Principal Issues: Whether Part XIII applies on a payment to a non-resident in respect of a debt obligation?
Position: Apparently not.
Reasons: The payment appears to be a repayment of principal.
XXXXXXXXXX 2007-024803 S. E. Thomson April 3, 2008
Dear XXXXXXXXXX :
Re: Withholding under Part XIII on payment to non-resident in respect of debt obligation
This is in reply to your letter of August 3, 2007 in which you ask for an advance income tax ruling in respect of the above payment. In the circumstances, it appears that the payment is a completed transaction, and as such, is subject to audit and assessment by the Canada Revenue Agency as considered warranted by the Compliance Programs Branch. However, we are able to offer our opinion in reference to a payment described in the following hypothetical facts:
1. A Ltd. is a Canadian resident company.
2. B Ltd. is a company resident in a non-treaty country and does not carry on business in Canada. B Ltd. deals at arm's length with A Ltd.
3. A Ltd. owned real property situated in Canada that it proposed to develop.
4. B Ltd. lent A Ltd. $5 million, secured by a 5-year mortgage on the real property. The terms of the mortgage contract provided that interest on the mortgage was to be paid every six months, and unpaid interest was to be added to the principal and compounded. Further, prior to a default, payments under the mortgage would be applied first in payment of interest, and second, in payment of principal. After a default, payments under the mortgage would be applied in any manner that B Ltd. chose.
5. After 5 years, no payments at all had been paid under the mortgage, so the mortgage was in default. Accrued interest of $2 million had been added to the principal of $5 million for a total amount outstanding of $7 million.
6. B. Ltd. applied for a court order to grant a foreclosure on the real property. The order for sale provided that the sale proceeds would be applied, in priority to outstanding property taxes, utilities and real estate commission, with the balance in payment under the mortgage.
7. A portion of the real property was sold under the foreclosure for proceeds of $2.7 million.
8. The court order was subsequently amended to provide specifically that the balance of the sale proceeds was to be paid on account of principal due under the mortgage.
9. The balance of the $2.7 million, after paying property taxes, utilities and real estate commission, was paid to B. Ltd. B. Ltd. has chosen to apply the payment towards the outstanding principal under the mortgage.
You would like to know if Part XIII tax is exigible on any portion of the balance of the $2.7 million that was paid to B. Ltd.
OUR VIEWS
In our view, the fact that the terms of the mortgage provided that, in the event of default, payments under the mortgage would be applied in any manner that B Ltd. chose, and the fact that under the court order the proceeds of disposition were to be applied to the principal under the mortgage, would indicate that the payment was a payment of principal, not interest. Therefore, Part XIII should not apply to the payment.
The foregoing opinion is not a ruling, and, in accordance with the practice referred to in Information Circular 70-6R5, is not binding on the Canada Revenue Agency.
Yours truly,
Sherry E. Thomson
For Director
International & Trusts Division
Income Tax Rulings Directorate