2004 Ruling 2003-0017891R3 - N/R withholding tax/ pools of mortgages

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: Whether withholding tax applies on interest paid to a non-resident on a Canadian Mortgage insured against default by Insurer?

Position: Favorable ruling given.

Reasons: For an insurance fee, Insurer guarantees the timely payment of principal and interest on a Canadian Mortgage. The Insurer has a guarantee provided by the Minister of Finance (the "Government Guarantee"). XXXXXXXXXX the Government Guarantee satisfies the requirement in clause 212(1)(b)(ii)(C).

XXXXXXXXXX 			2003-001789

XXXXXXXXXX, 2004

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling
XXXXXXXXXX

This is in response to your letter dated XXXXXXXXXX, wherein you requested advance income tax rulings on behalf of the above-noted taxpayer. We also acknowledge the information provided in subsequent correspondence and during various telephone conversations in connection with your request (XXXXXXXXXX).

We understand that to the best of your knowledge and that of the taxpayer involved none of the issues involved in the requested ruling is:

(i) in an earlier return of a taxpayer identified in this document or of a related person,

(ii) being considered by any Tax Services Office or Taxation Centre of the CRA in connection with a tax return already filed,

(iii) under objection by a taxpayer identified in this document or by a related person;

(iv) is before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has not expired; and

(v) is the subject of a previously issued ruling.

Unless otherwise stated, all references to a statute are to the Income Tax Act R.S.C. 1985 (5th Supp.), c.1, as amended, (the "Act") and all terms and conditions used herein that are defined in the Act have the meaning given in such definition unless otherwise indicated.

Our understanding of the facts and proposed transactions is as follows:

Facts

1. XXXXXXXXXX (hereinafter "Foreign Co") was incorporated under the laws of XXXXXXXXXX, on XXXXXXXXXX. Foreign Co does not carry on business in Canada, is not resident in Canada for purposes of the Act and has no permanent establishment in Canada within the meaning of the XXXXXXXXXX (hereinafter the "Canada-XXXXXXXXXX Treaty"). Foreign Co is a resident of XXXXXXXXXX with its head office located in XXXXXXXXXX.

2. XXXXXXXXXX.

3. XXXXXXXXXX (hereinafter "Parentco") was incorporated under the laws of XXXXXXXXXX, on XXXXXXXXXX. Parentco does not carry on business in Canada, is not resident in Canada for purposes of the Act and has no permanent establishment in Canada within the meaning of the Canada-XXXXXXXXXX Treaty. Parentco is a resident of XXXXXXXXXX with its head office located in XXXXXXXXXX . All of the issued and outstanding shares of Parentco are held by Foreign Co XXXXXXXXXX.

XXXXXXXXXX (hereinafter "Foreign Loan Co"). Foreign Loan Co is a resident of XXXXXXXXXX and XXXXXXXXXX. Foreign Loan Co XXXXXXXXXX will be the promoters of Non-Resident Finco (see paragraph 12 below).

4. XXXXXXXXXX (hereinafter "Finco") was incorporated under the laws of XXXXXXXXXX on XXXXXXXXXX. Finco does not carry on business in Canada, is not resident in Canada for purposes of the Act and has no permanent establishment in Canada within the meaning of the Canada-XXXXXXXXXX Treaty. All the issued and outstanding shares of Finco are owned by Parentco. Finco is a resident of XXXXXXXXXX with its head office located at XXXXXXXXXX.

Finco was formed for the sole purpose of carrying on the business activities described below under the heading "Proposed Transactions".

5. XXXXXXXXXX (hereinafter "Insurer") XXXXXXXXXX

XXXXXXXXXX

XXXXXXXXXX.

6. Pursuant to an agreement (the "Guarantee Agreement") XXXXXXXXXX, Canada provides a guarantee to the effect that it will make a payment to the lender equal to the benefits payable under the XXXXXXXXXX insurance policy XXXXXXXXXX.

Under the terms of the Guarantee Agreement the guarantee provided by Canada applies restrictively for loans fully secured by mortgages, issued by approved mortgage lenders, on occupied residential property which is, or will be, occupied by the borrower or which is rented.

