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.
Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.
Principal Issues: Whether interest computed by reference to foreign exchange rates or a stock exchange index would be exempt from withholding under paragraph 212(1)(b)(vii).
Position: General Comments.
Reasons: Question of fact depends on all relevant information pertaining to the situation.
XXXXXXXXXX 2000-001101
B. Kerr
Attention: XXXXXXXXXX
May 16, 2000
Dear Sirs:
Re: Paragraph 212(1)(b) of the Income Tax Act (the "Act")
This is in response to your letter of February 29, 2000, wherein you requested our views concerning paragraph 212(1)(b)(vii) of the Act with respect to index-linked notes.
You described two situations where the holder of a note may receive higher interest depending on the value of the Canadian dollar or the Dow Jones Industrial Average at certain times.
Paragraph 212(1)(b) of the Act imposes non-resident withholding tax on amounts paid by a person resident in Canada to a non-resident as, on account of, in lieu of payment of or in satisfaction of, interest.
Subparagraphs 212(1)(b)(i) to (xii) provide exceptions from the rule. However, the postamble to paragraph 212(1)(b) limits most of the exceptions in cases involving participating debt in order to prevent parties from mischaracterizing a payment as exempt interest when it is really a distribution of earnings by stating that where "...all or any portion of the interest is...computed by reference to revenue, profit, cash flow, commodity price or any similar criterion...the interest shall be deemed not to be interest described in subparagraphs 212(1)(b)(ii) to (vii) and (ix)."
With respect to interest rates that vary relative to foreign currency fluctuations, our position is as stated in Income Tax Technical News No. 11 ("ITTN No. 11").
It has long been a concern that where a debt instrument returns interest that varies according to the value of a foreign currency it may be argued that such interest is computed by reference to revenue, profit, cash flow, commodity price or any similar criterion. Although foreign currency can be bought and sold and as such could be considered a commodity, it is our position that in the context of the paragraph 2121)(b) postamble, "commodity price" should not be considered to include foreign currency fluctuations, but rather in general is to be limited to (for example) prices for tangible commodities manufactured, extracted or grown. It is our opinion that in cases of uncertainty it should be the underlying economic substance of a payment that determines whether or not it is interest for purposes of the paragraph 212(1)(b) exceptions. We do caution, however, that there may be instances where the linkage between the interest rate, exchange rate and profitability causes the words of the postamble to have effect. Such might be the case where the borrower's profitability is little more than a product of changes in exchange rates. Varying interest payments according to those same rates could be an indirect way of varying them according to profits.
It is our view that interest computed by reference to the Dow Jones Industrial Average can be considered to be computed by reference to a commodity price (the commodity being the stock on which the Average is based). Our concerns with such interest are similar to those for interest that fluctuates based on foreign currency. To date we have not adopted a position that would extend the position in ITTN No. 11 stated above to index linked debt. However, we would be prepared to consider doing so on a case-by-case basis if the issue is the subject of an advance income tax ruling request. This would only be the case where we could be satisfied that a linkage between the particular index and the profitability of the borrower does not exist.
We trust that these comments will be of assistance.
Yours truly,
for Director
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch
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