Principal Issues: Will Part XIII withholding tax apply to amounts of interest and/or principal payments made by a Canadian resident corporate guarantor (the "guarantor") to a non-resident lender where the original corporate borrower was the non-resident parent of the guarantor?
Position: If the interest is not fully exempt interest, and is paid or payable to a person with whom the payer is not dealing at arm's length, or is participating debt interest, the portion of the payment made by the guarantor on account or in lieu of payment of, or in satisfaction of, interest is liable to Part XIII withholding tax.
Reasons: An amount, on account or in lieu of payment of, or in satisfaction of interest, has been paid by a resident (the guarantor) to a non-resident (the lender).
XXXXXXXXXX 2007-024139 L. Carruthers, CA January 23, 2008
Dear XXXXXXXXXX :
Re: Withholding Tax on Payments Made by Guarantor
This is in reply to your letter of June 18, 2007, wherein you requested our technical interpretation of whether Part XIII withholding tax would apply to amounts of interest and/or principal payments made by a Canadian resident corporate guarantor to a non-resident lender where the original corporate borrower was a non-resident.
Our Comments
The facts in your letter appear to relate to a factual situation involving specific taxpayers. As explained in Information Circular IC-70-6R5, it is not this Directorate's practice to comment on proposed transactions involving specific taxpayers other than in the form of an advance income tax ruling. Should your situation involve a specific taxpayer and a completed transaction, you should submit all relevant facts and documentation to the appropriate tax services office for their views. Nevertheless, we offer the following general comments in connection with your request. As stated in paragraph 22 of IC-70-6R5, technical interpretations are not advance tax rulings and, accordingly, are not binding on the Canada Revenue Agency (the "CRA").
Unless otherwise stated, statutory references in this letter are to the Income Tax Act, R.S.C. 1985 (5th Suppl.) c. 1, as amended to the date hereof (the "Act") to include Bill C-28 S.C. 2007, c.35.
From the Department of Finance's Explanatory Notes to Bill C-28, the new provisions of paragraph 212(1)(b) will exempt from Part XIII tax any interest payments that a payer resident in Canada makes to a non-resident recipient with whom the payer deals at arm's length, other than those payments, i.e., "participating debt interest" as defined below, that are in effect a distribution of profits or the like. As well, interest on certain debt obligations, i.e., "fully exempt interest" as defined below, will be exempt even if paid to a non-arm's length person. Specifically, Part XIII of the Act, comprising of sections 212 to 218.1, imposes a withholding tax on certain payments, made by residents of Canada, to non-residents. After December 31, 2007, pursuant to subsection 212(1), "every non-resident person shall pay an income tax of 25% on every amount that a person resident in Canada pays or credits, or is deemed by Part I to pay or credit, to the non-resident person as, or on account or in lieu of payment of, or in satisfaction of, ... (b) interest that (i) is not fully exempt interest, and is paid or payable to a person with whom the payer is not dealing at arm's length, or (ii) is participating debt interest". The terms "fully exempt interest" and "participating debt interest" are defined in subsection 212(3) as follows:
"fully exempt interest" means
(a) interest that is paid or payable on a bond, debenture, note, mortgage, hypothecary claim or similar debt obligation
(i) of, or guaranteed (otherwise than by being insured by the Canada Deposit insurance corporation) by, the Government of Canada,
(ii) of the government of a province,
(iii) of an agent of a province,
(iv) of a municipality in Canada or a municipal or public body performing a function of government in Canada,
(v) of a corporation, commission or association to which any of paragraphs 149(1)(d) to (d.6) applies, or
(vi) of an educational institution or a hospital if repayment of the principal amount of the obligation and payment of the interest is to be made, or is guaranteed, assured or otherwise specifically provided for or secured by the government of a province;
(b) interest that is paid or payable on a mortgage, hypothecary claim or similar debt obligation secured by, or on an agreement for sale or similar obligation with respect to, real property situated outside Canada or an interest in any such real property, or to immovables situated outside Canada or a real right in any such immovable, except to the extent that the interest payable on the obligation is deductible in computing the income of the payer under Part I from a business carried on by the payer in Canada or from property other than real or immovable property situated outside Canada;
(c) interest that is paid or payable to a prescribed international organization or agency; or
(d) an amount paid or payable or credited under a securities lending arrangement that is deemed by subparagraph 260(8)(a)(i) to be a payment made by a borrower to a lender of interest, if
(i) the securities lending arrangement was entered into by the borrower in the course of carrying on a business outside Canada, and (ii) the security that is transferred or lent to the borrower under the securities lending arrangement is described in paragraph (b) or (c) of the definition "qualified security" in subsection 260(1) and issued by a non-resident issuer.
"participating debt interest" means interest (other than interest described in any of paragraphs (b) to (d) of the definition "fully exempt interest") that is paid or payable on an obligation, other than a prescribed obligation, all or any portion of which interest is contingent or dependent on the use of or production from property in Canada or is computed by reference to revenue, profit, cash flow, commodity price or any other similar criterion or by reference to dividends paid or payable to shareholders of any class of shares of the capital stock of a corporation.
As noted in paragraph 21 of Information Circular IC-77-16R4, Non-Resident Income Tax, it is our view that:
"A payment by a guarantor resident in Canada to a non-resident on account of or in lieu of payment of, or in satisfaction of interest that was on an obligation of a person in default, retains the character of interest in the hands of the non-resident."
As such, in our view, with respect to a payment by a guarantor resident in Canada of an amount on account of or in lieu of payment of, or in satisfaction of interest, the provisions of the preamble of subsection 212(1) would be met because an amount of interest would be paid or credited by a resident (the guarantor) to a non-resident (the lender).
Therefore, in our view, Part XIII withholding tax would apply to the interest portion of the payment by the resident guarantor if the provisions of paragraph 212(1)(b) are met, i.e., if the interest is not fully exempt interest, and is paid or payable to a person with whom the payer is not dealing at arm's length, or is participating debt interest. Furthermore, in our view, where interest on the original indebtedness would have met the provisions of paragraph 212(1)(b), the portion of the payment by a resident corporate guarantor retaining the character of interest would meet the provisions of paragraph 212(1)(b) as well.
The corollary is that where interest on the original indebtedness would not have met the provisions of paragraph 212(1)(b), such as if the interest was fully exempt interest, or was not fully exempt interest but was paid to an arm's length recipient, in our view, the portion of the payment by a resident corporate guarantor retaining the character of interest would not meet the provisions of paragraph 212(1)(b) either and therefore Part XIII would not apply.
We trust that our comments will be of assistance.
Yours truly,
R.A. Albert, CA
For Director
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate