30 June 1987 Income Tax Severed Letter 7-1826 - Part XIII tax exemption request on bank interest

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.

This is in reply to your memorandum dated May 27, 1987, in which you request our views on the Canadian tax consequences which result from interest paid by a Canadian depository to a U.S. resident organization, the XXX.

Based on the information provided in your memorandum and the attached documentation, we have the following general comments.

Our Comments

In our view the activities undertake in Canada by the XXX constitute "business activities", however, the XXX was organized as "not-for-profit" according to Article I of the association's Constitution and Bylaws. Therefore, if the XXX in Canada meets the technical conditions set out in paragraph 149(1)(l) of the Income Tax Act (the "Act"), the income earned from XXX activities is exempt from Part I tax. Based on the information provided with your memorandum, the interest income earned by the XXX may be incidental to its cities carried on in Canada. For your information, when considering whether XXX qualifies as a non-profit organization, we refer you to IT-496 entitled "Non-Profit Organizations" and note that in accordance with paragraphs 2(b) and (c) it must be organized exclusively for one or more of the designated purposes and it must in fact be operated exclusively for this same purpose.

Interest paid by the Canadian depository to the XXX is subject to a 25% withholding tax pursuant to paragraph 212(1)(b) in Part XIII of the Act. Of course, this rate of withholding is reduced to 15% pursuant to Article XI(2) dealing with Interest in the Canada-United States Income Tax Convention, 1980 (the "Convention"). However, Article XI(5) in effect says that such interest is not subject to Part XIII withholding tax where the beneficial owner of the interest carries on business in Canada through a permanent establishment, and the debt-claim in respect of which the interest is paid is effectively connected with such permanent establishment located in Canada.

As you are aware, the existence of a permanent establishment is determinable only by examining a number of factors many of which can be reviewed only after the fact. Consequently most such determinations are made by the relevant District Taxation Office during the course of their audit.

If it is determined that the organization does not have a permanent establishment in Canada, then the reduced rate of withholding tax on the interest is applicable pursuant to paragraph 212(1)(b) of the Act and Article XI(2) of the Convention. Regulation 805 contained in Part VIII of the Income Tax Regulations does not apply to exempt the interest paid to the non-resident where the organization's interest income cannot "... be attributed to the business carried on by him in Canada ...", i.e., where it does not have a permanent establishment in Canada to which the interest income could be attributed.

However, if it is determined that the organization does have a permanent establishment in Canada, and if the interest paid is effectively connected with such permanent establishment, Article XI(5) of the Convention relieves the Part XIII withholding tax entirely so that the organization ends up being subject only to Part I tax. Then, if the XXX meets the exempting conditions set out in paragraph 149(1)(l) of the Act, then both the organization's income from its activities plus its incidental and related interest income are exempt from Part I tax.

The issue which therefore remains unresolved is the determination of whether or not the XXX has a permanent establishment in Canada through which it carries on its "business activities". While the letter of March 25, 1987 from the C.P.A. representing the XXX states that the association does not have a permanent establishment in Canada, other information in the documentation attached to your memorandum discloses facts which lend some doubt to this assertion. It is suggested that the Department be provided with an update on the facts, which were originally obtained in 1969 and are, without question, no longer current.