15 September 2020 IFA Roundtable Q. 2, 2020-0852741C6 - IFA 2020 - Q2 - WHT on mismatched swap payments

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 portion of periodic payment under a swap agreement made to non-arm's length non-resident is considered interest and therefore subject to withholding tax.

Position: Generally, no.

Reasons: The 1984 Position attempts to look to the economic substance of a financial instrument and bifurcate a payment between interest income and section 9 income. This position is difficult to support in light of jurisprudence, provisions of the Act, and many administrative views expressed by Rulings on the taxation of derivative financial instruments. Consistent with the Supreme Court of Canada’s comments in Shell Canada Ltd v the Queen, [1999] 3 S.C.R. 622 (SCC), in absence of sham or a provision to the contrary, the better view is that no portion of the swap payment from Canco to NRco can be considered interest, and therefore, withholding tax does not apply.

2020 International Fiscal Association Conference
CRA Roundtable

Question 2 – Withholding tax on mismatched swap payments

A Canadian resident taxpayer (Canco) enters into a Swap Agreement (Swap Agreement) with a non-arm’s length non-resident company (NRco). Payments under the Swap Agreement are made by Canco to NRco annually, while NRco makes its payments to Canco quarterly.

The position expressed in Question 60 at the 1984 CTF Roundtable suggests that, in cases where swap payments are not made contemporaneously, as in the example above, withholding tax may apply to a portion of the outbound payments that represents an interest element.

Does this continue to be CRA’s position?

CRA Response

As expressed in many documents, the CRA considers that all amounts payable or receivable under the terms of a swap agreement are on account of income and are deductible or included under section 9 of the Act. This is based on CRA’s longstanding view that payments under a swap agreement do not have any specific character for legal purposes; that is, at law, swap payments are not interest, dividends, rent, royalties, payments for any services or proceeds of disposition, nor do they represent a substitute for a legal obligation to pay such amounts.

In order for withholding tax to apply to the interest component of a swap payment, the legal character of the amount paid by Canco to NRco must be recharacterized as interest for tax purposes. Whether the legal character of an amount paid or received by a taxpayer can be recharacterized for tax purposes was addressed by the Supreme Court of Canada in Shell Canada Ltd v the Queen, [1999] 3 S.C.R. 622 (SCC). In that case, the Court observed that absent a specific provision of the Act to the contrary, or a finding of a sham, the taxpayer’s legal relationships must be respected in tax cases. Applying this principle, it is our view that, generally, withholding tax would not apply in the example described above, absent a finding of a sham or the application of a specific provision of the Act such as section 245 or section 247.

Anna Flisfeder / Gwen Moore
September 15, 2020
2020-085274