7. XXXXXXXXXX. A Mortgage Backed Security ("MBS") is an undivided interest in a pool of residential mortgages which are insured against borrower default by XXXXXXXXXX Insurer. The objectives of the MBS program include encouraging the introduction of longer-term mortgages, the lowering of mortgage interest rates and the creation of a more smoothly functioning mortgage market by providing an alternative method of financing mortgages in order to develop a mature secondary mortgage market. The intent of the MBS program is to provide a mechanism to channel the supply of private investor funds to residential mortgages at reasonable rates of interest. The program has facilitated the development of an active and liquid secondary mortgage market attractive to both borrowers and lenders.

8. Finco and Insurer wish to institute a mortgage backed security program (the "Foreign Co MBS") modeled, in part, on the MBS program.

Proposed Transactions

9. Finco will select a taxable Canadian corporation (the "Servicerco") which is recognized as an approved lender of NHA - insured mortgages (generally, a financial institution) by Insurer. Finco and Servicerco will be unrelated and dealing at arm's length.

10. Finco and Servicerco will enter into a mortgage origination and servicing agreement (hereinafter the "Servicing Agreement"). While the Servicing Agreement has not, at this time, been drafted, the fee and specific terms and conditions will reflect the usual arm's length commercial terms for an agreement of this nature. Under the terms of the Servicing Agreement Servicerco will, for a fee, as an independent contractor and not as agent for Finco:

(a) introduce, market, originate and underwrite defined variable and/ or fixed rate mortgages in the Canadian marketplace (the "Canadian Mortgages") and arrange for their closing;

(b) receive funds ("Closing Funds") equal to the amount of the Canadian Mortgage at the time of closing such that Finco will become the beneficial owner at that time of the Canadian Mortgage. Pending closing, Closing Funds may be held by Trustco (see paragraph 11 below) on behalf of Finco;

(c) be responsible for all aspects of the servicing of the Canadian Mortgages in accordance with the standard servicing practices followed by Servicerco in servicing other mortgages and in accordance with mortgage insurance guidelines issued by Insurer;

(d) assign a unique identifier for all mortgages it services on behalf of Finco or Non-Resident Finco (see paragraph 12 below);

(e) perform all Finco's duties under the terms of the Mortgage Insurance Policy (described in paragraph 15 below);

(f) collect payments of principal and interest on the outstanding Canadian Mortgages and will remit these amounts, net of any fees payable (under the terms of the Servicing Agreement to the extent they have not been paid directly by Finco to Servicerco), to Finco;

(g) provide for the sale of the Canadian Mortgages by Finco to an arm's length entity; and

(h) will at all times be an approved lender of Insurer.

Additionally, under the terms and conditions of the Servicing Agreement:

(i) Finco will be entitled to receive the benefit of all payments under the Mortgage Insurance Policy (described in paragraph 15 below);

(j) Finco will be responsible for the payment of the one-time up front fee charged by Insurer (described in paragraph 18 below) for the guarantee of the Canadian Mortgage unless the Borrower pays; and

(k) Finco's mortgage criteria will be set out thereby ensuring it gets "quality mortgages" originated and underwritten by Servicerco.

Furthermore, fees charged by Trustco (described in paragraph 11 below) will be paid directly by Finco.

11. Finco will enter into an agreement (the "Holding Agreement") with a taxable Canadian corporation that is authorized under the laws of Canada or a province, to carry on the business of offering its services as a trustee to the public ("Trustco"). Finco and Trustco will be unrelated and dealing at arm's length.

While the Holding Agreement has not, at this time, been drafted, the fee and specific terms and conditions will reflect the usual arm's length commercial terms for an agreement of this nature. Under the terms of the Holding Agreement, Trustco will, for a fee, act as trustee for Finco.

As trustee for Finco, Trustco will be named as the registered holder of the Canadian Mortgages. While Trustco, as trustee for Finco, will, be named as the registered holder of the Canadian Mortgages, Finco will hold the beneficial ownership. The Holding Agreement is entered into for commercial reasons including registering title in the name of Trustco from the date of closing and facilitating the transfer of beneficial ownership to Non-Resident Finco under the Foreign Co MBS Program (described in paragraph 8 above and paragraph 21 below) as Trustco remains the registered owner throughout. Trustco will hold, in trust for Finco (and subsequently Non-Resident Finco) all mortgage documentation.

Pursuant to the Holding Agreement, fees charged by Trustco will be paid directly by Finco. Trustco will not be responsible for the payment of fees to Servicerco or others with respect to the Canadian Mortgages.

