9 September 1987 Income Tax Severed Letter 7-2060 - [Canada - U.S. Income Tax Convention (Convention) Excess Amounts - Rate of Withholding 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.

September 9, 1987

Specialty Rulings Directorate K.B. Harding (613)957-2129

RE: Canada - U.S. Income Tax Convention (Convention) Excess Amounts - Rate of Withholding Tax

This is in reply to your memorandum of August 25, 1987 concerning the treatment of "excess interest" and "excess royalties" referred to in paragraph 7 of articles XI and XII of the Convention.

In order to determine the treatment of the excess interest and royalties under the Convention the above articles clearly indicate in paragraph 7 that the "...excess part of the payments shall remain taxable according to the laws of each Contracting State, due regard being had to the other provisions of the Convention." It is our view that for domestic taxation purposes it is necessary to determine the nature of such excess in each particular situation and then apply the appropriate article of the Convention.

Where interest is paid under a loan or royalty arrangement that provides for excess amounts to be paid, it is arguable that such amounts would continue to be interest and royalty payments since they are paid under such an arrangement. However, since section 67 of the Act limits the deduction to a reasonable portion of the interest and royalties paid, it is necessary to determine how the excess should be included in the hands of the person receiving such income.

For example, if a corporation paid royalties to its parent corporation, the amount would be deductible pursuant to paragraph 18(1)(a) and section 67 of the Act to the extent it was reasonable. If unreasonable royalties were paid to the parent, the unreasonable portion (excess royalties) would probably be included in the parent's income by virtue of section 15(1) of the Act.

Subsection 214(3) of the Act states that where section 15 of the Act requires an amount to be included in a non-resident's income, the amount is deemed to have been paid to the taxpayer as a dividend from a corporation in Canada. Therefore, in our above example, the excess would be treated as a dividend under domestic law and would also be treated as a dividend for purposes of the Convention.

It should be noted that subsection 214(3) of the Act also deems other amounts paid to non-residents to be paid from particular sources.

It is highly probable that excess interest and royalties would generally be included in the non-residents income by virtue of either section 15 or subsections 56(2) or 247(1) of the Act. In all such cases, the Act deems such amounts to be a dividend. Accordingly, where the dividend rate under a tax convention or agreement is less than the rate of withholding tax on interest and royalties, the non-resident will pay a lower withholding rate on the excess interest and royalties.

We trust these comments are suitable for your purposes.

for Director Reorganizations and Non-Resident Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch