| 19(1) | 5-8555 |
| K.B. Harding | |
| (613) 957-2129 |
December 19, 1989
Dear Sirs:
This is in reply to your letter of August 23, 1989 wherein you requested our view whether withholding tax under section 212 is payable in the following hypothetical situation.
1. A Canadian corporation ("Canco") issued bonds to a Canadian resident corporate purchaser ("Purchaser Co.") at par value. The bonds have a feature which allows a purchaser to remove coupons from the bond certificate which are then to be redeemed as such coupons mature.
2. Purchaser Co. removes the appropriate coupons from the bond, redeems each coupon at the relevant interest payment date treating any and all proceeds so received as interest income in calculating its taxable income for the year in which it received the interest payments.
3. Purchaser Co. sells the residue of the bond to a U.S. resident corporate purchaser ("U.S. Co."). The sale of the bond takes place at a discounted value that reflects the current rates of interest in effect at the time of the sale.
4. U.S. Co. holds the bond until the bond's maturity date at which time it receives payment from Canco for the par value of the bond.
5. Canco, at all material times, deals at arm's length with both Purchaser Co. and U.S. Co.
6. Purchaser Co. and U.S. Co. are related within the meaning of the Act.
We are in agreement that subsection 214(6), (7) and (7.1) of the Income Tax Act (the "Act") are not applicable with respect to the redemption of the bond residue by U.S. Co. However, in our view the payment received by U.S. Co. could be reasonably regarded in part as a return of capital and in part as a return of interest. Accordingly, paragraph 16(1)(a) would deem the amount which could reasonably be regarded as interest to be interest on a debt obligation. This interest would be subject to 25% withholding tax unless the rate is reduced by a tax treaty or one of the exception contained in paragraph 212(1)(b) of the Act.
Accordingly, in the situation set out above, U.S. Co. would be liable to 15% withholding tax on the excess of the amount received on redemption over the amount paid for the bond residue.
We trust this is adequate for your purposes.
Yours truly,
K.H.M.for DirectorReorganizations and Non-Resident DivisionSpecialty Rulings DirectorateLegislative and IntergovernmentalAffairs Branch