference “A Borderless World: Realising the Potential of Electronic Commerce”, October 8, 1998, available at: http://www.oecd.org/pdf/M000015000/M00015517.pdf 7 Ibid.

http://www.oecd.org/pdf/M000015000/M00015517.pdf

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From June 1999 to March 2001, the CCRA and GST TAG held seven joint meetings. At the outset of the discussions, the GST TAG identified several issues with respect to the application of the GST/HST in an electronic commerce environment. As a result, the GST TAG was divided into three subcommittees to examine these issues in detail: the Carrying on Business Subcommittee, the Characterization and Telecommunications Subcommittee, and the Collection Mechanisms Subcommittee.

The discussions presented in this document represent the culmination of the work of the CCRA, taking into account consultations with the GST TAG and the subcommittees of the GST TAG.

In keeping with its commitment to international co-operation, Canada continues to actively participate in discussions on electronic commerce and consumption taxes such as the ongoing work of the OECD in this area. For example, the CCRA hosted a major international conference, Tax Administrations in an Electronic World, in Montreal in June 2001. This conference was co-sponsored by the OECD, the Commonwealth Association of Tax Administrators, the Inter-American Center of Tax Administrations, le Centre de rencontres et d’études des dirigeants des administrations fiscales, and the Intra-European Organisation of Tax Administrations. At this conference government officials from over 100 countries discussed how to develop and implement an international taxation framework for electronic commerce. Representatives of the International Monetary Fund, the United Nations, the World Bank, the Regional Development Bank and the European Union also participated.

The CCRA will continue both to work with international organizations and to consult with private sector stakeholders to address the challenges presented by the growth of electronic commerce. The release of this discussion paper for public comment is the latest step in this process.

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2 SUMMARY OF RECOMMENDATIONS

This section outlines the CCRA’s recommendations in the context of the current legislation (i.e., Excise Tax Act) with respect to the administration of the GST/HST in an electronic commerce environment.

THE MEANING OF “CARRYING ON BUSINESS IN CANADA” FOR GST/HST PURPOSES

Determining whether a non-resident person is carrying on business in Canada is an important step in establishing whether the non-resident is required to register for GST/HST purposes. A non-resident, other than a small supplier, carrying on business in Canada who makes taxable supplies in Canada is required to register.

Whether a business is being carried on in Canada is determined based on an examination of the facts of the particular situation. It is proposed that the CCRA make this determination based on a “place of operations” approach.

This approach considers a number of factors that are indicative of business being carried on in a particular jurisdiction. The weight to be ascribed to any one factor will depend on the nature of the business under review and the particular facts and circumstances of each case.

Some of the factors that may be used are:

The place where agents or employees of the non-resident are located

The location of an inventory of goods

The place of delivery The place where the business’s contracts are made

The place of payment The location of a bank account

The place where purchases are made The place where the non-resident’s name and business are listed in a directory

The place of manufacture or production The location of a branch office

The place from which transactions are solicited

The place where the service is performed

Some of the above factors may be less applicable to businesses engaged in electronic commerce (e.g. location of an inventory of goods), and still others (e.g. place of delivery) may require further description and explanation. In addition, new factors particular to electronic commerce may become relevant in the future.

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DETERMINING WHAT CONSTITUTES A PERMANENT ESTABLISHMENT FOR GST/HST PURPOSES

A non-resident who has a permanent establishment in Canada is treated as a resident of Canada and is subject to the same GST/HST obligations as a domestic supplier in respect of activities carried on through that permanent establishment.

For purposes of the definition of “permanent establishment” it is proposed that:

A Web site would not, in itself, constitute a permanent establishment.

A Web site hosting arrangement typically would not result in a permanent establishment for the enterprise that carries on business through that Web site.

A place where computer equipment, such as a server, is located may in certain circumstances constitute a permanent establishment, where the functions performed at that place are significant and an essential or core part of the business activity of the enterprise.

A permanent establishment could exist at a location even though no personnel of the enterprise are required to carry on its business activities at that location.

The fixed place of business of a particular person’s internet service provider would normally not constitute a permanent establishment of that person.

CHARACTERIZATION OF A SUPPLY THAT IS DELIVERED ELECTRONICALLY

The characterization of supplies is fundamental to the application of the GST/HST. It impacts on the determination of the place of supply, the rate of tax applicable to a supply, the manner in which tax is collected and the timing of liability for tax in respect of a supply.

Supplies made by electronic means (including digitized products) are considered to be either intangible personal property or services. To determine whether a particular supply is a supply of intangible personal property or a service, the CCRA proposes to use a number of factors which may be given lesser or greater weight depending on the circumstances of the transaction (referred to as the “Factor Approach”).

Factors that would indicate a supply made by electronic means is one of intangible personal property are:

• A right in a product or a right to use the product for personal or commercial purposes is provided, such as:

a. Intellectual property or the right to use intellectual property, e.g., a copyright.

b. Rights of a temporary nature, e.g., a right to view, access or use a product while on-line.

• A product has already been created or developed or is already in existence.

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• A product is created or developed for a specific customer, but the supplier retains ownership of the product.

• A right to make a copy of the digitized product is provided.

Factors that would indicate a supply made by electronic means is not one of intangible personal property, but rather a service are:

• There is human involvement in making the supply.

• The supply involves specific work that is performed by a person for a specific customer.

• The supply does not include a transfer of rights, e.g., technical know-how or if there is a transfer of rights, the rights are an incidental part of the supply.

DETERMINING WHETHER A SUPPLY IS A TELECOMMUNICATION SERVICE OR MERELY PROVIDED BY MEANS OF TELECOMMUNICATIONS

Some supplies made by electronic means must be further assessed to determine whether they are supplies of telecommunication services as there are special place of supply and zero-rating rules for telecommunication services. To assist in this determination, a set of indicators was developed.

The following indicators would point to a supply being a telecommunication service:

• The predominant purpose of the supply is to provide for the emission, transmission or reception of signs, signals, etc. (e.g., voice or data) through a telecommunications network or similar technical system.

• The predominant purpose of the supply is to make available a telecommunications facility, for the emission, transmission or reception of signs, signals, etc., through a telecommunications network or similar technical system.

• The predominant purpose of the supply is to provide a means through which other services or intangible personal property (e.g., content in a digitized format) are delivered, rather than to provide the services or intangible property.

• The supplier is not supplying the content that is emitted, transmitted, or received.

Examples of supplies that would be characterized as telecommunication services using the above indicators are Internet access, e-mail, voice telephony, electronic data interchange (EDI) transmission of income tax returns, and streamed (real time) Web-based broadcasting.

The following indicators point to a supply not being a telecommunication service:

• The predominant purpose of the supply is other than the provision of a telecommunication service.

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• A telecommunication service is used or consumed by the supplier in making a supply of a service or property (other than a telecommunication service).

• The supply includes the provision of a telecommunication service but only as a means of delivering another service or property.

• The supply of a telecommunication service is incidental to a supply of another service or property.

Examples of supplies that would not be telecommunication services are Web site hosting, preparation and EDI transmission of income tax returns, and the provision of digitized products.

DETERMINING THE PLACE OF SUPPLY IN AN ELECTRONIC COMMERCE ENVIRONMENT

The GST/HST is applicable to taxable supplies of property and services made in Canada. The GST/HST legislation includes place of supply rules to determine whether a supply is made in Canada.

As a supply made by electronic means is either intangible personal property or a service, the paper focuses on the rules relating to these types of supplies.

A supply of intangible personal property is made in Canada if it “may be used in whole or in part” in Canada. The term “may be used” is interpreted to mean “capable of being used”. When considering whether intangible personal property may be used in Canada, reference may be made to any written agreement for the supply including any restrictions on its use published on Web sites.

A service is supplied in Canada if it is “performed” in whole or in part in Canada. While it is necessary to examine each supply of a service on a case-by-case basis, it is proposed that a supply of a service will be performed at least in part in Canada if:

• the service requires a person to perform a task (i.e., the supplier acting through one or more of its employees), and the person performing or physically carrying out the task is situated in Canada at the time the activity is done;

• the service includes operations performed by the supplier’s computer equipment, and the computer equipment is located in Canada;

• the supply involves doing something to or with the recipient’s computers by accessing them from a remote location and the recipient’s computers are in Canada. (Note: this element does not apply to performing a service and then delivering the results electronically to the recipient’s computers); or

• any administrative activity related to the supply of that service is in Canada.

METHODS OF TAX COLLECTION

The growth in electronic commerce may lead to a shift in current tax collection points for products previously supplied as goods that can now be supplied by electronic means.

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CCRA will continue to use current tax collection mechanisms for electronic commerce. There are three tax collection mechanisms for GST/HST purposes:

• Customs collects tax on the importation of goods as they cross the border.

• A supplier of property or services who is registered or who is required to be registered must collect tax on taxable supplies made in Canada.

• A resident of Canada is required to self-assess tax on imported services or intangible personal property where the supply is made outside Canada, unless the supply is exempt or zero-rated, or the resident is acquiring the property or service for consumption, use or supply exclusively in commercial activities. This applies to supplies acquired by consumers as well as by businesses.

The CCRA will continue to monitor further developments in the area of tax collection mechanisms such as collection by trusted third parties and technology-based solutions.

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3 CARRYING ON BUSINESS IN CANADA

INTRODUCTION

This section examines the meaning of “carrying on business in Canada” for GST/HST purposes in an electronic commerce environment.

Whether a non-resident person is carrying on business in Canada is important for GST/HST purposes because:

• A non-resident supplier, other than a small supplier, must register for GST/HST purposes and charge the GST/HST on taxable supplies made in Canada where it is considered to be carrying on business in Canada.8

• Where a non-resident person is not carrying on business in Canada and has not registered voluntarily for GST/HST purposes, the non-resident’s supplies are considered to be made outside Canada and the non-resident is not required to charge GST/HST.9

As the CCRA’s current administrative policy on the meaning of “carrying on business in Canada” for GST/HST purposes was developed in the context of conventional commerce, the GST TAG and the CCRA undertook a comprehensive review of the policy and examined alternatives for determining whether a non-resident person is carrying on business in Canada. The ability of non-resident persons10 to interact with customers in Canada through servers and Web sites, with little or no requirement for human involvement, presents certain challenges for establishing whether a non-resident is considered to be carrying on business in Canada.

BACKGROUND

As the phrase “carrying on business in Canada” is not defined in the GST/HST legislation, the determination of the place where a particular business is carried on depends upon consideration of all relevant facts. The following factors are currently used by the CCRA in determining whether a person is carrying on business in Canada for GST/HST purposes:

1. the place where the contract is made

2. the place where the operations from which profits arise take place, and

8 Subsection 240(1). 9 Supplies that are considered to be made outside Canada which are subsequently imported into Canada may be subject to tax upon importation. Importers of goods may be required to pay the GST/HST at the border to Canada Customs. Recipients of imported intangible personal property or services may be required to self-assess the GST/HST. Refer to section 7 of this paper for detailed discussion on the place of supply. 10 Rules for determining whether a person is resident in Canada are in Section 132.

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3. other factors such as the place where

delivery of the goods is made payment is made

the goods are manufactured the orders are solicited

an inventory of the goods is maintained

the company maintains a branch or office, agents or employees, who are authorized to transact business on behalf of the non-resident person, are located

bank accounts are maintained back-up services are provided under the contract, and

the name and business of the non-resident is listed in a directory.

Generally, the first two factors are the predominant factors. 11

Determining whether a non-resident person is carrying on business in Canada is an important step in establishing whether the non-resident is required to register for GST/HST purposes.

A non-resident who is carrying on business in Canada and who makes taxable supplies in Canada is required to register for GST/HST purposes,12 unless the person is a small supplier. 13

A non-resident is considered to be carrying on business in Canada where the non-resident solicits in Canada orders to supply, or offers to supply, prescribed property (e.g., books, newspapers, periodicals, or magazines) that is to be sent by mail or courier to the recipient at an address in Canada. Such a non-resident is required to register for GST/HST purposes, unless it is a small supplier.14

A non-resident person who, in the ordinary course of carrying on business outside Canada, regularly solicits orders for the supply of tangible personal property for export to, or delivery in Canada, or has entered into an agreement for the supply of services to be performed in Canada, or for intangible personal property to be used in Canada, is permitted to register voluntarily for GST/HST purposes.15

11 GST/HST Policy Statement P-051R, Carrying on Business in Canada, March 8, 1999, available at: http://www.ccra-adrc.gc.ca/E/pub/gl/p-051rem/p-051r-e.htm. 12 Subsection 240(1). 13 A person is a small supplier and not required to register for the GST/HST if its total (gross) worldwide taxable revenues, including the worldwide taxable revenues of all of its associates do not exceed $30,000 annually. Subsection 148(1). 14 Subsection 240(4). 15 Paragraph 240(3)(b).

http://www.ccra-adrc.gc.ca/E/pub/gl/p-051rem/p-051r-e.htm

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Where a non-resident person is not registered and not required to be registered, a supply of personal property or a service made in Canada by that person is considered to be made outside Canada.16

INTERPRETATIVE ISSUES FOR ELECTRONIC COMMERCE

At issue is determining whether a non-resident is carrying on business in Canada where the non-resident is conducting business through a Web site.

Factors used by the CCRA for GST/HST purposes to determine whether a non-resident is carrying on business in Canada are taken from British and Canadian income tax cases which pre-date the development of electronic commerce. 17 Consequently, the factors reflect the traditional manner of doing business. For example, factors such as regional or local business directories, and the location of warehouses, manufacturing facilities, employees, and office and sales staff were considered indicative of the place where a business was carried on.

A vendor who makes supplies by electronic means may have a physical presence in more than one jurisdiction or in a jurisdiction other than where its customers are located. Through Web sites and servers, a vendor may provide detailed information concerning products, solicit orders for those products, provide a means of ordering, accepting and processing payments, and, in the case of products capable of being delivered electronically, deliver the products. All of these activities may be accomplished without an office, warehouse or other facilities, and without employees or sales staff located in jurisdictions where the products are sold.

16 Paragraphs 143(1)(a) and 143(1)(b). 17 British income tax cases Grainger & Sons v. Gough [1896] AC 325, 3 TC 462 (HL) F.L. Smidth & Co. v. Greenwood [1921] 3 KB 583, 8 TC 193 (CA), affirmed [1922] 1 AC 417 (HL) Firestone Tyre and Rubber Co. v. Lewellin [1957] 1 All ER 561, 37 TC 111 (HL) Canadian income tax cases Sudden Valley Inc. v. The Queen [1975] C.T.C. 2345, 75 DTC 263 (TRB), affirmed [1976] C.T.C. 297, 76 DTC 6178 (FCTD), affirmed [1976] C.T.C. 775, 76 DTC 6448 (FCA) Cutlers Guild Ltd. v. The Queen [1981] C.T.C. 115, 81 DTC 5093 (FCTD) John Pullman v. The Queen [1983] C.T.C. 52, 83 DTC 5080 (FCTD) Capitol Life Insurance Co. v. The Queen [1984] C.T.C. 141, 84 DTC 6087 (FCTD) GLS Leasco Inc et al v. MNR [1986] 2 C.T.C. 2034, 86 DTC 1484 (TCC) British Columbia social services tax case Re Geigy (Canada) Ltd. and Commissioner, Social Services Tax [1969] C.T.C. 79, 1 D.L.R. (3d) 354 (BCSC)

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The following chart illustrates the effect of electronic commerce on factors currently followed by CCRA.

