7 December 2001 External T.I. 2001-0101025 - Definition of underlying foreign tax

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 CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues: Definition of "underlying foreign tax" in Regulation 5907(1).

Position: General comments.

Reasons: Interpretation Bulletin IT-270R2.

XXXXXXXXXX 2001-010102
Éric Allard-Pouliot
December 7, 2001

Dear XXXXXXXXXX:

Re: Technical Interpretation Request: Definition of Underlying Foreign Tax

This is in reply to your letter of September 5, 2001, regarding the above-noted subject. More particularly, you have requested our opinion regarding the interpretation of the definition of "underlying foreign tax" in subsection 5907(1) of the Income Tax Regulations (the "Regulations") in light of the situation outlined below.

Facts

A Canadian corporation has a wholly owned subsidiary incorporated in the Cayman Islands ("Caymanco") which has lent money with interest to another wholly owned subsidiary of the Canadian corporation that was incorporated in Chile ("Chileco"). In your request, you mention that since Chileco carries on an active business in Chile, the interest income of Caymanco is deemed active pursuant to subsection 95(2) of the Income Tax Act (the "Act").

The loan agreement provides that all applicable taxes on interest payments made under the agreement shall be borne by Chileco. Any and all payments made under the agreement by or on behalf of Chileco shall be made free and clear of, and without deduction or withholding for or on account of, any taxes required by the Republic of Chile. In accordance with this agreement, Chileco has made interest payments to Caymanco and has grossed-up the amounts in order to pay the Chilean withholding tax.

In light of these facts, you require our opinion as to whether the amounts remitted by Chileco to the Chilean tax authorities as withholding tax on the interest payments could be considered to be income or profits tax paid to the government of a country by Caymanco that can reasonably be regarded as having been paid in respect of its taxable earnings. In other words, you inquire as to whether the amounts remitted by Chileco to the Chilean tax authorities as withholding tax on the interest payments are to be included in the computation of Caymanco's underlying foreign tax pursuant to subsection 5907(1) of the Regulations.

The particular circumstances in your letter on which you have asked for our views refer to a factual situation involving a specific taxpayer. As explained in Information Circular 70-6R4, it is not the Directorate's practice to comment on proposed transactions involving specific taxpayers other than in the form of an advance income tax ruling. However, we are prepared to offer the following general comments which may be of assistance to you.

Comments

Pursuant to subsection 5907(1) of the Regulations, the portion of any "income or profits tax" paid to the government of a country by a foreign affiliate of a corporation that can reasonably be regarded as having been paid in respect of the taxable earnings of the affiliate is to be included in the computation of the foreign affiliate's underlying foreign tax. Therefore, in order to be included in the computation of the underlying foreign tax of Caymanco, the Chilean withholding tax must, among other things, constitute an "income or profits tax" and be paid by Caymanco to the government of a country.

The expression "income or profits tax", although not defined in either the Act or the Regulations, is used in many provisions of both the Act and the Regulations. It is used, among others, in subsection 126(7) of the Act for the purposes of the foreign tax credit rules. The position of the Canada Customs and Revenue Agency (the "CCRA") regarding these rules is explained in Interpretation Bulletin IT-270R2. It is stated in paragraph 8 of this Bulletin that:

"In determining whether or not a particular foreign tax qualifies as an "income or profits tax", the basic scheme of application is compared with that of the Canadian Income Tax Act. If the basis of taxation is substantially similar, the foreign tax is accepted as an income or profits tax. To be "substantially similar", the foreign tax must be levied on net income or profits (but not necessarily as would be computed for Canadian tax purposes) unless it is a tax similar to that imposed under Part XIII of the Act. Notwithstanding any of the foregoing guidelines, a tax that is specifically identified as being subject to the provisions of a comprehensive income tax treaty between Canada and a particular country automatically qualifies as an income or profits tax."

Even though these comments were made with respect to subsection 126(7) of the Act and the foreign tax credit rules, they reflect the CCRA's interpretation of the expression "income or profits tax" as used throughout the Act and the Regulations.

With respect to the situation outlined in your request, the withholding tax levied by the Republic of Chile on interest payments is subject to Article 11 of the Canada-Chile Income Tax Convention. Therefore, in accordance with the CCRA's position outlined in paragraph 8 of Interpretation Bulletin IT-270R2, such withholding tax automatically qualifies as an "income or profits tax" for the purposes of the definition of underlying foreign tax in subsection 5907(1) of the Regulations.

However, as previously mentioned, this income or profits tax must be paid by the foreign affiliate in order to be included in the computation of its underlying foreign tax. This requirement is similar to the one provided under the definition of "business-income tax" in subsection 126(7) of the Act. In this regard, the CCRA's position is outlined in paragraph 15 of Interpretation Bulletin IT-270R2, which provides the following:

"Only a foreign income or profits tax that is paid by the taxpayer can be included in the foreign tax credit calculation. In this connection, but subject to 13 above [paragraph 13 discusses withholding tax which is paid in excess of that specified in a treaty between Canada and the foreign country], the recipient of foreign-source income is considered to have paid any amount withheld and remitted by the payer on account of or in settlement of the recipient's foreign tax liability. Payment is considered to have been made at the time the amount was withheld."

Therefore, assuming that under the Chilean taxation statutes the liability for the payment of the withholding tax on the interest payments made by Chileco to Caymanco is that of Caymanco and that the amounts withheld and remitted by Chileco to the Chilean tax authorities are on account of or in settlement of Caymanco's liability, we will consider that the withholding tax was paid by Caymanco for the purposes of the computation of its underlying foreign tax under subsection 5907(1) of the Regulations.

The above comments are an expression of opinion only and are not binding on the CCRA, as explained in paragraph 22 of Information Circular 70-6R4. We trust that the foregoing will be of assistance to you.

Yours truly,

Alain Godin, Manager
International and Trusts Division
Income Tax Rulings Directorate
Policy and Legislation Branch