12. An arm's length person will create a trust (the "Non-Resident Finco") under the laws of XXXXXXXXXX. The trustee of Non-Resident Finco will be a XXXXXXXXXX trust company incorporated under the laws of XXXXXXXXXX and listed on the XXXXXXXXXX Stock Exchange.

Non-Resident Finco will be created for the special purpose of acquiring Finco's beneficial ownership in the Canadian Mortgages as described in paragraph 21 below. In this regard, Non-Resident Finco will serve to create a "bankruptcy remote vehicle" from which to institute the Foreign Co MBS Program (described in paragraph 8 above and paragraph 21 below).

The expression "bankruptcy remote vehicle" means that the activities of Non-Resident Finco will be tightly controlled through its deed of trust so that, as a single purpose trust, it will only be able to incur liabilities on the basis that the sole recourse of third parties for liabilities of Non-Resident Finco will be the assets of the trust, principally the portfolio of Canadian Mortgages. As a consequence, Non-Resident Finco will not have liabilities to third parties which might otherwise expose it to legal action and potential bankruptcy. The goal is to ensure that the holders of the bonds or notes issued by Non-Resident Finco (see paragraph 22 below) as part of the proposed securitization process will always have full and exclusive recourse to the Canadian Mortgages and be secured by a first charge on the Canadian Mortgages. By utilizing such a single-purpose trust, the credit rating agencies involved in rating bonds or notes issued as part of the securitization process will grant a higher credit rating to the bonds or notes than would otherwise be the case, if the Canadian Mortgages could be subject to other third party claims.

Non-Resident Finco will not carry on business in Canada and will not be resident in Canada for purposes of the Act. Finco and any persons related to Finco will not have any ownership interest in Non-Resident Finco. Finco will not be a beneficiary of Non-Resident Finco.

13. Servicerco, and Non-Resident Finco will enter into a mortgage servicing agreement (hereinafter the "N/R Servicing Agreement"). Non-Resident Finco and Servicerco will be unrelated and dealing at arm's length. While the N/R Servicing Agreement has not, at this time, been drafted, the fee and specific terms and conditions will reflect the usual arm's length commercial terms for an agreement of this nature.

The terms of the N/R Servicing Agreement will be substantially the same terms (to the extent such terms are applicable) as the Servicing Agreement between Sevicerco and Finco as described in paragraph 10 above. In this regard, under the terms of the N/R Servicing Agreement Servicerco will, for a fee, as an independent contractor and not as agent for N/R Finco:

(a) be responsible for all aspects of the servicing of the Canadian Mortgages in accordance with the standard servicing practices followed by Servicerco in servicing other mortgages and in accordance with mortgage insurance guidelines issued by Insurer;

(b) assign a unique identifier for all mortgages it services on behalf of Non-Resident Finco;

(c) perform all Non-Resident Finco's duties under the terms of the Mortgage Insurance Policy (described in paragraph 15 below);

(d) collect payments of principal and interest on the outstanding Canadian Mortgages and will remit these amounts, net of any fees payable (under the terms of the N/R Servicing Agreement to the extent they have not been paid directly by N/R Finco to Servicerco), to Non-Resident Finco;

(e) provide for the sale of the Canadian Mortgages by Non-Resident Finco to an arm's length entity; and

(f) will at all times be an approved lender of Insurer.

Additionally, under the terms and conditions of the N/R Servicing Agreement:

(g) Non-Resident Finco will be entitled to receive the benefit of all payments under the Mortgage Insurance Policy (described in paragraph 15 below). In this regard, the benefits of the Mortgage Insurance Policy will be assigned to Non-Resident Finco upon its acquisition of the Canadian Mortgage as described in paragraph 21 below.

Futhermore, fees charged by Trustco will be borne by Non-Resident Finco.

14. Non-Resident Finco will enter into an agreement (the "N/R Holding Agreement") with Trustco. Non-Resident Finco and Trustco will be unrelated and dealing at arm's length.

While the N/R Holding Agreement has not, at this time, been drafted, the fee and specific terms and conditions will reflect the usual arm's length commercial terms for an agreement of this nature. It is anticipated that the terms and conditions of the N/R Holding Agreement will be substantially the same, with the appropriate changes) as the Holding Agreement described in paragraph 11 above.

Under the terms of the N/R Holding Agreement, Trustco will, for a fee, act as trustee for Non-Resident Finco and in this regard, Trustco will continue to be named as the registered holder of the Canadian Mortgages acquired by Non-Resident Finco from Finco as described in paragraph 21 below. While Trustco, as trustee of Non-Resident Finco, will, continue as the named registered holder of the Canadian Mortgages, Non-Resident Finco will, upon acquiring the Canadian Mortgages from Finco as described in paragraph 21 below, hold the beneficial ownership.

15. Finco and Insurer will enter into an agreement (the "Acknowledgment Agreement") XXXXXXXXXX for purposes of Insurer's mortgage insurance policies, any certificate of insurance issued thereunder and any related procedural guidelines issued pursuant thereto (the "Mortgage Insurance Policy"), provided that Servicerco is responsible for the origination, underwriting and servicing of the Canadian Mortgages. Finco will be responsible for any non-compliance with the duties of an approved mortgage lender set out in Insurer's Mortgage Insurance Policy.

The Mortgage Insurance Policy in respect of a Canadian Mortgage may, in addition, provide for the timely payment to Servicerco for the benefit of Finco or Non-Resident Finco, as the case may be, of all payments then due under each Canadian Mortgage in default. This feature will permit Finco and Non-Resident Finco to meet their respective obligations to their lenders or to the Non-Resident Finco Note holders.

The Acknowledgment Agreement will provide for the continuation of the coverage following the sale of the Canadian Mortgage to Non-Resident Finco (see paragraph 21 below) with a requirement that following the sale of the mortgages by Finco to Non-Resident Finco, Non-Resident Finco will undertake, to ensure that Serviceco will be responsible for the servicing of the Canadian Mortgages.

16. Non-Resident Finco and Insurer will enter into an agreement (the "Non-Resident Acknowledgment Agreement") XXXXXXXXXX for purposes of Insurer's Mortgage Insurance Policies.

Insurer will further undertake to permit the assignment of Finco's rights and the assumption of Finco's obligations under the Acknowledgment Agreement to Non-Resident Finco provided that Servicerco continues to be responsible for the servicing of all Canadian Mortgages acquired by Non-Resident Finco from Finco. Non-Resident Finco will, with respect to any Canadian Mortgages held by it, be responsible for any non-compliance with the duties of an approved mortgage lender set out in Insurer's Mortgage Insurance Policy.

17. Servicerco will, under the terms of the Servicing Agreement, be responsible for supervising the closing of a mortgage transaction entered into between Finco and the borrower (the "Borrower"). The Borrower will be an owner of occupied residential property. The mortgage loan will be made for the purpose of assisting the Borrower in the purchase of existing and new residential dwellings which will be owner-occupied or which may be rented or for the renovation or improvement of an existing dwelling or certain other purposes as permitted by XXXXXXXXXX Guarantee Agreement. The loan proceeds will be advanced by Finco to the Borrower at the time of closing in exchange for a mortgage (Canadian Mortgage) on the property.

18. In return for a fee paid by Finco or a Borrower, Insurer will insure, under the terms of its Mortgage Insurance Policy, the Canadian Mortgage beneficially owned by Finco, against losses from default by the Borrower. Thus, the Canadian Mortgage, beneficially owned by Finco, registered in the name of Trustco and administered by Servicerco, are insured by Insurer.

The manner of payment and calculation of the fee have not been determined at this time however it is anticipated that the terms and conditions including the fee will reflect existing commercial terms determined in arm's length negotiations similar to other agreements entered into by Insurer with other mortgage lenders.

19. Finco will advance funds to Borrower on the security of the Canadian Mortgage and at the time of the closing Finco will become the beneficial owner of the Canadian Mortgage. As a matter of convenience, pending closing, said closing funds may be held by Trustco on behalf of Finco. XXXXXXXXXX.

Finco will fund its mortgage lending activities with funds borrowed from a warehouse facility lender XXXXXXXXXX. Finco will utilize these funds to acquire the Canadian Mortgages. By borrowing for a term of XXXXXXXXXX, Finco will have a low cost of funds. Finco will lend funds to the Borrowers secured by the Canadian Mortgages on terms such that the interest paid on the Canadian Mortgages exceed Finco's cost of funds XXXXXXXXXX.