Effect of electronic commerce on factors currently followed by CCRA.

• Place of contract

The place of contract for electronic transactions may depend on certain factors including the type of Web site, the terms of the agreement between the parties including the presence of a jurisdiction clause and the validity of such a clause, and relevant federal and provincial legislation and international agreements. All of these may lead to the place of contract being in a jurisdiction different from the jurisdiction in which the supplier is carrying on business.

• Place where payment is made

With electronic commerce there is no need for the supplier to maintain bank accounts or to rely on its personnel to process payments in every jurisdiction where sales take place. Payment authorization from a third party (such as a bank or other financial intermediary), and generation of a response to the customer that payment has been approved may be carried out automatically through a Web site and software.

• Storage of digitized products

Digitized products may be supplied to customers through a server that is accessed through a business’s Web site. Customers may be given the choice of downloading the digitized product from a number of servers located in a number of jurisdictions.

• Presence of on-site personnel

Current technology allows for the provision of services, such as after sales technical assistance, electronically from anywhere in the world. Customer service can be handled via the Internet or by the use of electronic mail or long distance telephone service. With electronic commerce, the need for employees and agents in every jurisdiction where products are sold is reduced or eliminated.

• Regional or local business directories

Suppliers of products and services via the Internet rely to an extent on Internet directories and software search engines for potential customers to locate their Web sites. Consequently, it may not be necessary for suppliers to list their names and businesses in traditional print directories.

Taking into consideration new business processes (as noted in the above chart) available to persons that make supplies by electronic means, the CCRA’s policy for determining whether a person is carrying on business in Canada for GST/HST purposes was reviewed and alternative options were considered.

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OPTIONS FOR CARRYING ON BUSINESS

The CCRA’s current policy

To determine the place where a particular business is carried on, the CCRA takes into consideration all relevant facts of a particular situation. In reviewing these facts, the CCRA uses the factors listed in the Background of this section. Generally, the place where the contract is made and the place where the operations from which profits arise take place are considered to be the predominant factors. Where one of these predominant factors is present together with one or more of the other factors linking a non-resident to Canada, the non-resident may be considered to be carrying on business in Canada.

For example, where a non-resident is making supplies of goods through a Web site to consumers resident in Canada, the non-resident may be considered to be carrying on business in Canada if the place of contract and one or more other factors (for example, the place where the goods are manufactured) are in Canada. Similarly, the non-resident may be considered to be carrying on business in Canada if the place of operations from which profits arise and one or more other factors are in Canada.

Place of operations 18

This option is similar to the CCRA’s current policy except that no factor is considered to be predominant. The weight to be ascribed to any particular factor depends on the nature of the business under review and the particular facts and circumstances of each case. Although some of the factors referring to physical presence may not be relevant in electronic commerce, generally the test used in this option would be consistent in its application both to business carried on electronically and to business carried on by conventional means. Under this option the factors that would be examined include:









As a supplier’s need for a significant business presence in the jurisdiction of its international customers is reduced by electronic commerce, a non-resident making

18 “Place of operations” is purely a descriptive title used for ease of reference and is not meant to refer to one of the predominant factors in CCRA’s current policy.

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supplies by electronic means to residents of Canada may be less likely to be required to register for GST/HST purposes if this option were adopted than under the current policy.

Assuming an increase in cross-border trade in electronic commerce, and a possible decrease in the number of non-residents required to register for GST/HST purposes, the adoption of this option could result in more residents of Canada being required to self-assess GST/HST on acquisitions of intangible personal property and services than under the current policy.19 For example, a person who purchases software over the Internet from a non-resident non-registrant and downloads it to their computer system, would be required to self-assess and remit the GST/HST directly to the CCRA unless the software was for use exclusively in commercial activities of the person.

Place of contract20

Under this option, the place of contract would be the main factor used in identifying the place where a person is carrying on business for GST/HST purposes. Non-residents making supplies by electronic means would be required to register for GST/HST purposes if the contracts they enter into with their Canadian customers were considered to be made in Canada. For example, where a customer in Canada purchases and downloads a software package from a Web site of a non-resident and the terms of the agreement for the supply of the software stipulate that the place of contract is in Canada; the non-resident would be considered to be carrying on business in Canada.

Where conducting business over the Internet results in contracts being made in Canada, this option could result in increased registration compared with the current policy, since it relies only on the place of contract as a determining factor.

It should be noted that this option does not appear to be supportable based on the existing jurisprudence on “carrying on business in Canada”.

Type of business

Under this option factors similar to those under CCRA’s current policy would be used to determine the place where a business is carried on. However, the relative importance of certain factors in this determination would depend upon the type of business conducted.21 In this context, “type of business” refers to the type of supply being made by the business, i.e., tangible personal property, intangible personal property or services.

For supplies of goods ordered over the Internet, as under the CCRA’s current policy, emphasis would be placed on a number of factors (i.e., place of contract, place of operations from which profits arise and other factors such as location of inventory, place of delivery, place of manufacturing).

19 Section 218. 20 “Place of contract” is purely a descriptive title used for ease of reference and is not meant to refer to one of the predominant factors in CCRA’s current policy. 21 For example, see the approach used for income tax purposes in the CCRA Interpretation Bulletin IT-270R2, Foreign Tax Credit, which bases the relevance of factors to be employed on the particular business, available at: http://www.ccra-adrc.gc.ca/E/pub/tp/i270r2em/i270r2e.htm.

http://www.ccra-adrc.gc.ca/E/pub/tp/i270r2em/i270r2e.htm

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In contrast, where the supplier is engaged in making supplies of intangible personal property (e.g. software) or services by electronic means, emphasis would be placed on only some of these factors, such as those that do not require a physical presence, e.g., the place of contract, the place where orders are solicited, and the place where a service is performed.

For suppliers of intangible personal property or services made by electronic means this option could result in increased registration compared with the current policy, since it relies only on the place of contract (assuming the place of contract is in Canada). However, for suppliers of goods the determination for carrying on business in Canada would be the same as under the CCRA’s current policy, and as a result there would be no increase or decrease in registration of such suppliers.

Place of consumption

Under this option if a non-resident is making supplies that are consumed within Canada, the non-resident would be considered to be carrying on business in Canada for GST/HST purposes.

Registration would be required for all non-resident suppliers (other than small suppliers) of goods, services or intangibles made by electronic means where such supplies are for consumption in Canada.

It should be noted that this option does not appear to be supportable based on the existing jurisprudence on “carrying on business in Canada”.

Web site interactivity

Under this option, determining whether a non-resident making supplies by electronic means is carrying on business in Canada would take into account the degree of accessibility and interactivity it has with the consumer through its Web site. Interactivity would be based on a sliding scale.

One end of the scale would be the situation where a non-resident clearly transacted business with customers in Canada that involved the repeated transmission of computer files over the Internet. In this situation the non-resident would be considered to be carrying on business in Canada.

At the opposite end of the scale would be situations where a non-resident had simply posted information on a site that was accessible to users in Canada. In this situation, the non-resident would not be considered to be carrying on business in Canada.

Interactive Web sites, where users could exchange information with the host computer would occupy a position in the middle of the scale. In these situations, the level of interaction and the commercial nature of the exchange of information would determine whether the non-resident would be considered to be carrying on business in Canada.

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This option is founded on decisions made in non-tax cases involving the Internet in the United States, which establish a nexus (connection) to a particular state jurisdiction through Web site accessibility to the state’s residents. In these cases a Web site used to solicit orders from a jurisdiction may be enough to create a nexus with that jurisdiction.22

To the extent that non-residents are conducting business with customers in Canada using highly interactive Web sites, this option would increase the number of non-residents required to register for GST/HST purposes since it does not require physical presence in Canada.

ANALYSIS AND RECOMMENDATION

The following options for determining whether a non-resident is carrying on business in Canada were eliminated from further consideration for the reasons explained below:

• “Place of contract” relies on the place of contract as the main determining factor. Such heavy reliance on one factor would allow non-residents to avoid carrying on business in Canada merely by choosing to conclude contracts outside Canada. In addition, this option was rejected as it would not be supportable based on the existing jurisprudence with respect to “carrying on business in Canada”.

• “Type of business” emphasizes certain factors depending on the type of business conducted. This option was rejected because of its heavy reliance on factors such as the place of contract for supplies made by electronic means.

• Under the “Place of consumption” option, every non-resident (other than a small supplier) making taxable supplies for consumption in Canada would be required to register for GST/HST purposes. This option was rejected as it would not be supportable based on the existing jurisprudence with respect to “carrying on business in Canada”.

• “Web site interactivity” relies on the degree of interactivity and accessibility the non-resident has with customers in Canada through its Web site. On the surface, this option appears to be the most relevant as it takes into consideration new business processes available to persons making supplies by electronic means. Web site interactivity may be an appropriate test for determining carrying on business since the non-resident’s target market and the functionality of its Web site are matters usually determined for business, and not tax reasons. However, it was rejected because of the lack of supporting jurisprudence.

Since the above options were set aside, the only options remaining to be considered were the current administrative policy and “place of operations”.

Although the CCRA’s current policy is applicable with respect to supplies made by electronic means, it was recognized that the policy places reliance on a “predominant” factor (i.e., place of contract or place of operations from which profits arise) for determining carrying on business. As a result, the place of operations was considered to be the best approach because it avoids reliance on a “predominant” factor.

22 See for example, Zippo Manufacturing Company v. Zippo Dot Com, Inc., 952 F. Supp. 1119 (W.D. Pa. 1997)

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Therefore, it is proposed that the “place of operations” approach be adopted as the CCRA’s guideline for determining whether a non-resident is “carrying on business in Canada”. While such a determination is a question of fact, under this approach the factors to be considered by the CCRA would include, but not be limited to:









The weight to be ascribed to any particular factor would depend on the nature of the business under review and the particular facts and circumstances of each case.

Where a non-resident person is not required to register for the GST/HST under this approach, tax will be collected by Canada Customs at the border on the importation of goods, and through self-assessment by residents of Canada on the importation of intangible personal property and services.

In this regard it is important to remember that non-resident persons making supplies to consumers in Canada may register voluntarily for the GST/HST in cases where they regularly solicit orders of tangible personal property for delivery in Canada, or they have entered into an agreement for the supply of services to be performed in Canada or for the supply of intangible personal property to be used in Canada.

It is noted that some factors under this option may be less relevant for businesses engaged in electronic commerce than for those engaged in more conventional forms of commerce. In particular, those factors that rely on a non-resident having a physical presence in Canada, such as the place where the goods in question are manufactured, may be less applicable. In addition, some factors may require further description and explanation to take into consideration the particular nature of electronic commerce. For example, in determining the place where payment is made, rules concerning the place of posting or receipt of cheques may be replaced by other considerations such as the place where approval for the electronic transfer of funds takes place. Finally, new factors particular to electronic commerce may become relevant. For example, where computers are programmed to carry out transactions with little or no human involvement (e.g. a highly automated Web site that processes orders automatically) the place where the computer is located may become a factor for consideration. The CCRA’s GST/HST policy would develop over time to reflect these changes.

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APPLICATION OF RECOMMENDED APPROACH

The following examples illustrate the “place of operations” approach in comparison with the CCRA’s current policy as a means of determining whether a non-resident making supplies by electronic means is “carrying on business in Canada” without having a permanent establishment in Canada.

Example 1

A non-resident corporation supplies downloadable audio files by way of sale. The non-resident has a Web site hosted on its own server located at its main office in the United States. The non-resident advertises its Web site on the Internet and the advertisements are directed to the Canadian market. The Web site and server are fully interactive: the Canadian customer may view product listings of music and other advertising, place orders (including payment for audio files selected), and receive a downloaded copy of the purchased audio files without any contact with the non-resident corporation’s personnel. The place of contract is in Canada. The customer pays by credit card and an independent service provider located in Canada processes payment for the non-resident. Once the audio files are received by the customer they may be used in Canada. All customer service and after-sales support is provided by means of telephone or e-mail by the non-resident corporation’s personnel located in its main office in the United States.

In this example the non-resident would not be considered to be carrying on business in Canada under the “place of operations” approach. Of the list of factors to be considered, only the following would indicate some business activity of the non-resident in Canada: (1) advertising is directed to potential customers in Canada; (2) place of contract is in Canada; (3) purchases of the product are made in Canada; and (4) payment is processed in Canada. However, in general these factors would not, by themselves, indicate that the business was being carried on in Canada.

Under the CCRA’s current policy the non-resident in this example would likely be considered to be carrying on business in Canada because at least one of the predominant factors (i.e., the place of contract) is in Canada, and one or more of the other factors is in Canada (i.e., advertising, purchase and payment are in Canada).

Example 2

A non-resident vendor supplies the right to use various software applications to customers in Canada. The non-resident owns and controls a Web site located on a server in Canada. The server that stores and provides access to the Web site is owned and operated by an independent Internet Service Provider (ISP) and is therefore not at the disposal of the non-resident. The non-resident advertises its software applications on its Web site, and this advertising is directed to the Canadian market. In addition, the non-resident advertises its software applications and Web site in Canadian newspapers. The software applications are stored on the server as part of the Web site. The Canadian customer can order software applications by completing and submitting an order form on-line. Once the customer order form is submitted, the Web site processes the order automatically and grants the customer a right of access to the selected software applications. Customer access is controlled and monitored by use of a computer-generated user ID and password. Customers are invoiced automatically and electronically, according to the number of hours the applications are used. The customer

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may pay by credit card or cheque. An independent service provider located in Canada processes payment for the vendor. Finally, an independent contractor located in Canada provides after-sales customer support on behalf of the non-resident.

In this example the facts support that the non-resident is carrying on business in Canada under the “place of operations” approach. Of the list of factors to be considered, the following would indicate significant business activity of the non-resident in Canada: (1) activities performed by an automated, interactive Web site located in Canada, (2) advertising in Canadian newspapers, (3) the use of independent contractors located in Canada for after-sales customer support, and (4) the provision of payment processing by independent service providers located in Canada.

Under the CCRA’s current policy the non-resident would also be considered to be carrying on business in Canada.

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4 PERMANENT ESTABLISHMENT

INTRODUCTION

This section addresses the meaning of “permanent establishment” for GST/HST purposes in the context of electronic commerce.

Where a non-resident has a permanent establishment in Canada, the non-resident is treated as a resident of Canada and is subject to the same GST/HST obligations as a domestic supplier in respect of activities carried on through that permanent establishment. Where a non-resident (other than a small supplier) makes taxable sales through that permanent establishment, the non-resident is required to register for GST/HST purposes and to charge, collect and remit GST/HST on taxable supplies made in Canada. In addition, the non-resident is not required to post security23 with the CCRA.

The concept of permanent establishment is also important for direct tax purposes. Double taxation (i.e., taxation on the same income in two different countries) is generally avoided by entering into bilateral tax treaties which allocate taxing rights between countries. There are over 1500 bilateral tax treaties which follow the principles and the detailed provisions of the OECD Model Tax Convention (the Convention).24 The Convention provides that business profits of non-resident enterprises may only be taxed in a country to the extent that they are attributable to a permanent establishment that the enterprise has in that country. Canada’s tax treaties generally adopt a definition of permanent establishment as set out in Article 5 of the Convention.

As a consequence of the significance of the concept of permanent establishment for international direct tax purposes, it was recognized in the early stages of the consultation process with the GST TAG that the review of the concept of permanent establishment for GST/HST purposes could not be carried out in isolation. As a result, the CCRA decided to consider the results of the OECD study of “permanent establishment” for purposes of the Convention.

Working Party No.1 of the OECD25 released two drafts26 for public comment of its work on the Changes to the Commentary on the OECD Model Tax Convention on Article 5 (the Commentary) concerning the issue of the application of the current definition of permanent establishment in the context of electronic commerce. Comments received from the public assisted Working Party No.1 in drafting the recommended changes to the Commentary. The OECD Committee on Fiscal Affairs adopted these changes and released a final paper27 on the changes to the Commentary.28

23 Non-residents who do not maintain a permanent establishment in Canada and who become registered for GST/HST purposes must provide security to the CCRA. This security is intended to ensure that tax will be collected and remitted as required. Subsection 240(6) 24 http://www.oecd.org/oecd/pages/home/displaygeneral/0,3380,EN-about-104-3-no-no-no-104,FF.html 25 Working Party No. 1 on Tax Conventions and Related Questions is a subsidiary body of the OECD Committee on Fiscal Affairs and is responsible for drafting changes to the OECD Model Tax Convention. 26 October 1999 and March 2000. 27 The changes included in the paper deal exclusively with the permanent establishment definition as it currently appears in Article 5 of the OECD Model Tax Convention. The Technical Advisory Group on Monitoring the Application of Existing Treaty Norms for the Taxation of Business Profits in the Context of Electronic Commerce of the OECD is continuing to examine how the current treaty rules for taxation of business profits apply in the context of electronic commerce and examine proposals for alternative rules.

http://www.oecd.org/oecd/pages/home/displaygeneral/0,3380,EN-about-104-3-no-no-no-104,FF.html

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The consultative process of the CCRA and the GST TAG focused on the evaluation of the changes to the Commentary as put forward in the final paper. The following examines the conclusions made by the OECD and evaluates whether they could be adopted for Canadian GST/HST purposes.

THE OECD ON PERMANENT ESTABLISHMENT FOR ELECTRONIC COMMERCE

The Convention provides that business profits of a non-resident enterprise may only be taxed in a country to the extent that they are attributable to a permanent establishment the enterprise has in that country. Article 5 of the Convention defines the term “permanent establishment”.29

The OECD Committee on Fiscal Affairs has adopted changes to the Commentary to Article 5 of the Convention concerning the application of the current definition of “permanent establishment” in the context of electronic commerce. The recommended changes include the following determinations:

A Web site cannot, in itself, constitute a permanent establishment. 30

A Web site hosting arrangement typically does not result in a permanent establishment for the enterprise that carries on business through that Web site.31

An Internet service provider normally will not constitute a dependent agent of another enterprise so as to constitute a permanent establishment for that enterprise.32

The server on which the Web site is stored and through which it is accessible is a piece of equipment having a physical location and such location may thus constitute a “fixed place of business” of the enterprise that operates that server.33

While a place where computer equipment, such as a server, is located may in certain circumstances constitute a permanent establishment, this requires that the functions performed at that place be significant as well as an essential or core part of the business activity of the enterprise.

Refer to Appendix A for a complete copy of Clarification on the Application of the Permanent Establishment Definition in E-Commerce: Changes to the Commentary on Article 5, released by the OECD on December 22, 2000.

28 Clarification of the Application of the Permanent Establishment Definition in E-Commerce: Changes to the Commentary on the Model Tax Convention on Article 5, December 22, 2000, OECD Committee on Fiscal Affairs, available at: http://www.oecd.org/pdf/M000015000/M00015535.pdf 29 The table in Appendix B includes the text of Article 5 of the OECD Model Tax Convention. 30 Paragraph 42.2, Commentary on Article 5 of the OECD Model Tax Convention. 31 Paragraph 42.3, op. cit. 32 Paragraph 42.1, op. cit. 33 Paragraph 42.2, op. cit.


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BACKGROUND

Permanent establishment for GST/HST purposes is defined as follows:

“permanent establishment”, in respect of a particular person, means

(a) a fixed place of business of the particular person, including

(i) a place of management, a branch, an office, a factory or a workshop, and

(ii) a mine, an oil or gas well, a quarry, timberland or any other place of extraction of natural resources,

through which the particular person makes supplies, or

(b) fixed place of business of another person (other than a broker, general commission agent or other independent agent acting in the ordinary course of business) who is acting in Canada on behalf of the particular person and through whom the particular person makes supplies in the ordinary course of business;34

The CCRA’s interpretative policy on permanent establishment35 provides that the examples listed in the definition can each be regarded as constituting a fixed place of business provided that supplies are made through that fixed place of business. In situations where the examples do not apply, the following guidelines are considered when determining whether or not a person has a fixed place of business:

• There must be space (e.g., a physical presence ranging from a booth at an exhibition to an office);

• There must exist a degree of continuity and permanence in the place of business;

• Control must exist (i.e., there must be a person in the place of business who has the authority to make decisions with respect to the operations of the business); and

• Constant presence and ordinary routine must exist.

It is important to note that preparatory or auxiliary activities undertaken by a non-resident through a permanent establishment in Canada will not cause the non-resident to have to register for GST/HST purposes. Examples of preparatory or auxiliary activities are:

• The use of a fixed place of business solely for the purpose of storage, display or delivery of goods or merchandise belonging to the non-resident;

• The maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise or of collecting information for the non-resident; and

34 Subsection 123(1). 35 GST/HST Policy Statement P-208, The Phrases “Fixed Place of Business” and “Through Which the Particular Person Makes Supplies” in the Definition of “Permanent Establishment “, January 17, 1997, available at: http://www.ccra-adrc.gc.ca/E/pub/gl/p-208em/p-208-e.htm.

http://www.ccra-adrc.gc.ca/E/pub/gl/p-208em/p-208-e.htm

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• The maintenance of a fixed place of business, solely for the purpose of carrying on any combination of activities mentioned above, provided that the overall activity of the fixed place of business resulting from this combination is still considered to be of a preparatory or auxiliary nature.

The current interpretative policy does not specifically address paragraph (b) of the definition of “permanent establishment.”

Where a non-resident person has a permanent establishment in Canada, that person is considered to be resident in Canada in respect of, and only in respect of, the person’s activities carried on through that permanent establishment.36

As a result, a non-resident person with a permanent establishment in Canada is subject to the same registration requirements as a resident person.37 That is, the non-resident person must register for the GST/HST if taxable supplies are made in the course of a commercial activity carried on in Canada, unless the person is a small supplier.

Because a non-resident with a permanent establishment in Canada is treated as a resident with respect to supplies made through that permanent establishment, the following rules apply:

• Supplies made in Canada by the non-resident through the permanent establishment will not be subject to the special place of supply rules applicable to non-residents.38

• Supplies acquired by the non-resident at the permanent establishment in Canada may not be eligible for zero-rating.39

• The non-resident may be required to self-assess tax on the taxable importation of property and services acquired for consumption, use or supply through the permanent establishment. 40

For more detailed information regarding the above refer to section 7, “Place of Supply” in this paper.

In addition, a permanent establishment of a non-resident person situated in Canada is considered to be a separate person from any other permanent establishment of the non-resident person situated outside of Canada. 41 As a result, cross-border transactions between branches of the same entity may be subject to the GST/HST.

Non-resident persons who are required to register or who register voluntarily for GST/HST purposes must provide and maintain security if they do not have a permanent establishment in Canada.42

36 Subsection 132(2). 37 Subsection 240(1). 38Generally, the place of supply rules in subsection 143(1) deems a supply made by a non-resident non-registrant in Canada to be made outside of Canada unless certain conditions apply. 39 Zero-rating rules are found in Part V of Schedule VI. Many zero-rating rules require that the supply be made to a non-resident person. For example, section 7 of Part V of Schedule VI zero-rates supplies of most services “made to a non-resident person”. 40 Section 218. 41 Subsection 132(4). 42 Subsection 240(6).

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The definition of permanent establishment in Article 5 of the Model Tax Convention is similar to the definition of permanent establishment in the Excise Tax Act for purposes of the GST/HST.43 As a result the issues addressed by the OECD in its review of the Commentary in the context of electronic commerce are similar to those for GST/HST purposes. The OECD conclusions on these issues were therefore examined for GST/HST purposes.

ANALYSIS

Fixed Place of Business

For purposes of both the Convention and the GST/HST, in order to have a permanent establishment there must be a fixed place of business44. Therefore the analysis of the OECD in respect of whether a Web site, a Web site hosting arrangement and/or a server can be considered a “fixed place of business” of a person is relevant for GST/HST purposes.

The OECD adopted the conclusion that a Web site and a Web site hosting arrangement typically could not constitute a permanent establishment of an enterprise. However in certain cases, the place where a server is located could constitute a permanent establishment. The conclusions were supported by the following rationale:

• A Web site is not tangible property and therefore does not have a location that can constitute a place of business.

• A server is tangible property and therefore has a physical location which may constitute a “fixed place of business” of the person that operates the server. The server must be at the disposal45 of the person (for example, owned or leased and operated by the person). A Web site hosting arrangement typically does not result in the server being at the disposal of the enterprise. The server would also need to meet the requirement of being fixed (located at a certain place for a sufficient period of time).

For GST/HST purposes, in circumstances where a business does not require actual premises to function, and only has space available to it for its use, the space could qualify as a “fixed place of business”.46 Of the arrangements discussed above, only a server at a particular location could satisfy the requirement of space. That is, the server on which a Web site is stored and through which it is accessible is a piece of equipment having a physical location and such location may thus constitute a “fixed place of business” of the enterprise that operates that server.

43 Appendix B contains a comparison of the GST/HST and OECD concept of permanent establishment. 44 See Appendix B. 45 Paragraph 4 of the Commentary on Article 5 of the OECD Model Tax Convention elaborates that a place of business may exist where no premises are available or required for carrying on the business of the enterprise and it simply has a certain amount of space at its disposal. 46 Generally, the term “fixed” refers to a specific geographical location, such as “fixed address”. However, there may be cases where, for example, equipment is fixed by reference to space (i.e., a ship) that has mobility within a single jurisdiction.

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Human involvement at the place of business

The OECD adopted the conclusion that where an enterprise operates computer equipment at a particular location, a permanent establishment may exist at that location even though no personnel of the enterprise are required to carry on its business activities at that location.47

Under the current GST/HST administrative policy, the presence of personnel is an indicator that a particular person has a permanent establishment at a particular location. However, the presence of personnel is not a requirement of the definition of “permanent establishment” in the GST/HST legislation. Thus, the possibility that a business may be carried on at a particular location without personnel is not precluded under the Act.

Dependent agent

For purposes of the Convention, a principal is deemed to have a permanent establishment in a jurisdiction where a dependent agent habitually concludes contracts in the name of the principal in that jurisdiction.

For GST/HST purposes, a fixed place of business of another person who is acting on behalf of a particular person and through whom the particular person makes supplies will be considered to be a permanent establishment of the particular person.

The OECD adopted the conclusion that an Internet Service Provider (ISP) would not normally constitute a dependent agent of another enterprise, so as to constitute a permanent establishment for that enterprise. This conclusion was based on the fact that ISPs either do not generally have the authority to conclude contracts in the name of the enterprise and do not regularly conclude such contracts, or because they are independent agents acting in the ordinary course of their business, since they typically host Web sites of many different enterprises.

For GST/HST purposes, an ISP would generally not be making supplies on behalf of a particular person and therefore the fixed place of business of the ISP would not be a permanent establishment of the particular person.

Significant and essential activities

The Convention states that the term “permanent establishment” does not include certain activities that are considered to be preparatory or auxiliary.48 The Commentary expands this discussion by stating that the decisive criterion in determining whether a fixed place of business constitutes a permanent establishment is whether or not the activity of the fixed place of business in itself forms an essential and significant part of the activity of the enterprise as a whole.49

For GST/HST purposes, a fixed place of business will not constitute a permanent establishment where its activities are restricted to preparatory or auxiliary functions. A preparatory activity is considered to be a preliminary or introductory activity that serves to ready the business. An auxiliary activity is considered to be an aiding or contributory activity that is designed to support the main business. 47 Paragraphs 8 to 13 of the Commentary on Article 5 of the OECD Model Tax Convention 48 See Appendix B. 49 Paragraph 24 of the Commentary on Article 5 of the OECD Model Tax Convention.

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The OECD adopted the conclusion that, while a place where computer equipment (i.e. a server) is located may constitute a permanent establishment in electronic commerce, this requires that, in addition to being a fixed place of business, the functions performed through the computer equipment must be significant and essential business activities of the enterprise.50Where the activities carried on through computer equipment at a given location are restricted to those considered to be of a preparatory or auxiliary nature, the computer equipment will not constitute a permanent establishment. Examples of activities that would generally be regarded as preparatory or auxiliary include providing a communications link, advertising goods or services, relaying information through a mirror server for security or efficiency purposes, gathering market data, or supplying information.51

For GST/HST purposes, the activities of a person carried on through computer equipment at a particular place must be significant and essential in order for that place to be considered a permanent establishment of the person. As noted above, fixed place of business will not constitute a permanent establishment where the activities carried out at that place are restricted to preparatory or auxiliary functions.

RECOMMENDATION

Based on an evaluation of the foregoing it is recommended that for purposes of the definition of permanent establishment in the Excise Tax Act:

A Web site would not, in itself, constitute a permanent establishment.

A Web site hosting arrangement typically would not result in a permanent establishment for the enterprise that carries on business through that Web site.

A place where computer equipment, such as a server, is located may in certain circumstances constitute a permanent establishment, where the functions performed at that place are significant and an essential or core part of the business activity of the enterprise.

A permanent establishment could exist at a location even though no personnel of the enterprise are required to carry on its business activities at that location.

The fixed place of business of a particular person’s internet service provider would normally not constitute a permanent establishment of that person.

The adoption of these recommendations by CCRA would be consistent with those adopted by the OECD.

50 Paragraphs 42.8 and 42.9 of the Commentary on Article 5 of the OECD Model Tax Convention. 51 Paragraph 42.7 of the Commentary on Article 5 of the OECD Model Tax Convention.

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5 CHARACTERIZATION ISSUES FOR GST/HST PURPOSES

INTRODUCTION

This section addresses the characterization of supplies made by electronic means for purposes of the GST/HST. The characterization of a supply as tangible personal property, intangible personal property, real property or a service is fundamental to the application of the GST/HST.

