Principal Issues: Whether portion of periodic payment under a swap agreement made to non-arm's length non-resident is considered interest and therefore subject to withholding tax, as provided in answer to question 60 of the 1984 CTF Roundtable.
Position: No.
Reasons: The 1984 Position attempts to look to the economic substance of a financial instrument and bifurcate a payment between interest income and section 9 income. This position is difficult to support in light of jurisprudence, provisions of the Act, and many administrative views expressed by Rulings on the taxation of derivative financial instruments. Consistent with the Supreme Court of Canada’s comments in Shell Canada Ltd v the Queen, [1999] 3 S.C.R. 622 (SCC), the better view is that no portion of the swap payment can be considered interest, and therefore, withholding tax does not apply.
FEDERAL TAX ROUNDTABLE OCTOBER 7, 2020
APFF CONFERENCE 2020
16. Withholding tax on asymmetric payments under a swap agreement
A taxpayer resident in Canada ("Canco") enters into a swap agreement with a non-resident corporation ("NRco") with which it does not deal at arm's length. Under the swap agreement, payments to NRco by Canco are made annually, while payments to Canco by NRco are made quarterly.
According to the position stated in response to Question 60 of the 1984 Canadian Tax Foundation Conference Round Table, it is suggested that in cases where payments under a swap agreement are not made simultaneously, as in the above example, withholding tax should apply to the interest portion of the payments made abroad.
Question to the CRA
Is this still the CRA's position?
CRA Response
As set out in various of its publications, the CRA considers that all amounts payable or receivable under the terms of a swap agreement are on account of income and are to be included or deducted under section 9. This is consistent with the CRA's long-standing position that payments under a swap agreement do not have a specific character for legal purposes. Thus, as a matter of law, payments under a swap agreement are not interest, dividends, rents, royalties or payments for services or proceeds of disposition, nor do they represent a substitute for a legal obligation to pay such amounts.
In order for withholding tax to apply to the interest component of a payment under a swap agreement, the legal character of the payment by Canco to NRco must be recharacterized as interest for income tax purposes. Whether the legal nature of an amount paid or received by a taxpayer can be recharacterized for tax purposes was addressed by the Supreme Court of Canada in Shell Canada Ltd. v. Canada (footnote 1). In that case, the Court observed that, absent a specific provision of the Income Tax Act to the contrary, or a finding that a transaction is a sham, the legal relationship between the parties must be respected for tax purposes. In applying that principle, the CRA is of the view that, absent a sham or the application of a specific provision of the Income Tax Act (e.g., sections 245 or 247), withholding taxes would generally not apply in the above example.
Marie-Claude Routhier,
613-670-8921
October 7, 2020
2020-086707
FOOTNOTES
Due to our system requirements, footnotes contained in the original document are reproduced below:
1 [1999] 3 SCR 622