19 March 1985 Income Tax Severed Letter A-0620 - [850319]

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.

A-0620 Wm. R. McColm (613) 995-2455

March 19, 1985

This is in reply to your letter of October 24, 1984, concerning the calculation of the foreign tax credit where the income involved is received from a payor in a country with which Canada has a tax treaty and that treaty has a tax sparing provision.

In the hypothetical situation set out in your letter, a Canadian bank loans money to a foreign debtor and in 1984 receives $100 (Cdn.) of interest income from the debtor. As required by the loan agreement the amount received by the bank is not of withholding tax. Thus, the debtor, in addition to paying the agreed amount of interest, also pays on behalf of the bank any applicable withholding taxes to the government of his country. The loan has special status in the debtor's country and qualifies for a 95% exemption from the normal withholding tax.

Our comments are made in relation to the above situation as if the debtor
were a resident of Spain, where we understand the normal rate of withholding
is 24%. In the above circumstances, the withholding would normally be $24
but is reduced, because of the special status of the loan in Spain, to
$1.21 ($100-100). The bank is therefore required to include in computing
             98.8
its income for Canadian income tax purposes the $100 of interest received
plus the $1.21 of tax paid thereon on its behalf by the debtor to the
Spanish Government.

The rate of Spanish tax payable by the bank in respect of the interest is limited to 15%, pursuant to Article II of the Canada-Spain Income Tax Convention (the "Treaty"). In our view, for the purposes of Article XXIII of the Treaty, the deemed foreign taxes payable are also so limited, and, in the calculation thereof, this rate is applied in respect of the interest received plus withholding taxes actually paid thereon. Thus, in the above example, the amount of foreign tax payable pursuant to the provisions of the Income Tax Act and the provisions of Article XXIII of the treaty is $15.18 (15% x $101.21). The 'non-business-income tax' pursuant to paragraph 126(7)(c) of the Income Tax Act, in the above circumstances, would be $15.18 less any portion thereof deducted pursuant to subsection 20(12) of the Act by the taxpayer.

We trust these comments will be of assistance.

Yours truly,

for Director Non-Corporate Rulings Division