The characterization of a supply is important for determining:

• the place of the supply;

• the timing of tax liability;

• whether the supply is subject to a zero-rating or exempting provision; and

• the manner in which tax is collected (under Division II, III or IV).

Electronic commerce allows suppliers to deliver to their customers certain products in an electronic form that have been traditionally regarded as tangible personal property. This “digitization” raises the issue as to whether such a supply can still be characterized as the supply of a good. As well, electronic commerce allows suppliers to automate services that were traditionally performed by individuals. This raises a question as to whether such supplies can still be characterized as supplies of services. At the OECD Ministerial Conference on electronic commerce held in Ottawa in October 1998 the Electronic Commerce Taxation Framework Conditions52 were endorsed. One of the key conclusions of the framework conditions was that for the purposes of consumption taxes and electronic commerce, the supply of digitized products should not be treated as a supply of goods. This conclusion was used as a building block for further work by the CCRA and the GST TAG on the issue of characterization.

BACKGROUND

The Excise Tax Act contains definitions of “property”, “personal property” and “service” in subsection 123(1).

“property” means any property, whether real or personal, movable or immovable, tangible or intangible, corporeal or incorporeal, and includes a right or interest of any kind, a share and a chose in action, but does not include money;

“personal property” means property that is not real property;

“service” means anything other than

(a) property,

52 Electronic Commerce: Taxation Framework Conditions, A Report by the Committee on Fiscal Affairs as presented to Ministers at the OECD Ministerial Conference “A Borderless World: Realising the Potential of Electronic Commerce”, October 8, 1998, available at: http://www.oecd.org/pdf/M000015000/M00015517.pdf


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(b) money, and

(c) anything that is supplied to an employer by a person who is or agrees to become an employee of the employer in the course of or in relation to the office or employment of that person.

For GST/HST purposes a supply by way of lease, licence or similar arrangement of the use or right to use real property or tangible personal property is deemed to be a supply of the underlying property.53

Any property that is not real property is either tangible or intangible personal property. While these terms are not defined by the Act, tangible personal property may be viewed as including all objects or things that may be touched or seen, and that are movable at the time the supply is made, other than money. Intangible personal property includes contractual rights, options, shares in the common stock of a corporation, the right to recover a debt, intellectual property (patents, trade-marks, trade-names), and rights in relation to goods that are not in possession and other rights which may be enforced by the courts, but does not include money.54

The CCRA has generally addressed the characterization of supplies, that is, distinguishing a supply of services from property (whether real property, tangible personal property or intangible personal property), on a case-by-case basis.

For example, the CCRA generally considers the sale of off-the-shelf (shrink-wrap) software to be a supply of tangible personal property or the importation of goods.55 However, the supply of software by way of lease, licence or similar arrangement where the software is delivered by electronic means is considered to be a supply of intangible personal property for GST/HST purposes. The supply of custom software, where the software is developed to the specifications of a particular recipient and where the recipient is the owner of the software, is considered to be a supply of a service.

Another example is the supply of photocopying. In most cases, photocopying is a supply of tangible personal property (i.e., the photocopies).56 However, under certain circumstances, the supply of photocopies may be considered the supply of a service where the recipient of the supply provides the necessary inputs. If a customer were to bring the original document and the paper on which to make the copies to the photocopy shop, then the supply of the photocopies would be a supply of a service.


The characterization of a particular supply as one of property or a service is a process that is fundamental to the application of GST/HST in any circumstances, including where supplies are delivered by electronic means. While there is general agreement that a supply delivered by electronic means is not a supply of goods, one must still determine

53 Subsection 136(1). 54 Memorandum 3.1 of the GST/HST Memoranda Series, Liability for Tax, August 1999, paragraphs 57 and 58, available at: http://www.ccra-adrc.gc.ca/E/pub/gm/3-1em/3-1-e.htm. 55 Technical Information Bulletin B-037R, Imported Software, November 1, 1994, available at: http://www.ccra-adrc.gc.ca/E/pub/gm/b-037rem/b-037r-e.html. 56 Policy Statement P-236, Supply of Photocopies, March 29, 2000 [effective July 1, 2000], available at: http://www.ccra-adrc.gc.ca/E/pub/gl/p-236em/p-236-e.htm.

http://www.ccra-adrc.gc.ca/E/pub/gm/3-1em/3-1-e.htm

http://www.ccra-adrc.gc.ca/E/pub/gm/b-037rem/b-037r-e.html

http://www.ccra-adrc.gc.ca/E/pub/gl/p-236em/p-236-e.htm

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whether the supply is one of intangible personal property or a service in order to determine the application of the GST/HST to the supply.

As previously indicated, the definition of “property” for GST/HST purposes includes intangible property. If a supply cannot be characterized as a supply of property (including intangible property), it is considered to be a supply of a service.57 Electronic commerce introduces particular challenges for characterization due to the ease with which intangible personal property (including property rights of any kind) and services can be supplied in a highly automated manner. In addition, supplies made by electronic means may often involve the making of a single supply of a number of elements.

To assist in the characterization of supplies made by electronic means, the following options were considered.

OPTIONS FOR CHARACTERIZATION

Factor Approach

The “Factor Approach” uses factors to determine whether a supply made by electronic means is best characterized as intangible personal property or a service. It is considered that characterization of these types of supplies is dependent upon the nature of the agreement between the supplier and the customer, and whether any rights (including rights of a temporary nature) are transferred between the supplier and customer.

Factors that would indicate a supply made by electronic means is one of intangible personal property are:

• A right in a product or a right to use the product for personal or commercial purposes is provided such as:

a. Intellectual property or the right to use intellectual property, e.g., a copyright.

b. Rights of a temporary nature, e.g., a right to view, access or use a product while on-line.

• A product has already been created or developed or is already in existence.

• A product is created or developed for a specific customer, but the supplier retains ownership of the product.

• A right to make a copy of the digitized product is provided.

Factors that would indicate a supply made by electronic means is a service and not one of intangible personal property are:

• There is human involvement in making the supply.

57 See definition of “service” in subsection 123(1).

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• The supply involves specific work that is performed by a person for a specific customer.

• The supply does not include a transfer of rights, e.g., technical know-how or if there is a transfer of rights, the rights are an incidental part of the supply.

Reliance on any one factor may not provide a sufficient basis for discerning the substance of the supply or supplies made. In cases where the applicable factors indicate more than one characterization the relative importance of each factor must be considered in the context of the supply.

The Factor Approach gives full effect to the definition of “property” in the Act as it considers all rights that could be transferred between a supplier and its customer, and provides a method for making consistent determinations. It is also flexible, as the factors can be given appropriate weight depending on the circumstances surrounding a particular transaction. It should be capable of dealing with new developments in electronic commerce businesses. However, there is an element of judgment required in applying the factors to any given supply.

Results Approach

The “Results Approach” looks at the underlying supply that results from the agreement between a supplier and customer. This approach does not rely upon whether a supply involves a right of access or another temporary or limited right to something but rather on the substance of what the customer is left with at the end of the transaction. The approach looks to whether a customer has a right to make a copy of the product or whether the product is only available while the customer is on-line. In the latter case, the substance of the supply is the limited use of the electronic product in a “managed environment”58 and therefore would more likely be the supply of a service. A supply would be characterized as one of intangible personal property in cases where the object of the supply is the right to make a copy of the product, or a right to use the product for personal use for an unlimited period of time or for commercial exploitation.

Supplies that are clearly intangible personal property are not at issue under this approach. For example, the supply of the copyright to an image or other such work is intangible personal property.

This Results Approach provides a method for making consistent determinations. It also has a certain intuitive appeal as property is generally thought of as something of lasting or future value, and supplies that expire or are used up during the course of the provision of a supply do not have this characteristic.

This approach however has a significant shortcoming as it does not give full effect to the definition of “property” in the GST/HST legislation, since it comes close to equating intangible personal property with intellectual property. The definition of “property” for GST/HST purposes includes tangible and intangible personal property and a right or interest of any kind, which is much broader than what would be considered intangible personal property under this approach.

58For purposes of this paper a “managed environment” is one in which a supplier provides the right to temporary on-line access to software and data and maintains the information technology environment that hosts the application software.

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ANALYSIS AND RECOMMENDATION

In evaluating the two approaches, supplies that are clearly intangible personal property are not at issue. An example of this type of supply is the supply of a downloaded book. Under both approaches the supply would be one of intangible personal property.

A supply that is clearly the provision of a service, which can now be delivered remotely by electronic means, would continue to be the supply of a service. An example of this type of supply is the supply of a legal opinion delivered to the client by e-mail.

At issue are supplies of which the nature has changed due to the introduction of technology to the process of making the supply. For example, where after-sales support may have been provided by an employee speaking to a customer over the telephone, now it may be provided through access to a technical database enabling the customer to search for the required information. Another example would be where, instead of purchasing a copy of game software, a customer can now subscribe to an Internet site that permits the customer to play the game on-line.

The difference between the characterization of these types of supplies under the two approaches can be illustrated by the following examples:

Example1

The customer can access and search a database (e.g., a site containing business addresses and telephone numbers) to retrieve specific data.

Factor Approach: The database is in existence and the customer is provided with the right to use the database and software (i.e., search engine) required to retrieve the information. There is no human involvement on the part of the supplier in the search and retrieval process. As a result, the supply would be a supply of intangible personal property.

Results Approach: The customer is simply allowed access to perform a search and to obtain the required information. Where the information is not subject to copyright the supply would be characterized as a service as the value to the customer is the ability to search and not the data.

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Example 2

The customer can access and use a software program (e.g., a games site) without being able to download a copy of the program.

Factor Approach: The software program is already in existence and the customer is provided with the right to use it. There is no human involvement on the part of the supplier in the making of the supply and the supply does not involve specific work performed for a specific customer. The supply would be considered to be a supply of intangible personal property.

Results Approach: Since a copy of the program is not being provided to the customer, and the customer can only access and use the program on the supplier’s server, the supply has no lasting value. As a result, the supply would be characterized as a service.

The fundamental difference between the Results Approach and the Factor Approach is that in the Results Approach, characterization relies on the substance of what the customer is left with at the end of the transaction, whereas the Factor Approach takes into account characteristics of a supply that may expire or be used up in the process of making the supply and therefore may not exist at the end. This reliance on the end result means that the Results Approach does not take into consideration all of the rights that may be considered property for GST/HST purposes.

As the Factor Approach considers the transfer of property rights of a lasting nature, such as the right to make a copy of a product, and also the transfer of property rights of a temporary nature, such as the right to view, access or use a product while the customer is on-line, it does take into consideration all of the rights that may be considered property for GST/HST purposes. Consequently, it is recommended that the Factor Approach be adopted as the framework for characterizing a supply made by electronic means.

APPLICATION OF RECOMMENDED APPROACH

To further illustrate the application of the Factor Approach to supplies that are made by electronic means, 28 examples of transactions were analyzed and characterized for GST/HST purposes.59 The examples describe a cross-section of typical electronic commerce supplies, but are not intended to reflect all types of transactions and contractual arrangements occurring over the Internet. Consequently, the characterization of these supplies should not be given broad application.

59 The examples are taken from the 28 categories of transactions developed by the Technical Advisory Group on Treaty Characterization of Electronic Commerce Payments of the OECD. This group was established by the OECD Committee on Fiscal Affairs to examine the characterization of various types of electronic commerce payments under tax conventions with a view to providing the necessary clarifications in the Commentary to the OECD Model Tax Convention. The group’s final report [Tax Treaty Characterization Issues Arising from E-Commerce - A Report to Working Party No. 1 of the OECD Committee on Fiscal Affairs, February 1, 2001, available at: http://www.oecd.org/pdf/M000015000/M00015536.pdf] analyzes whether income derived from electronic commerce transactions would be more appropriately classed as royalty income, as defined in the OECD Model Tax Convention or income from business profits. Although these categories were developed for the characterization of income for tax treaty purposes, the CCRA and the GST TAG found them useful in characterizing supplies made by electronic means for GST/HST purposes.


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Each example provides a short description of the business activities taking place, followed by a brief analysis of whether the supply is tangible personal property, intangible personal property or a service. For purposes of analysis, it is assumed that each example describes a single supply unless otherwise stated.60

The CCRA and the members of the GST TAG reached a consensus on the characterization of the supplies made in 23 of the 28 examples. In the remaining five examples, the opinion of the GST TAG differed from that of the CCRA as to the characterization of the supply. For these five examples a separate description of, and reasons for, the alternative result are provided.

The 28 examples have been classified into seven broad groupings of supplies for ease of reference.

I. Electronic Ordering of Goods

II. Electronic Ordering and Downloading of Digitized Products

III. Software Maintenance Contracts

IV. Application or Web Site Hosting and Data Warehousing

V. Supplies Related to Online Sales

VI. Subscription to Databases and Web Sites

VII. Information Provided by Electronic Means

I. Electronic Ordering of Goods

The supplies in this grouping typically involve a customer ordering goods by electronic means. The introduction of technology does not affect the nature of the supply as it remains tangible personal property.

Example 1. Electronic order processing of tangible products

The customer selects an item from an on-line catalogue of tangible goods and orders the item electronically directly from a commercial provider. There is no separate charge to the customer for using the on-line catalogue. The product is physically delivered to the customer by a common carrier. (OECD Category 1)

There was a consensus that this was a supply of tangible personal property.

There was a discussion as to whether the example was meant to focus on the use of the on-line catalogue, or the delivery of the good. It was agreed that it should be viewed as a supply of a good to a customer, and that the use of the on-line catalogue was merely an aspect of the ordering process.

60 CCRA has developed a policy, P-077R, Single and Multiple Supplies, April 1, 1998 that provides guidelines for the determination of whether a supply is a single supply or multiple supplies, available at: http://www.ccra-adrc.gc.ca/E/pub/gl/p-077rem/p-077r-e.htm.

http://www.ccra-adrc.gc.ca/E/pub/gl/p-077rem/p-077r-e.htm

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II. Electronic Ordering and Downloading of Digitized Products

These supplies typically involve a customer downloading a digitized product from a supplier. Such supplies would generally be characterized as intangible personal property. A limitation with respect to the frequency or period of use of a downloaded copy of a digitized product, even to a single occurrence, was not considered to alter the nature of the supply.

Example 2. Electronic ordering and downloading of digital products

The customer selects an item from an on-line catalogue of software or other digital products and orders the product electronically directly from a commercial provider. There is no separate charge to the customer for using the on-line catalogue. The digital product is downloaded onto the customer’s hard disk or other non-temporary media. (OECD Category 2)

There was a consensus that this was a supply of intangible personal property.

It was agreed that the supply in this example is downloaded software or other digitized product, and not access to the on-line catalogue. The product is already in existence as it is listed in the catalogue and available for downloading. A right to make a copy of the digitized product is provided as well as the right to use the product for personal or commercial purposes.

Example 3. Electronic ordering and downloading of digital products for purposes of commercial exploitation of the copyright

The customer selects an item from an on-line catalogue of software or other digital products and orders the product electronically directly from a commercial provider. There is no separate charge to the customer for using the on-line catalogue. The digital product is downloaded onto the customer’s hard disk or other non-temporary media. The customer acquires the right to commercially exploit the copyright in the digital product (e.g., a book publisher acquires a copyrighted picture to be included on the cover of a book that it is producing). (OECD Category 3)


This is similar to Example 2, except that the supply includes the right to commercially exploit the copyright in the digitized product.

Example 4. Updates and add-ons

The provider of software or other digital product agrees to provide the customer with updates and add-ons to the digital product. There is no agreement to produce updates or add-ons specifically for a given customer. (OECD Category 4).


The same logic and conclusions as outlined in Examples 2 and 3 would apply in characterizing the supply of an update or add-on. The customer is given the right to copy and the right to use the product for personal or commercial purposes.

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Example 5. Limited duration software and other digital information licences

The customer receives the right to use software or other digital products for a period of time that is less than the useful life of the product. The product is either downloaded electronically or delivered on a tangible medium such as a CD. All copies of the digital product are deleted or become unusable upon termination of the licence. (OECD Category 5).

There was a consensus that this could be interpreted in more than one way depending upon the facts.

• Where the software is supplied electronically (i.e., downloaded as a digitized product), it is the same type of supply as in Example 2, with the exception that the software can only be used for a limited period of time. The limitation of the period of use of the product does not affect its characterization as a supply of intangible personal property.

• Where the product is off-the-shelf (shrink wrapped) software delivered on a tangible medium, it would be characterized as tangible personal property.

Example 6. Single-use software or other digital product

The customer receives the right to use software or other digital products one time. The product may be either downloaded or used remotely (e.g., use of software stored on a remote server). The customer does not receive the right to make copies of the digital product other than as required to use the digital product for its intended use. (OECD Category 6)


The same logic and conclusions as outlined in Example 2 would apply. The limitation of the right to use the product to a single use does not affect the characterization.

Example 7. Subscription to a Web site allowing the downloading of digital products

The provider makes available to subscribers a Web site featuring copyrighted digital content (e.g., music). Subscribers pay a fixed periodic fee for access to the site. Unlike Example 23, the principal value of the site to subscribers is the possibility to download these digital products. (OECD Category 28)


The subscribers are acquiring the right to download digitized products from the Web site and therefore the supply is similar to that of Example 2.

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III. Software Maintenance Contracts

The supplies in this grouping typically combine software updates with technical support. Technical support may be provided on-line, by use of a trouble-shooting database, or by communications (e.g., e-mail), with human involvement. The supplies in this grouping are characterized as either intangible personal property or services depending upon the nature of the agreement between the supplier and the customer.

Example 8. Software maintenance

Software maintenance contracts typically bundle software updates together with technical support. A single annual fee is charged for both updates and technical support. In most cases, the principal object of the contract is the software updates. (OECD Category 12)


As the supply is essentially the provision of a software update delivered electronically, the supply is a supply of intangible personal property. As in Example 4, the customer is given the right to copy and the right to use the product for personal or commercial purposes.

Example 9. Customer support over a computer network

The provider provides the customer with on-line technical support, including installation advice and trouble-shooting information. This support can take the form of on-line technical documentation, a trouble-shooting database, and communications (e.g., by e-mail) with human technicians. (OECD Category 14)

There was a consensus the supply in this example could be characterized as either a supply of intangible personal property or a service depending on the facts.

The supply of technical support in this example includes on-line documentation, trouble-shooting database and advice from technicians. Where the supply is essentially a supply of interaction with technicians, the supply will be characterized as a service. In this case the supply would involve specific work performed for a specific customer.

Where the supply is essentially the supply of existing technical information in the form of on-line documentation and a database, the supply will be characterized as a supply of intangible personal property. In this case the supply would involve the right to use the documentation and database to obtain information.

IV. Application or Web Site Hosting, and Data Warehousing

These supplies include remote access and use of software, space on and access to servers to store data or run software, and technical support. The supplies in this grouping are characterized as either intangible personal property or services depending upon the nature of the agreement between the supplier and the customer and whether any rights are being transferred.

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Example 10. Application hosting − separate licence

A user has a perpetual licence to use a software product. The user enters into a contract with a host entity whereby the host entity loads the software copy on servers owned and operated by the host. The host provides technical support to protect against failures of the system. The user can access, execute and operate the software application remotely. The application is executed either at a customer’s computer after it is downloaded into RAM or remotely on the host’s server. This type of arrangement could apply, for example, for financial management, inventory control, human resource management or other enterprise resource management software applications. (OECD Category 7).

There was a consensus that this was the supply of a service.

As the agreement between the supplier and the customer is to host software on a server maintained by the supplier, and the software licence is held by the customer, there is no transfer of rights in property or for the use of property between the supplier and the customer.

In a typical transaction the supplier owns and maintains the equipment on which the application is hosted. The customer does not have possession or control of the equipment.

Example 11. Application hosting − bundled contract

For a single, bundled fee, the user enters into a contract whereby the provider, who is also the copyright owner, allows access to one or more software applications, hosts the software applications on a server owned and operated by the host, and provides technical support for the hardware and software. The user can access, execute and operate the software application remotely. The application is executed either at a customer’s computer after it is downloaded into RAM or remotely on the host’s server. The contract is renewable annually for an additional fee. (OECD Category 8)


This is similar to the supply in Example 10. However, as the supplier rather than the customer is the copyright holder for the software, there is a provision to the customer of the right to use the software. Although the supplier is also hosting the software application(s) on its server(s), and providing technical support for the hardware and the software, where the supply is essentially the provision of a right to use software it would be considered a supply of intangible personal property.

Example 12. Application Service Provider ("ASP")

The provider obtains a licence to use a software application in the provider’s business of being an application service provider. The provider makes available to the customer access to a software application hosted on computer servers owned and operated by the provider. The software automates a particular back-office business function for the customer. For example, the software might automate sourcing, ordering, payment, and delivery of goods or services used in the customer’s business, such as office supplies or travel arrangements. The provider does not provide the goods or services. It merely provides the customer with the means to automate and manage its interaction with

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third-party providers of these goods and services. The customer has no right to copy the software or to use the software other than on the provider’s server, and does not have possession or control of a software copy. (OECD Category 9).

There was a consensus that the supply in this example could be characterized as either a supply of intangible personal property or a service depending on the facts.

This is similar in substance to Example 11 if the supply is the provision of a right to use application software hosted by the supplier. The supply would be characterized as intangible personal property.

In contrast, where the ASP uses the software to perform one or more business functions for the customer, and the customer’s access is restricted to data entry only (i.e., the customer does not have a licence to use the software), the supply would be a service.

Example 13. ASP licence fees

In the example above, the ASP pays the provider of the software application a fee which is a percentage of the revenue collected from customers. The contract is for a one year term. (OECD Category 10)


As mentioned in Example 12 this is a supply of application software by way of licence. The fact that the supplier of the application software is remunerated based on a percentage of revenue collected from customers of the ASP was not considered to have any effect on the characterization of the supply.

Example 14. Web site hosting

The provider offers space on its server to host Web sites. The provider obtains no rights in the copyrights created by the developer of the Web site content. The owner of the copyrighted material on the site may remotely manipulate the site, including modifying the content on the site. The provider is compensated by a fee based on the passage of time. (OECD Category 11)

There was a consensus that this was a supply of a service.

This is similar to Example 10. As the agreement between the supplier and the customer is to host the customer’s Web site on a server maintained by the supplier, and the customer maintains all rights in the Web site, there is no transfer of rights in property or for the use of property between the supplier and the customer.

In a typical transaction the supplier owns and maintains the equipment on which the Web site is hosted. The customer does not have possession or control of the equipment.

Example 15. Data warehousing

The customer stores its computer data on computer servers owned and operated by the provider. The customer can access, upload, retrieve and manipulate data remotely. No software is licensed to the customer under this transaction. An example would be a retailer who stores its inventory records on the provider’s hardware and persons on the

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customer’s order desk remotely access this information to allow them to determine whether orders could be filled from current stock. (OECD Category 13)


This is similar to Example 14. The agreement between the supplier and the customer is to store the customer’s computer data on a server maintained by the supplier. Since no software is licensed to the customer and there is no indication of any other rights in property being transferred to the customer, the supply is considered to be a supply of a service.

V. Supplies Related to On-line Sales

The supplies in this grouping include advertising, referral, and representation on behalf of on-line suppliers of goods or services. The supplier provides a means of bringing consumers and merchants together on-line, but does not make the supply of the goods or services. The supplies would generally be characterized as services.

Example 16. Advertising

Advertisers pay to have their advertisements disseminated to users of a given Web site. So-called “banner ads” are small graphic images embedded in a Web page, which when clicked by the user will load the Web page specified by the advertiser. Advertising rates are most commonly specified in terms of a cost per thousand “impressions” (number of times the ad is displayed to a user), though rates might also be based on the number of “click-throughs” (number of times the ad is clicked by a user). (OECD Category 17)


The supplier is publicizing the message of the customer on its Web site. There is no supply of rights in property or for the use of property. The supply of publicizing a message is considered to be a supply of a service of advertising for GST/HST purposes.

Example 17. On-line shopping portals

A Web site operator hosts electronic catalogues of multiple merchants on its computer servers. Users of the Web site can select products from these catalogues and place orders on-line. The Web site operator has no contractual relationship with shoppers. It merely transmits orders to the merchants, who are responsible for accepting and fulfilling orders. The merchants pay the Web site operator a commission equal to a percentage of the orders placed through the site. (OECD Category 22)


This is similar to Examples 14 and 16. The Web site operator is hosting catalogues of merchants in order that consumers may select products and place orders on-line which are transmitted by the operator to the merchants. There is no transfer of rights in property or for the use of property between the Web site operator and the merchants.

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Example 18. On-line auctions

The provider displays many items for purchase by auction. The user purchases the items directly from the owner of the items, rather than from the enterprise operating the site. The vendor compensates the provider with a percentage of the sales price or a flat fee. (OECD Category 23)

There was a consensus that this was the supply of a service.

The same logic and conclusions as outlined in Example 17 apply in characterizing this supply in that no rights in property or for the use of property are transferred between the provider and the vendor.

Example 19. Sales referral programs

An on-line provider pays a sales commission to the operator of a Web site that refers sales leads to the provider. The Web site operator will list one or more of the provider’s products on the operator’s Web site. If a user clicks on one of these products, the user will retrieve a Web page from the provider’s site from which the product can be purchased. When the link on the operator’s Web page is used, the provider can identify the source of the sales lead and will pay the operator a percentage commission if the user buys the product. (OECD Category 24)


The same logic and conclusions as outlined in Example 17 apply in characterizing this supply in that no rights in property or for the use of property are transferred between the Web site operator and the on-line provider of the product.

Example 20. Carriage fees

A content provider pays a particular Web site or network operator in order to have its content displayed by the Web site or network operator. (OECD Category 27)


This is similar to Example 16. The Web site operator is displaying its customer’s content. There is no transfer of rights in property, or for the use of property between the operator and the content provider.

VI. Subscription to Databases and Web Sites

The supplies in this grouping typically involve the provider making digitized content available for customers for search, retrieval and use. These supplies would generally be characterized as intangible personal property.

Example 21. Data retrieval

The provider makes a repository of information available for customers to search and retrieve. The principal value to customers is the ability to search and extract a specific item of data from amongst a vast collection of widely available data. (OECD Category 15)

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A consensus was not reached as to the characterization of the supply in this example.

The CCRA’s view is that the supply should be characterized as intangible personal property as it generally involves the right to access and use the database and software programs or other content to search and retrieve information. There is no human involvement on the part of the supplier in the making of the supply to the customer.

The alternative view is that the supply should be characterized as a service, because any rights transferred would be insignificant and the principal value to the customer is the work performed by the supplier in order to maintain a managed environment.

Example 22 Delivery of exclusive or other high-value data

As in the previous example, the provider makes a repository of information available to customers. In this case, however, the data is of greater value to the customer than the means of finding and retrieving it. The provider adds significant value in terms of content (e.g., by adding analysis of raw data) but the resulting product is not prepared for a specific customer and no obligation to keep its contents confidential is imposed on customers. Examples of such products might include special industry or investment reports. Such reports are either sent electronically to subscribers or are made available for purchase and download from an on-line catalogue or index. (OECD Category 16)


The CCRA’s view is that the supply should be characterized as intangible personal property. In substance this is the same supply as Example 21. The supply generally involves the right to access and use the database and software programs or other content to search and retrieve information. There is no human involvement on the part of the supplier in the making of the supply to the customer. The fact that the data is of greater value than the ability to search does not affect the characterization of the supply.

The alternative view is that the supply would be a service for the same reasons as outlined in Example 21.

Example 23. Access to an interactive Web site

The provider makes available to subscribers a Web site featuring digital content, including information, music, video, games, and activities (whether or not developed or owned by the provider). Subscribers pay a fixed periodic fee for access to the site. The principal value of the site to subscribers is interacting with the site while online as opposed to getting a product or services from the site. (OECD Category 21)


The CCRA’s view is that the supply should be characterized as intangible personal property. In essence it is a supply to the subscriber of a right to use software, and the right to access other digitized content on the Web site. Although a copy of a digitized product is not provided, there is a transfer of property rights of a temporary nature such as a right to view, access or use a product while the customer is on-line. There is no human involvement in making the supply and the content on the Web site consists of existing products.

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The alternative view is that this can be considered the supply of a service because the principal value is the customer’s ability to interact with the Web site or with others through the Web site in a managed environment.

Example 24. Streamed (real time) Web-based broadcasting61

The user accesses a content database of copyrighted audio and/or visual material. The broadcaster receives subscription or advertising revenues. (OECD Category 26)

In this example it was determined that there were two separate supplies, that is, the provision of content database, and the provision of advertising by the “broadcaster”.

• Provision of content database

A consensus was not reached as to the characterization of this supply.

The CCRA’s view is that the supply should be characterized as intangible personal property. In essence it is a supply to the subscriber of a right to access and use the digitized content, software and programs on the Web site. This is the case even if a copy of the digitized product is not provided. There is no human involvement in making the supply and the content on the Web site consists of existing products.

The alternative view is that this can be considered the supply of a service because the principal value is the customer’s ability to interact with the Web site or with others through the Web site in a managed environment.

• Provision of advertising by a broadcaster

There was a consensus that this was a supply of a service for the reasons identified in Example 16.

VII. Information provided by electronic means

The supplies in this grouping range from professional advisory services, to the periodic electronic delivery of data to subscribers in accordance with their personal preferences. These supplies are characterized as either services or intangible personal property depending upon the extent of human involvement in the making of the supply. If the supply is of an existing product or product that was created for a group of customers who receive rights to the product (e.g., subscription for data delivered on a periodic basis), the supply would be characterized as intangible personal property.

Example 25. Electronic access to professional advice (e.g., consultancy)

A consultant, lawyer, doctor or other professional service provider advises customers through e-mail, video conferencing, or other remote means of communication. (OECD Category 18)


61 While the title in this example refers to “real time Web-based broadcasting”, the description of the supply is of a user accessing a content database rather than receiving a broadcast. For an example of Web-based broadcasting refer to section 6 of this paper entitled “Telecommunications”.