20. Servicerco will receive payments of principal and interest from the Borrower under the Canadian Mortgage and will remit this amount, net of any fees payable to Servicerco, to Finco.

21. Upon the accumulation of a pool of Canadian Mortgages, having an estimated aggregate principal outstanding of, for example, $XXXXXXXXXX, (the "Mortgage Pool"), Finco will sell and Non-Resident Finco will acquire the Mortgage Pool for an amount equal to the outstanding principal balance subject to any adjustment for accrued or prepaid interest on the pooled mortgages.

The terms of the sale of the Mortgage Pool will require payment by Non-Resident Finco to Finco of an amount equal to the outstanding principal balance subject to any adjustment for accrued or prepaid interest on the pooled mortgages.

Under the terms of the sale and subject to the Non-Resident Servicing Agreement, Non-Resident Finco will be assigned Finco's rights and assume Finco's responsibilities under the Servicing Agreement.

Finco will sell the Mortgage Pool to Non-Resident Finco in order that it can meet its obligations to repay the warehouse facility (see paragraph 12 above). XXXXXXXXXX.

Once Finco has paid off the warehouse loan, Finco will make further borrowings from the warehouse lender and utilize the borrowed funds to acquire further Canadian Mortgages upon which Finco will make a profit until it sells these Canadian Mortgages and repays the warehouse facility. This cycle will be repeated on an on-going basis as Finco sells its Mortgage Pools and uses the proceeds to repay Finco's warehouse loans.

22. To fund its acquisition of the Mortgage Pool, Non-Resident Finco will borrow the required amount from non-resident investors in the international marketplace evidenced by the issuance of securitized bonds or notes (the "Non-Resident Finco Notes"). The Canadian Mortgages will be charged in favour of a trust company licensed to carry on business in Canada (the "Security Trustee") as security for payment by Non-Resident Finco of the monies due from time to time on the Non-Resident Finco Notes. Although the Canadian Mortgages have been charged to secure the issuance of the Non-Resident Finco Notes, Non-Resident Finco will continue to own the Canadian Mortgages. The Security Trustee will not own a direct interest in the Canadian Mortgages. If Non-Resident Finco defaults on its obligations under the Non-Resident Finco Notes, the Security Trustee will realize on its security by selling the Canadian Mortgages as part of its orderly realization process. The Non-Resident Finco Notes will not be offered in Canada.

23. Payments received, net of any fees payable to Servicerco or Trustco, by Non-Resident Finco under the terms of the Canadian Mortgages from Servicerco, or in the event of a default from the Insurer, will be used to fund Non-Resident Finco's financial obligations to non-resident investors holding the Non-Resident Finco Notes.

24. All or substantially all of the assets of Non-Resident Finco will consist of Canadian Mortgages acquired from Finco. Non-Resident Finco may, from time to time, acquire permitted liquid investments such as short term government debt to temporarily invest excess cash on hand between payment dates.

25. For the purpose of this application and the rulings requested herein, a mortgage includes a hypothec and a mortgage on the leasehold interest of a lessee.

Purpose of the Proposed Transactions

To provide Canadians with an additional borrowing alternative in the domestic mortgage market. It is anticipated that the addition of a new lender in the Canadian residential mortgage business will enhance competition and foster innovation in products and services.

Ruling Given

Provided that the above description of facts, proposed transactions and purpose of the proposed transactions are accurate and constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and the purpose thereof, and provided further that the proposed transactions are completed in the manner described above, we confirm that:

By virtue of subclause 212(1)(b)(ii)(C)(I) interest paid or credited in respect of a Canadian Mortgage to Finco or Non-Resident Finco, as the case may be, will be exempt from tax pursuant to paragraph 212(1)(b).

This ruling is given subject to the general limitations and qualifications set out in Information Circular IC 70-6R5 dated May 17, 2002, and are binding on the Canada Revenue Agency in respect of Canadian Mortgages issued after XXXXXXXXXX and before XXXXXXXXXX.

This ruling is based on the Act in its present form and does not take into account amendments to the Act which, if enacted into law, could have an effect on the ruling provided herein.

Comment

Nothing in this letter should be construed as implying that CCRA has agreed to any other tax consequences relating to any facts or proposed transactions referred to herein other than those as specifically described in the rulings given above.

Yours truly,

XXXXXXXXXX
for Director
Financial Industries Division
Income Tax Rulings Directorate
Policy and Planning Branch