CRA publishes its position on tracing interest payments, made to a non-qualifying US parent, to earnings of a connected business

Interest paid by Canco to its US parent (USco) will qualify for Treaty benefits (i.e., no withholding tax), even if USco is not a qualifying person, if that interest is derived by USco "in connection with or incidental to" a (non-investment management) trade or business of USco that is "substantial in relation to the activity carried on in [Canada] giving rise to that income."  CRA has published its response at the 2010 annual Canadian Tax Foundation conference indicating that, in the scenario where the cross-border debt was incurred by Canco to fund both a connected and non-connected business, Canco will be required to establish that the interest payments are funded out of the earnings of the connected business in order to avoid withholding.

Neal Armstrong.  Summary of 28 November 2010 Annual CTF Round Table, Q. 12, 2010-0387001C6 under Treaties – Art. XXIX A.