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The supply involves specific work that is performed by a person for a specific customer. The supply does not involve the transfer of rights to an existing product.

Example 26. Technical information

The customer is provided with undivulged technical information concerning a product or process (e.g., narrative description and diagrams of a secret manufacturing process). (OECD Category 19)

There was a consensus that the supply in this example could be characterized in more than one way, depending upon the facts.

Where the customer is provided with the right to use information by way of licence, whether the information is in existence or developed specifically for the customer, the supply is intangible personal property.

Where the supply is one of developing information for a specific customer, and the customer owns the information developed, the supply is characterized as a service.

Example 27. Information delivery

The provider electronically delivers data to subscribers periodically in accordance with their personal preferences. The principal value to customers is the convenience of receiving widely available information in a custom-packaged format tailored to their specific needs. (OECD Category 20)


The CCRA’s view is that the supply could be characterized as either a service or intangible personal property, depending upon the facts.

A supply of the right to custom-packaged information should be characterized as intangible personal property where there is no human involvement on the part of the supplier in the making of the supply.

However, where the supply essentially involves specific work that is performed by a person for a specific customer, the supply should be characterized as a service.

The alternative view is that the supply of custom-packaged information should be characterized as a service regardless of the extent of human involvement on the part of the supplier in the making of the supply.

Example 28. Content acquisition transactions

A Web site operator pays various content providers for news stories, information, and other on-line content in order to attract users to the site. Alternatively, the Web site operator might hire a content provider to create new content specifically for the Web site. (OECD Category 25)

There was a consensus that the supply in this example could be characterized in more than one way, depending upon the facts.

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Where the supply is the right to use content by way of licence, whether the content is in existence or developed specifically for the customer, the supply is characterized as intangible personal property.

Where the content provider is developing content specifically for the Web site operator, and the Web site operator owns the content developed, the supply is characterized as a service.

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6 TELECOMMUNICATIONS

INTRODUCTION

This section examines the issue of characterization of a supply as a telecommunication service for GST/HST purposes, that is, of determining whether or not a given supply is a telecommunication service. This determination is important because there are special GST/HST place of supply and zero-rating rules for telecommunication services which can impact both on the rate of tax applicable to a given supply and the manner in which the tax is collected.

Telecommunication systems are the backbone of the Internet, and, by extension, the backbone of electronic commerce. It is the underlying telecommunication systems that allow the interaction between computers, servers, and mainframes (i.e., the global public network of computers that make up the Internet), facilitating the transfer of signals, data, and information across the world. Without the telecommunication systems link by which signals, data, and information are distributed, electronic commerce would not be possible.

As part of the consultative process of the CCRA and the GST TAG, a number of indicators were developed to assist in determining whether a supply was that of a telecommunication service.

The focus of this section is on the characterization of a supply as a telecommunication service. The consequential application of the place of supply62 or the zero-rating rules63 to supplies characterized as telecommunication services is not examined.

BACKGROUND

A “telecommunication service” is defined for GST/HST purposes as:

(a) the service of emitting, transmitting or receiving signs, signals, writing, images or sounds or intelligence of any nature by wire, cable, radio, optical or other electromagnetic system, or by any similar technical system, or

(b) making available for such emission, transmission or reception telecommunications facilities of a person who carries on the business of supplying services referred to in paragraph (a)64

A “telecommunications facility” is defined for GST/HST purposes as:

any facility, apparatus or other thing (including any wire, cable, radio, optical or other electromagnetic system, or any similar technical system,

62 These rules are explained in Memorandum 3.3 of the GST/HST Memoranda Series, Place of Supply, April 2000, paragraphs 39-44, available at: http://www.ccra-adrc.gc.ca/E/pub/gm/3-3em/3-3-e.html. 63 These rules are explained in Memorandum 4.5.3 of the GST/HST Memoranda Series, Exports – Services and Intellectual Property, paragraphs 38-40, available at: http://www.ccra-adrc.gc.ca/E/pub/gm/4-5-3em/4-5-3-e.htm. 64 Subsection 123(1).

http://www.ccra-adrc.gc.ca/E/pub/gm/3-3em/3-3-e.html

http://www.ccra-adrc.gc.ca/E/pub/gm/4-5-3em/4-5-

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or any part thereof) that is used or is capable of being used for telecommunications65

The definition of "telecommunications facility" is broad in scope and includes satellites, downlink and uplink earth stations, fibre-optic transmission systems, telephones and fax machines.

The following are examples of a "telecommunication service":

• local and long-distance telephone services;

• cable and pay television;

• facsimiles and electronic mail;

• video, audio and computer link-ups;

• data transmission; and

• providing access to a telecommunications facility, such as a dedicated line. 66

The following supplies delivered by means of telecommunications are not considered to be “telecommunication services”:

• translation services;

• charges for the relocation of services;

• 1-900 numbers;

• wire news services; or

• directory assistance.67


For GST/HST purposes, the challenge is in determining whether a particular supply falls within the definition of a “telecommunication service”. Specifically, one must determine if the supply is a service of emitting, transmitting, or receiving signs, signals, etc. as described in the definition.

This determination is made difficult by the rapid evolution of technology in the telecommunications industry. Not only are there new supplies of telecommunication services but suppliers can also use telecommunication services as the means of delivering other products and services. Drawing the distinction between a

65 Ibid. 66Examples of “telecommunication service” taken from Towards Replacing the Goods & Services Tax Department of Finance Canada, 1996, pages 75-76, available at: http://www.fin.gc.ca/toce/1996/gstov-e.html 67 Ibid.

http://www.fin.gc.ca/toce/1996/gstove.html

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telecommunication service as a supply in itself, and telecommunications as a means by which another supply is made is an important issue for characterization.

The following indicators were developed to assist in the characterization of a supply as a telecommunication service.

INDICATORS FOR CHARACTERIZATION

The following indicators point to a supply being a telecommunication service:

• The predominant purpose of the supply is to provide for the emission, transmission or reception of signs, signals, etc. (e.g., voice or data) through a telecommunications network or similar technical system.

• The predominant purpose of the supply is to make available a telecommunications facility, for the emission, transmission or reception of signs, signals, etc. through a telecommunications network or similar technical system.

• The predominant purpose of the supply is to provide a means through which other services or intangible personal property (e.g., content in a digitized format) are delivered, rather than to provide the services or intangible property.

• The supplier is not supplying the content that is emitted, transmitted, or received.

The following indicators point to a supply not being a telecommunication service:

• The predominant purpose of the supply is other than the provision of a telecommunication service.

• A telecommunication service is used or consumed by the supplier in making a supply of a service or property (other than a telecommunication service).

• The supply includes the provision of a telecommunication service but only as a means of delivering another service or property.

• The supply of a telecommunication service is incidental to a supply of another service or property.

EXAMPLES

The following are typical examples of supplies where the issue arises as to whether a supply is considered to be a telecommunication service for GST/HST purposes. The CCRA and members of the GST TAG generally reached a consensus on the characterization of supplies. Where the opinion of the GST TAG differed from that of the CCRA, the alternative view is provided.

Internet access service

A consumer pays a fee to an Internet Service Provider (ISP) for Internet access. The connection is made by a modem, which allows the consumer to send and receive data

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over a telephone line. The telephone line is supplied to the consumer by a third party provider of telephone services. To access the Internet, a user “calls” the ISP to log on (if not already connected), and the user’s request for a particular Web site is routed to the server hosting the desired data.

The CCRA’s view is that this is a supply of a telecommunication service.

The predominant purpose of the service is to provide the consumer with a connection allowing transmission and reception of data over the Internet. Generally, this is the predominant purpose of the service even where the ISP provides content or access to content as part of its service. Simply put, the recipient is generally looking to the ISP to supply the means by which access to the Internet is obtained.

The alternative view is that the supply made by the ISP is access to the information content on the Internet and therefore not a telecommunication service.

E-mail

A company contracts with a vendor for the provision of e-mail services. For a fee, the vendor will ensure that the company’s personnel will be able to send and receive intra-office and external e-mails. The vendor dedicates space on a server for the composition, reception and storage of e-mail messages sent to or by the company. The company is provided with e-mail addresses (ID), a mailbox, and the use of a network, thus allowing its employees to send, receive and store information on a secure basis. The company addresses its outgoing e-mail to a recipient’s e-mail address, and the mail is routed to the server and forwarded to its final destination. Incoming mail addressed to the company is routed to the server and directed to a particular employee.

There was a consensus that this was a supply of a telecommunication service.

The predominant purpose of the service is to allow the company to send and receive electronic mail. The vendor is providing the company with a service of transmitting writing, images, etc., by means of its server and the use of a network.

Web site hosting

A company enters into an agreement with an ISP to provide Web site hosting services for the company’s Web site. Under the agreement, the ISP is responsible for housing the Web site on a server owned and maintained by the ISP. This includes ensuring the security of the server and ensuring that the Web site is accessible over the Internet. The server is linked to the Internet through dedicated lines acquired from a telephone service provider. The company is responsible for the design and content of the Web site. The agreement only addresses the arrangements for Web site hosting and does not deal with Internet access.

There was a consensus that this was not a supply of a telecommunication service.

The predominant purpose of the supply is the storage and maintenance of the Web site on a server in a manner that allows access to the Web site on the Internet. In making the supply of this service the ISP uses or consumes a number of inputs (telecommunication services, hardware, and software).

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Internet access services, e-mail and Web site hosting

A consumer pays a fee to an ISP for Internet access. In addition to the Internet access, the consumer receives e-mail services and space on the ISP’s server to create and maintain a personal Web page. The consumer determines the content of the Web page, but the page is hosted on the ISP’s server.

The CCRA’s view is that the services provided by the ISP are supplies of telecommunication services.

This is a typical transaction between an ISP and an individual consumer. The ISP is making a single supply which includes providing the consumer with a connection to the Internet, an e-mail account and space on the ISP’s server. The predominant purpose of the supply to the consumer is the connection to the Internet. As in the case of Internet access services, the supply of a connection to the Internet is considered to be a telecommunication service.

The alternative view is that the supply made by the ISP is access to the information content on the Internet and therefore not a telecommunication service.

Voice telephony services provided through the Internet

A consumer pays a fee to a company for long distance “telephone calls” made over the Internet. The consumer is able to place “telephone calls” from his/her computer or telephone to any place in the world. The calls are routed through the networks that make up the Internet backbone.

There was a consensus that this was a supply of a telecommunication service.

The predominant purpose of the supply is to provide transmission of voice communication. The supplier of the voice telephony is providing a traditional voice telephone service, except that the service is being provided over the Internet.

Electronic Data Interchange (EDI) transmission of income tax returns

A company is engaged by an approved EFILE tax preparer to electronically file income tax returns for its clients. The tax preparer completes all of the income tax returns prior to submitting them to the company for electronic submission. Upon receipt of the returns, the company validates the format of the returns, encrypts the data, validates the values indicated in the tax return boxes (e.g., SIN numbers), and electronically submits the returns to the CCRA.

There was a consensus that the service provided by the company to the tax preparer was a telecommunication service.

The predominant purpose of the supply is the electronic transmission of data. The validation and encryption are part of the service of transmitting the data.

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Preparation and EDI transmission of income tax returns

A consumer pays a fee to a tax preparer to prepare and electronically file his or her income tax return with the CCRA. The tax preparer completes the income tax return, validates the format and values, encrypts the data, and electronically transmits the return to the CCRA.

There was a consensus that the supply provided by the tax preparer was not a telecommunication service.

The tax preparer is making a single supply which includes a number of constituent elements, e.g., the preparation of the tax return and its transmission to the CCRA. The predominant purpose of the supply is the preparation of the tax return. Therefore, the supply is not a telecommunication service.

Provision of digitized products (e.g., film, video, music)

A consumer selects and orders a digitized product from a commercial provider. The digitized product is downloaded onto the consumer’s hard drive or other non-temporary media of the consumer’s choice.

There was a consensus that the provision of the digitized products was not a supply of a telecommunication service.

The supply of a digitized product that is readily available for download over the Internet is the supply of intangible personal property (IPP).68 A telecommunication service is used or consumed by the supplier in making the supply of the digitized product.

Web-based broadcasting

A consumer pays a subscription fee for access to audio and/or visual content that is streamed (broadcast in real time) over the Internet. A copy of the content is not provided to the consumer.

There was a consensus that the supply of the audio and/or visual content streamed over the Internet was a telecommunication service.

The predominant purpose of the supply is to provide the consumer with the right to receive the content being broadcast. This is analogous to a traditional radio or television broadcasting service. The supply of broadcasting is considered to be a telecommunication service for GST/HST purposes.

68 Refer to explanation in Example 2 of the section entitled “Characterization Issues for GST/HST Purposes”.

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7 PLACE OF SUPPLY

INTRODUCTION

This section examines the application of the GST place of supply rules to supplies made by electronic means and the consequential application of the import and export rules to these supplies.69 This examination was carried out by the CCRA in consultation with the GST TAG.

The GST is a tax on consumption in Canada. As such, the GST applies to domestic purchases and to imports of property and services. Property and services consumed outside Canada are not subject to the GST.

The GST place of supply, export and import rules operate in the following manner to tax consumption in Canada:

• The GST is imposed on supplies of property and services made in Canada. The GST place of supply rules determine whether a supply is made in Canada or outside Canada.

• Generally where a taxable supply is made in Canada, tax is payable by the recipient of the supply and collectable and remittable by the supplier as agent of the Crown.70

• However a taxable supply made in Canada that is exported for consumption outside Canada is zero-rated (taxed at a rate of 0%).71 A supplier is not required to collect tax on zero-rated supplies.

• Where goods are imported into Canada tax is collected by Customs at the border.72

• A recipient may be required to self-assess tax in respect of a taxable supply of intangibles or services made outside Canada and imported into Canada.73

It should be noted that this section does not examine the place of supply rules for the Harmonized Sales Tax (HST). 74

BACKGROUND

As supplies made by electronic means are characterized as either intangible personal property or services, the place of supply, import and export rules as they relate to tangible personal property or real property are not discussed in this section.

69 Telecommunication services are governed by separate place of supply and export rules unique to those supplies and are not examined in this section. 70 Section 165 and 221. 71 The export rules are in Part V of Schedule VI. 72 Section 212. 73 Section 218. 74 The Harmonized Sales Tax (HST) is imposed on taxable supplies made in three provinces of Canada Nova Scotia, New Brunswick, and Newfoundland referred to as participating provinces. The HST is administered by the CCRA and is imposed by the Excise Tax Act. Place of supply rules determine whether a supply is made in a participating province and are different from the general place of supply rules for GST.

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For purposes of this review, it is important to note that a non-resident with a permanent establishment in Canada is considered to be a resident of Canada in respect of activities carried on through that establishment, and a resident with a permanent establishment outside Canada is considered to be a non-resident in respect of activities carried on through that establishment.75

Place of supply

There are specific place of supply rules76 for supplies of intangible personal property and for services. This highlights the importance of the characterization issue discussed in section 5 of this paper.

