31 May 2013 External T.I. 2013-0486011E5 - Loan to non-resident - Part XIII 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.

Principal Issues: Whether the reduced rate of withholding tax as set out in the Canada-Netherlands Income Tax Convention would apply in respect of an amount that is deemed to be paid as a dividend pursuant to paragraph 214(3)(a) of the Income Tax Act in the context of a partnership making a loan to the non-resident corporate shareholder of the partnership's Canadian resident corporate partners.

Position: It is our view that in interpreting subparagraph 2(a) of Article 10 of the Treaty to a 214(3)(a) deemed dividend resulting from a loan from a partnership to the non-resident corporate shareholder of its Canadian resident corporate partners, one would apply the ownership and control thresholds therein to the Canadian resident corporate partners.

Reasons: In the context of applying the provisions of Article 10 of the Treaty, subsection 96(1) of the Act does not apply and the partnership is not considered a separate person. Therefore, each of the Canadian resident corporate partners would be viewed as having paid their pro rata share of the 214(3)(a) deemed dividend.

XXXXXXXXXX
2013-048601
L.M. Carruthers, CA
(613) 957-2113

May 31, 2013

Dear XXXXXXXXXX:

Re: Paragraph 214(3)(a) of the Income Tax Act and
Article 10 of the Canada-Netherlands Income Tax Convention

We are writing to you in response to your letter requesting an interpretation of whether the reduced rate of withholding tax set out in subparagraph 2(a) of Article 10 of the Canada-Netherlands Income Tax Convention (the "Treaty") applies in respect of an amount that is deemed, pursuant to paragraph 214(3)(a) of the Income Tax Act (the "Act"), to be paid as a dividend in the context of the following hypothetical facts:

1. Foreign Grandparent is a corporation resident in the Netherlands for the purposes of the Treaty.

2. Foreign Grandparent owns all of the capital of Foreign Parent, a corporation resident in the Netherlands for the purposes of the Treaty.

3. Foreign Parent owns all of the capital stock of CanCo1, a corporation resident in Canada for the purposes of the Act and of the Treaty. CanCo1's taxation year ends on December 31.

4. CanCo1 owns all of the capital stock of CanCo2, a corporation resident in Canada for the purposes of the Act and of the Treaty. CanCo2's taxation year ends on December 31.

5. CanCo1 is the 99% limited partner, and CanCo2 is the 1% general partner, of CanLP, a limited partnership formed in Canada that carries on active business in Canada. CanLP's fiscal period ends on December 31.

6. CanLP has excess cash from its business operations.

Situation 1:

CanLP lends $1,000,000 to Foreign Parent.

Situation 2:

CanLP lends $1,000,000 to Foreign Grandparent.

Our Comments

In both hypothetical situations described above, if Part I of the Act were applicable, the amount of the loan would, assuming none of the exceptions in section 15 of the Act applied, be included in computing the income of the debtor pursuant to subsection 15(2) of the Act. For the purposes of Part XIII of the Act, if section 15 or subsection 56(2) were to require, if Part I of the Act were applicable, an amount to be included in computing a taxpayer's income, paragraph 214(3)(a) of the Act deems the amount to be paid to the taxpayer as a dividend from a corporation resident in Canada. Therefore, absent relief under the Treaty, subsection 212(2) of the Act would result in a 25 per cent Part XIII withholding tax on a dividend deemed paid to Foreign Parent and to Foreign Grandparent in the hypothetical situations described above.

Article 10 of the Treaty, in our view, provides relief from Part XIII withholding tax on the deemed dividends described above. Subparagraph 2(a) of Article 10 of the Treaty provides that if the recipient of the dividend (i.e., Foreign Parent or Foreign Grandparent as applicable) owns at least 25 per cent of the capital of, or controls directly or indirectly at least 10 per cent of the voting power in, the company paying the dividend, a 5 per cent withholding tax rate would apply. It is our view that in applying subparagraph 2(a) of Article 10 of the Treaty to the hypothetical scenarios described above, one would apply the ownership and control thresholds therein to CanCo1 and CanCo2.

As stated in paragraph 2 of Interpretation Bulletin IT-90, a partnership is the relation that subsists between persons carrying on business in common with a view to profit. That statement is in conformity with the common law definition of a partnership. Furthermore, a partnership is not included in the definition of a "person" in subsection 248(1) of the Act. Subsection 96(1) of the Act does require that a partnership be treated as a separate person but only for computing certain amounts in respect of the partners for the purposes of Part I of the Act.

In the context of applying the provisions of Article 10 of the Treaty, subsection 96(1) of the Act does not apply and CanLP is not considered a separate person. As CanLP is not a separate person, each of the partners thereof would be viewed as having made their pro rata share of the loan described in hypothetical situations 1 and 2 above. It follows, in our view, that each of CanCo1 and CanCo2 would be considered, for the purposes of Article 10 of the Treaty, to have paid their pro rata share of the dividend deemed to have been paid pursuant to paragraph 214(3)(a) of the Act.

Situation 1:

Foreign Parent owns all of the capital stock of CanCo1 and, therefore, owns at least 25 per cent of the capital, and directly controls at least 10 per cent of the voting power in, CanCo1.

Foreign Parent does not own any of the capital stock of CanCo2, however, because its wholly owned subsidiary, CanCo1, owns all of the capital stock of CanCo2, it can be concluded that Foreign Parent indirectly controls at least 10 per cent of the voting power in CanCo2.

Therefore, as Foreign Parent satisfies the ownership threshold of owning at least 25 per cent of the capital of Canco1 and the controlling threshold of controlling directly or indirectly at least 10 per cent of the voting power in CanCo2, in our view, the conditions of subparagraph 2(a) of Article 10 of the Treaty would be satisfied and the reduced withholding tax rate of 5 per cent would be available to Foreign Parent with respect to the deemed dividend.

Situation 2:

Foreign Grandparent does not own any of the capital stock of CanCo1 or CanCo2, however, because its wholly owned subsidiary, Foreign Parent, owns all of the capital stock of CanCo1, it can be concluded that Foreign Grandparent indirectly controls at least 10 per cent of the voting power in CanCo1.

Furthermore, since CanCo1 owns all of the capital stock of CanCo2, it can be concluded that Foreign Grandparent, through its ownership of all of the capital of Foreign Parent which owns all the capital stock of CanCo1, indirectly controls at least 10 per cent of the voting power in CanCo2.

Therefore, as Foreign Grandparent satisfies the controlling threshold of controlling directly or indirectly at least 10 per cent of the voting power in each of CanCo1 and CanCo2, in our view, the conditions of subparagraph 2(a) of Article 10 of the Treaty would be satisfied and the reduced withholding tax rate of 5 per cent would be available to Foreign Grandparent in respect of the deemed dividend.

If the loans are repaid, the non-resident companies may be eligible for a refund of the Part XIII tax paid.

We hope this information is of assistance to you.

Yours truly,

Olli Laurikainen, CPA, CA
Section Manager for Division Director
International and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
Canada Revenue Agency