Standard withholding tax gross-ups do not engage the mandatory tax disclosure rules

It is suggested that the mere presence of contractual protection (CP) is not sufficient to engage the CP hallmark and that a “discernible link must exist between the CP and the avoidance transaction in question.” This is consistent with CRA’s example of an RRSP trustee receiving an indemnity regarding the RRSP acquiring non-qualified investments, as such indemnity “relates to transactions (for example, the making of non-qualified investments) that do not form part of the tax motivation that gives rise to the avoidance transaction” (establishing the RRSP).

To apply a similar approach in the context, for example, of a cross-border loan transaction with a gross-up clause, where the loan itself was not an avoidance transaction but was part of a series of transactions that included an avoidance transaction (e.g., a rollover transaction), an entirely appropriate conclusion would be that the usual indemnity and gross-up are not CP “in respect of” that avoidance transaction.

Furthermore, given that CP is defined in relation to a “tax benefit,” which, in turn, refers to a reduction, avoidance, or deferral of amounts payable under the ITA, because interest to an arm’s-length foreign lender generally is not taxable under the ITA, there is no identifiable “reduction, avoidance or deferral” that would make the existence of a tax benefit clear. A tax benefit may also be identified by referring to an alternative transaction that might reasonably have been carried out but for the existence of the tax benefit (Copthorne) - yet, in normal cross-border lending situations, no such reasonable alternative is likely to exist.

Accordingly, the absence of a tax benefit is a further potential basis for a standard gross-up and indemnity in an arm’s-length lending transaction not engaging the CP hallmark.

Neal Armstrong. Summary of Andrew Spiro and Jessica Charendoff, “Mandatory Disclosure Is Here: Now What?” Perspectives on Tax Law & Policy, Vol. 4, No. 3, September 2023, p. 1 under s. 237.3(1) – contractual protection.