A supply of intangible personal property is made in Canada if:

• the property may be used in whole or in part in Canada, or

• the property relates to real property situated in Canada, to tangible personal property ordinarily situated in Canada, or to a service to be performed in Canada.

A supply of intangible personal property is made outside Canada if:

• the property may not be used in Canada, or

• the property relates to real property situated outside Canada, to tangible personal property ordinarily situated outside Canada, or to a service to be performed wholly outside Canada.

A supply of a service is made in Canada if the service is, or is to be, performed in whole or in part in Canada, or the service relates to real property situated in Canada.

A supply of a service is made outside Canada if the service is, or is to be, performed wholly outside Canada, or the service relates to real property situated outside Canada.

Non-residents may be subject to special place of supply rules. 77 A supply of personal property or a service made by a non-resident is made outside Canada unless:

• the supply is made in the course of a business carried on in Canada;78 or

• the non-resident is registered for GST/HST purposes at the time the supply is made.

Exports

The export provisions zero-rate certain supplies of intangible personal property and services made in Canada to a non-resident person.

A supply of intangible personal property made to a non-resident is only zero-rated where the non-resident is not registered and it is a supply of intellectual property. This includes

75 Subsections 132(2) and 132(3). 76 Section 142. 77 Section 143. 78 For a discussion of “Carrying on Business in Canada” see section 3 of this paper.

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an invention, patent, trade secret, trade-mark, trade-name, copyright, industrial design or any right, licence or privilege to use any such property.79

Under the general zero-rating provision for exported services80, a supply of a service made to a non-resident person is zero-rated. However, there are certain exceptions to this rule, for example:

• a supply of a service made to an individual who is in Canada when in contact with the supplier in relation to the supply;

• an advisory, consulting or professional service;

• a service in respect of real property situated in Canada;

• a service in respect of tangible personal property that is situated in Canada at the time the service is performed;

• a service of acting as an agent of the non-resident person or of arranging for, procuring or soliciting orders for supplies by or to the person.

There are specific zero-rating provisions for certain exported services including some of those excluded from the general provision, such as:

• a supply of an advertising service made to a non-resident person who is not registered;81

• a supply of a service of instructing non-resident individuals in certain courses or administering certain examinations when the supply is made to a non-resident who is not an individual and is not registered;82

• subject to certain exceptions, a supply of an advisory, professional or consulting service made to a non-resident person.83

Imports

The recipient of a taxable (other than a zero-rated) supply is required to self-assess and remit tax in respect of importations of intangible personal property or services where the recipient is a resident84 of Canada and the supply is acquired for use in Canada otherwise than exclusively in the course of a commercial activity. Therefore a person is not required to self-assess tax where a full input tax credit could be claimed if the person were a registrant.85

Certain supplies of intangible personal property made outside Canada to residents are excluded from the self-assessment provisions, for example where the intangible personal property relates to real property situated outside Canada, to a service to be

79 Section 10 of Part V of Schedule VI. 80 Section 7 of Part V of Schedule VI. 81 Section 8 of Part V of Schedule VI. 82 Section 18 of Part V of Schedule VI. 83 Section 23 of Part V of Schedule VI 84 Rules for determining whether a person is resident in Canada are in section 132. 85 Section 217.

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performed wholly outside Canada or to tangible personal property situated outside Canada.86

Certain supplies of services made outside Canada to residents are excluded from the self-assessment provisions, for example entertainment services consumed by employees while on business travel outside Canada, a service in respect of real property situated outside Canada, a service in respect of tangible personal property situated outside Canada at the time the service is performed, and a transportation service.87

Where a recipient is required to self-assess tax, the amount is based on the value of the consideration for the supply. The recipient is required to pay the tax to the Receiver General for Canada and file a return in respect of that tax.88


Traditional concepts used to determine the place of supply of intangible personal property or services, such as the place where intangible personal property may be used or the place where a service is performed, become more difficult to apply to supplies made electronically.

For intangible personal property, the primary interpretative issue for place of supply in respect of supplies made electronically is determining whether the supply is made in Canada in cases where there are no contractual or legal restrictions as to the jurisdiction where the property may be used.

For services, the principal interpretative issue for place of supply is determining whether a service is performed in whole or in part in Canada, when the service is delivered from a remote location by electronic means.

INTANGIBLE PERSONAL PROPERTY

Analysis

The GST place of supply rule for intangible personal property deems a supply to be made in Canada if it “may be used in whole or in part” in Canada. The term “may be used” is interpreted to mean “capable of being used.” In other words, a supply of intangible personal property could be considered to be made in Canada even where it is not actually used in Canada. The fact that the supply may be made to a recipient who is outside Canada has no bearing on whether the supply is made in Canada.

In determining whether intangible personal property may be used in Canada, reference may be made to any written agreement for the supply. An agreement containing terms governing the place of use of the intangible personal property is common in a business-to-business transaction. In consumer transactions there may be a general restriction as to the use of the intangible personal property to which the recipient agrees either expressly or by implication upon acquisition of the supply. For example, the restriction might be explained on the Web site through which the product is supplied.

86 Paragraph 217(c). 87 Paragraph 217(a). 88 Sections 218 and 219.

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Application

The following cases illustrate the application of the place of supply rules, in combination with the import and export rules, to supplies of intangible personal property made by electronic means.

Case 1. Non-resident supplier who is not registered

A taxable supply of intangible personal property is made to a recipient by electronic means. The supplier is a non-resident who is not registered for the GST and is not making the supply in the course of a business carried on in Canada. The property is acquired for consumption, use, or supply in the course of the recipient’s activities in Canada.

In this situation it is not necessary to determine the place where the intangible personal property may be used. As the supplier is a non-resident who is not registered and is not making the supply in the course of business carried on in Canada, the place of supply rules for non-residents apply and the supply is considered to be made outside Canada. As a result, the supplier is not required to collect tax, but the recipient may be required to self-assess tax.

The application of tax to the supply is as follows:

1. Recipient is a resident of Canada: The recipient is required to self-assess tax unless the property is acquired for consumption, use or supply exclusively in commercial activities.

2. Recipient is a non-resident who has a permanent establishment in Canada: The recipient is considered to be a resident of Canada for activities of the person carried on through the permanent establishment in Canada. The recipient is required to self-assess tax where the property is for use, consumption or supply otherwise than exclusively in the course of the recipient’s commercial activities carried out through that permanent establishment in Canada.

3. Recipient is a non-resident who does not have a permanent establishment in Canada: The recipient is not a resident of Canada and therefore is not subject to the self-assessment rules. Tax does not apply even where the property will be used in Canada.

Case 2. Registered suppliers of intellectual property

Intangible personal property that is intellectual property (e.g., software) is supplied to a recipient by electronic means. There are no restrictions with respect to the place of use of the intangible personal property under the terms of the agreement for the supply. The supplier is a registrant.

Since there are no restrictions on the place of use of the intellectual property, the supply is made in Canada. The supplier is a registrant and is therefore required to collect tax. However, as the supply is intellectual property, the supply may be zero-rated if it is supplied to a non-resident, non-registrant.

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1. Recipient is a resident of Canada who is not registered: The supplier is required to charge tax.

2. Recipient is a resident of Canada who is registered: The supplier is required to charge tax.

3. Recipient is a resident of Canada who is registered with a permanent establishment outside Canada: The recipient is considered to be a non-resident with respect to the activities carried on through the permanent establishment outside Canada. Even if the intellectual property is for use solely in the activities of the permanent establishment outside Canada, the supplier is required to charge tax, because the place of supply is in Canada. The supply is not zero-rated because the recipient is registered.

4. Recipient is a resident of Canada who is not registered, with a permanent establishment outside Canada: If the recipient acquires the intellectual property for use solely in activities of the permanent establishment outside Canada, the supply is zero-rated.

5. Recipient is a non-resident who is registered, with a permanent establishment in Canada: The supply is not zero-rated as the recipient is a registrant. The supplier is required to charge tax.

6. Recipient is a non-resident who is registered and who does not have a permanent establishment in Canada: The supply is not zero-rated as the recipient is a registrant. The supplier is required to charge tax.

7. Recipient is a non-resident non-registrant: The supply is zero-rated.

Case 3. Registered suppliers of intangible personal property that is not intellectual property

Intangible personal property that is not intellectual property (e.g. access to a database) is supplied to a recipient by electronic means. Under the terms of the agreement for the supply, there are no restrictions in respect of the place from which the customer may access the information, or where the information may be used. The supplier is a registrant.

As there are no restrictions on the place of use of the intangible personal property, the supply is made in Canada. The supplier is required to collect tax. Since this is a supply of intangible personal property other than intellectual property the supply is not eligible for zero-rating.

SERVICES

Analysis

A service is supplied in Canada if it is “performed” in whole or in part in Canada. Although, the word “performed” is not defined in the legislation, traditionally the place of performance of a service is the physical place where the person doing the work is

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situated. For example, where a non-resident supplier sends a technician to Canada to provide programming services, the place of performance is in Canada.

Where all of the activities carried out by the supplier in performing the service are clearly undertaken in Canada (i.e., the employees performing the service are in Canada, or the supplier’s equipment used in providing the service is located in Canada) the place of performance of the service is not an issue. However, with electronic commerce, determining the place of performance of a service is problematic since services can be delivered electronically from outside Canada. For example a supplier, rather than sending the technician to Canada, can have the technician perform the work from outside Canada by electronically accessing the customer’s software.

As technology allows a service provider to carry out work from outside Canada on a customer’s property located in Canada determining the place of performance of the service becomes an issue. Since the “physical place” where the work is performed is both at the location of the service provider and the location of the customer’s property that is the object of the service, it is necessary to take into account the location of the customer’s property in determining the place of performance.

Services that are wholly performed outside Canada and then delivered electronically to the recipient’s computer in Canada are considered to be made outside Canada. For example, the supply of a programming service where the programming is done at the supplier’s location outside Canada and e-mailed to a recipient in Canada, is considered to be made outside Canada.

For GST purposes, a supply of a service is made in Canada if it is performed in whole or in part in Canada. In order to determine whether the service is partly performed in Canada all aspects of the service being supplied must be considered. Electronic commerce makes it easier for a supplier to provide different aspects of a service from different jurisdictions. For example, a programming service may be supplied from one jurisdiction and technical support for that service may be provided from another jurisdiction.

Administrative activities related to a particular supply of a service are considered in determining whether the supply is made in Canada. These activities can also be provided from a jurisdiction other than that where the work is performed. For example, a supplier prepares a report in Canada in respect of programming services carried out outside Canada.

On the other hand, administrative activities that support the business operations of the supplier (i.e., keeping books and records, hiring of personnel, marketing, financing, etc.) which are not undertaken in respect of a particular supply, are not considered in determining whether the supply is made in Canada.

Recommendation

While it is necessary to examine each supply of a service on a case-by-case basis, a supply of a service will be performed at least in part in Canada if:

• the service requires a person performing a task (i.e., the supplier acting through one or more of its employees), and the person performing or physically carrying out the task is situated in Canada at the time the activity is done;

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• the service includes operations performed by the supplier’s computer equipment, and the computer equipment is located in Canada;

• the supply involves doing something to or with the recipient’s computers by accessing them from a remote location and the recipient’s computers are in Canada. (Note: this element does not apply to performing a service and then delivering the results electronically to the recipient’s computers); or

• any administrative activity related to the supply of that service is in Canada.

This approach looks at the entire range of activities related to a supply, and if any of those activities are performed in Canada, the place of supply is in Canada.

Application

The following cases illustrate the application of the GST place of supply rules based on the recommended approach, in combination with the import and export rules, to supplies of services made by electronic means.

Case 4. Non-resident supplier who is not registered

A taxable supply of a service is made to a recipient by electronic means. The supplier is a non-resident who is not registered for the GST and is not making the supply in the course of a business carried on in Canada. The service is acquired for consumption, use, or supply in the course of the recipient’s activities in Canada.

In this example, it is not necessary to determine whether the service was “performed” in Canada. As the supplier is a non-resident who is not registered and is not making the supply in the course of a business carried on in Canada, the place of supply rules for non-residents apply and the supply of the service is considered to be made outside Canada. The supplier is not required to collect tax, but the recipient may be required to self-assess tax.


1. The recipient is a resident of Canada: The recipient is required to self-assess tax, unless the recipient has acquired the service for consumption, use or supply exclusively in commercial activities.89

2. Recipient is a non-resident and has a permanent establishment in Canada: The recipient is considered to be a resident of Canada for the activities of the person carried on through a permanent establishment in Canada. The recipient is required to self-assess tax if the service is for use, consumption or supply otherwise than exclusively in the course of the recipient’s commercial activity carried out through that permanent establishment in Canada.

3. Recipient is a non-resident and does not have a permanent establishment in Canada: The recipient is not a resident of Canada and therefore is not subject to the self-assessment rules. Tax does not apply.

89 There are other exclusions under section 217. However, for purposes of this illustration they are not relevant.

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Case 5. Registered suppliers of services

A service (e.g., a hosting service) is supplied to a recipient by electronic means. The supplier who is a registrant provides technical support for the hosting service by remotely accessing the recipient’s computers in Canada.

Under the proposed approach for determining the place of supply of a service, even when the employee who is physically performing the work is located outside Canada, the service is considered to be partly performed in Canada as the supply involves carrying out work on the recipient’s computers located in Canada. As a result, the service is made in Canada and the supplier is required to collect tax. The supply may be zero-rated provided that none of the exceptions apply.

The application of the tax to the supply is as follows:

1. Recipient is a resident of Canada who is not registered (or is registered but is not using the hosting service exclusively in commercial activities): The supplier is required to charge tax.

2. Recipient is a resident of Canada who is registered: The supplier is required to charge tax.90

3. Recipient is a non-resident who is registered, with a permanent establishment in Canada: The supplier is required to charge tax. The zero-rating provisions for exports do not apply, since the non-resident is deemed to be a resident because of the presence of a permanent establishment in Canada.

4. Recipient is a non-resident who is registered, and does not have a permanent establishment in Canada: Since the non-resident does not have a permanent establishment in Canada, the supply is zero-rated, provided that none of the exceptions91 apply.

5. Recipient is a non-resident who is not registered: The supply is zero-rated, provided that none of the exceptions apply.

90 Zero-rating might be available for some services as explained below.

1. Recipient is a resident of Canada who is registered, with a permanent establishment outside Canada: If the recipient acquires the supply for use in a permanent establishment outside Canada solely in the course of the permanent establishment’s activities (i.e., the service is not used in Canada either in whole or in part), the recipient is considered to be a non-resident for that purpose and the supply may be eligible for zero-rating, provided that none of the exceptions apply. Otherwise the supply is subject to tax (i.e., the service is used both in and outside Canada).

2. Recipient is a resident of Canada who is not registered, with a permanent establishment outside Canada: If the recipient acquires the supply for use in a permanent establishment outside Canada solely in the course of the permanent establishment’s activities (i.e., the service is not used in Canada either in whole or in part), the recipient is considered to be a non-resident for that purpose and the supply may be eligible for zero-rating, provided that none of the exceptions apply. Otherwise the supply is subject to tax (i.e., the service is used both in and outside Canada).

91 Section 7 of Part V of Schedule VI

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8 TAX COLLECTION MECHANISMS

INTRODUCTION

This section outlines the collection mechanisms currently being used in Canada for GST/HST purposes and provides an overview of the work being done on alternative tax collection mechanisms at an international level.

While the expansion of electronic commerce in goods, intangibles, and services is unlikely to raise many new GST/HST compliance problems that are not already identifiable it does have the potential to exacerbate these problems. The growth in electronic commerce may lead to a shift in current tax collection points for products previously supplied as goods which can now be supplied by electronic means. Although GST/HST is collected by Customs on the importation of goods, purchasers of imported services or intangibles are required to self-assess and remit tax. The self-assessment mechanism, particularly for business-to-consumer transactions, in an electronic commerce environment may not be the most effective tax collection mechanism.

Since the impact of electronic commerce on tax collection mechanisms is international, it was recognized in the early stages of the consultation process with the GST TAG that it was important to monitor and participate in the work being done on alternative tax collection mechanisms at an international level.

BACKGROUND

GST/HST is collected on taxable supplies consumed in Canada. There are three tax collection mechanisms in use for GST/HST purposes:

• Customs collects tax on the importation of goods as they cross the border.

• A supplier of property or services who is registered or who is required to be registered must collect tax on taxable supplies made in Canada.

• A resident of Canada is required to self-assess tax on imported services or intangible personal property where the supply is made outside Canada, unless the supply is exempt or zero-rated, or the resident is acquiring the property or service for consumption, use or supply exclusively in commercial activities. This applies to supplies acquired by consumers as well as by businesses.

OPTIONS

In a report released by the OECD on February 1, 2001, entitled Consumption Tax Aspects of Electronic Commerce,92 various tax collection mechanisms that could be used in an electronic commerce environment were reviewed. This review was based on the premise that the specific area of concern in this context was the cross-border trade of services and intangible property. Five mechanisms were analyzed to determine which was best suited to deal with the cross-border trade in services and

92 Consumption Tax Aspects of Electronic Commerce: A Report from Working Party No. 9 on Consumption Taxes to the Committee on Fiscal Affairs, February 2001, available at: http://www.oecd.org/pdf/M000015000/M00015514.pdf


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intangibles: self-assessment/reverse charge; non-resident registration; tax at source and transfer; collection by trusted third parties; and technology-based solutions.

The report recognized that current international tax systems must continue to be used until new tax collection mechanisms are operational. For business-to-business transactions, it was recommended that a self-assessment or reverse charge system be used in cases where a supplier is not registered nor required to be registered for consumption tax in the jurisdiction of the purchaser. Under this regime, recipients would be required to determine the tax owing on imports of services and intangible personal property, and to remit this amount to the domestic tax authority.

However, the report also recognized that, at the international level, self-assessment has not been entirely effective in ensuring tax collection in business-to-consumer transactions. In the short term, the report recognized the need for a registration-based mechanism for business-to-consumer transactions, and in particular recommended a simplified registration approach that would minimize the compliance burden for non-resident suppliers.

With respect to new methods of tax collection, the report examined a “tax at source and transfer” option. A business would collect tax on “exported” supplies made to non-residents, and remit the amount collected to their domestic revenue authority, which would then transfer the amount to the revenue authority in the country of consumption. In the short term to medium term, the feasibility of this option was questionable, since it would significantly increase administrative costs and would require international agreements between revenue authorities. However, it was recognized that, from a purely technological perspective, this option might be feasible in the longer term.

The report also considered tax collection by third parties. Under this option, a third party (such as, a financial intermediary) would collect the tax on payments between suppliers and recipients of digitized supplies, and the third party would then remit the tax to the country of consumption. While it was recognized that this system could be effective, the report questioned the feasibility of shifting the responsibility for collection to third parties, such as financial institutions.

The final option reviewed in the report was the use of technology-based or technology-facilitated solutions to tax collection (e.g., the use of tamper-proof software which would automatically calculate the tax due on a transaction and remit it to the destination jurisdiction). The report indicated that this approach offered much potential in the medium term.

Although technology should not be relied upon to solve the issues facing tax authorities, it could assist in developing alternative tax collection mechanisms in the future that may include a combination of the options already discussed as well as others. The OECD has committed itself to continue the exploration of technology-based collection mechanisms and will continue to study the issue through to June 2003.

Canada will continue to participate in the work of the OECD and will continue to monitor further developments in the area of tax collection mechanisms. In the meantime with respect to electronic commerce transactions CCRA will continue to use the current tax collection mechanisms as outlined above.

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APPENDIX A

Clarification on the Application of the Permanent Establishment Definition in E-Commerce: Changes to the Commentary on Article 5

On December 22, 2000 the OECD’s Committee on Fiscal Affairs adopted changes to the Commentary on Article 5 of the Model Tax Convention on Income and Capital. These changes, in the form of paragraphs 42.1 to 42.10, were added following paragraph 42 of the existing Commentary on Article 5. The new paragraphs were added to illustrate or interpret the provisions of Article 5 as they apply to electronic commerce.

It is significant to note that no changes have been made to Article 5, itself, with respect to electronic commerce. Consequently, the provisions of Article 5 apply equally to both electronic commerce and more conventional forms of commerce, subject to paragraphs 1 to 42.10 of the Commentary.

The following is a reproduction of the text of paragraphs 42.1 to 42.10 taken from the paper entitled “Clarification of the Application of the Permanent Establishment Definition in E-commerce: Changes to the Commentary on the Model Tax Convention on Article 5” released on December 22, 2000, by the OECD Committee on Fiscal Affairs. The complete text of this document can be found at the following Internet address: http://www.oecd.org/pdf/M000015000/M00015535.pdf

Add the following heading and paragraphs 42.1 to 42.10 immediately after paragraph 42 of the

Commentary on Article 5

Electronic commerce

42.1 There has been some discussion as to whether the mere use in electronic commerce operations of computer equipment in a country could constitute a permanent establishment. That question raises a number of issues in relation to the provisions of the Article.

42.2 Whilst a location where automated equipment is operated by an enterprise may constitute a permanent establishment in the country where it is situated (see below), a distinction needs to be made between computer equipment, which may be set up at a location so as to constitute a permanent establishment under certain circumstances, and the data and software which is used by, or stored on, that equipment. For instance, an Internet web site, which is a combination of software and electronic data, does not in itself constitute tangible property. It therefore does not have a location that can constitute a “place of business” as there is no “facility such as premises or, in certain instances, machinery or equipment” (see paragraph 2 above) as far as the software and data constituting that Web site is concerned. On the other hand, the server on which the Web site is stored and through which it is accessible is a piece of equipment having a physical location and such location may thus constitute a “fixed place of business” of the enterprise that operates that server.


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42.3 The distinction between a web site and the server on which the Web site is stored and used is important since the enterprise that operates the server may be different from the enterprise that carries on business through the web site. For example, it is common for the web site through which an enterprise carries on its business to be hosted on the server of an Internet Service Provider (ISP).

Although the fees paid to the ISP under such arrangements may be based on the amount of disk space used to store the software and data required by the web site, these contracts typically do not result in the server and its location being at the disposal of the enterprise (see paragraph 4 above), even if the enterprise has been able to determine that its web site should be hosted on a particular server at a particular location. In such a case, the enterprise does not even have a physical presence at that location since the web site is not tangible. In these cases, the enterprise cannot be considered to have acquired a place of business by virtue of that hosting arrangement. However, if the enterprise carrying on business through a web site has the server at its own disposal, for example it owns (or leases) and operates the server on which the web site is stored and used, the place where that server is located could constitute a permanent establishment of the enterprise if the other requirements of the Article are met.

42.4 Computer equipment at a given location may only constitute a permanent establishment if it meets the requirement of being fixed. In the case of a server, what is relevant is not the possibility of the server being moved, but whether it is in fact moved. In order to constitute a fixed place of business, a server will need to be located at a certain place for a sufficient period of time so as to become fixed within the meaning of paragraph 1.

42.5. Another issue is whether the business of an enterprise may be said to be wholly or partly carried on at a location where the enterprise has equipment such as a server at its disposal. The question of whether the business of an enterprise is wholly or partly carried on through such equipment needs to be examined on a case-by-case basis, having regard to whether it can be said that, because of such equipment, the enterprise has facilities at its disposal where business functions of the enterprise are performed.

42.6 Where an enterprise operates computer equipment at a particular location, a permanent establishment may exist even though no personnel of that enterprise are required at that location for the operation of the equipment. The presence of personnel is not necessary to consider that an enterprise wholly or partly carries on its business at a location when no personnel are in fact required to carry on business activities at that location. This conclusion applies to electronic commerce to the same extent that it applies with respect to other activities in which equipment operates automatically, e.g. automatic pumping equipment used in the exploitation of natural resources.

42.7 Another issue relates to the fact that no permanent establishment may be considered to exist where the electronic commerce operations carried on through computer equipment at a given location in a country are restricted to the preparatory or auxiliary activities covered by paragraph 4. The question of whether particular activities performed at such a location fall within paragraph 4 needs to be examined on a case-by-case basis having regard to the various functions performed by the enterprise through that equipment.

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Examples of activities, which would generally be regarded as preparatory or auxiliary, include:

- providing a communications link – much like a telephone line – between suppliers and customers;

- advertising of goods or services;

- relaying information through a mirror server for security and efficiency purposes;

- gathering market data for the enterprise;

- supplying information.

42.8 Where, however, such functions form in themselves an essential and significant part of the business activity of the enterprise as a whole, or where other core functions of the enterprise are carried on through the computer equipment, these would go beyond the activities covered by paragraph 4 and if the equipment constituted a fixed place of business of the enterprise (as discussed in paragraphs 42.2 to 42.6 above), there would be a permanent establishment.

42.9 What constitutes core functions for a particular enterprise clearly depends on the nature of the business carried on by that enterprise. For instance, some ISPs are in the business of operating their own servers for the purpose of hosting web sites or other applications for other enterprises. For these ISPs, the operation of their servers in order to provide services to customers is an essential part of their commercial activity and cannot be considered preparatory or auxiliary. A different example is that of an enterprise (sometimes referred to as an "e-tailer") that carries on the business of selling products through the Internet. In that case, the enterprise is not in the business of operating servers and the mere fact that it may do so at a given location is not enough to conclude that activities performed at that location are more than preparatory and auxiliary. What needs to be done in such a case is to examine the nature of the activities performed at that location in light of the business carried on by the enterprise. If these activities are merely preparatory or auxiliary to the business of selling products on the Internet (for example, the location is used to operate a server that hosts a web site which, as is often the case, is used exclusively for advertising, displaying a catalogue of products or providing information to potential customers), paragraph 4 will apply and the location will not constitute a permanent establishment.

If, however, the typical functions related to a sale are performed at that location (for example, the conclusion of the contract with the customer, the processing of the payment and the delivery of the products are performed automatically through the equipment located there), these activities cannot be considered to be merely preparatory or auxiliary.

42.10 A last issue is whether paragraph 5 may apply to deem an ISP to constitute a permanent establishment. As already noted, it is common for ISPs to provide the service of hosting the web sites of other enterprises on their own servers. The issue may then arise as to whether paragraph 5 may apply to deem such ISPs to constitute permanent establishments of the enterprises that carry on electronic

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commerce through web sites operated through the servers owned and operated by these ISP.

While this could be the case in very unusual circumstances, paragraph 5 will generally not be applicable because the ISPs will not constitute an agent of the enterprises to which the web sites belong, because they will not have authority to conclude contracts in the name of these enterprises and will not regularly conclude such contracts or because they will constitute independent agents acting in the ordinary course of their business, as evidenced by the fact that they host the web sites of many different enterprises. It is also clear that since the web site through which an enterprise carries on its business is not itself a “ person” as defined in Article 3, paragraph 5 cannot apply to deem a permanent establishment to exist by virtue of the web site being an agent of the enterprise for purposes of that paragraph."

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APPENDIX B

Comparison of GST/HST and OECD concepts of permanent establishment

GST/HST legislation – Definition of permanent establishment subsection 123(1) of the Excise Tax Act

Article 5 of the OECD Model Tax Convention

Permanent establishment in respect of a particular person, means

(a) a fixed place of business of the particular person including

(i) a place of management, a branch, an office, a factory or a workshop, and

(ii) a mine, an oil or gas well, a quarry, timberland or any other place of extraction of natural resources

through which the particular person makes supplies or,

1. For the purposes of this Convention, the term “permanent establishment" means a fixed place of business through which the business of an enterprise is wholly or partly carried on.

2. The term “permanent establishment” includes especially:

a) a place of management;

b) a branch;

c) an office;

d) a factory;

e) a workshop, and

f) a mine, an oil or gas well, a quarry or any other place of extraction of natural resources.

3. A building site or construction or installation project constitutes a permanent establishment only if it lasts more than twelve months

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GST/HST Legislation – Definition of permanent establishment subsection 123(1) of the Excise Tax Act93

Paragraph 4 of Article 5. Article 5 of the OECD Model Tax Convention

4. Notwithstanding the preceding provisions of this Article, the term “permanent establishment" shall be deemed not to include:

g) the use of facilities solely for the purpose of storage, display or delivery of goods or delivery of goods or merchandise belonging to the enterprise;

h) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery;

i) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise;

j) the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise or of collecting information, for the enterprise;

k) the maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any other activity of a preparatory or auxiliary character;

l) the maintenance of a fixed place of business solely for any combination of activities mentioned in subparagraphs (a) to (e) provided that the overall activity of the fixed place of business resulting from this combination is of a preparatory or auxiliary character.

93 There is no discussion of activities within this definition.

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GST/HST legislation – Definition of permanent establishment subsection 123(1) of the Excise Tax Act

Article 5 of the OECD Model Tax Convention

a fixed place of business of another person (other than a broker general commission agent or other independent agent acting in the ordinary course of business) who is acting in Canada on behalf of the particular person and through whom the particular person makes supplies in the ordinary course of business

5. Notwithstanding the provisions of paragraphs 1 and 2, where a person - other than an agent of an independent status to whom paragraph 6 applies - is acting on behalf of an enterprise and has, and habitually exercises, in a Contracting State an authority to conclude contracts in the name of the enterprise, that enterprise shall be deemed to have a permanent establishment in that State in respect of any activities which that person undertakes for the enterprise, unless the activities of such person are limited to those mentioned in paragraph 4 which, if exercised through a fixed place of business, would not make this fixed place of business a permanent establishment under the provisions of that paragraph.

6. An enterprise shall not be deemed to have a permanent establishment in a Contracting State merely because it carries on business in that State through a broker, general commission agent or any other agent of an independent status, provided that such persons are acting in the ordinary course of their business.

7. The fact that a company which is a resident of a Contracting State controls or is controlled by a company which is a resident of the other Contracting State, or which carries on business in that other State (whether through a permanent establishment otherwise), shall not of itself constitute either company a permanent establishment of the other.

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