14 June 1989 Income Tax Severed Letter 7-3743 - Non-resident tax implications of share lending transaction

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 of March 10, 1989 concerning the treatment of non-residents in the following share lending transaction.

It is our understanding that you are concerned with a situation where a non-resident lender, which is an exempt U.S. pension fund in the United States, loans shares of the pension fund to a non-resident broker-dealer. The loan arrangement is made through a custodial bank in the United States which holds securities in trust on behalf of pension funds and other entities.

In consideration of the loan the broker dealer pays to the lender a loan premium based on the par value of the debt instruments. The borrower shall have all the incidents of ownership of the borrowed securities. The borrower or his agent is required to provide collateral acceptable to the lender in an amount equal to at least 102 per cent of the market value of the borrowed securities. To the extent that any cash or non-cash distribution is made on the collateral, the lender shall pay the distribution to the borrower (or agent) in accordance with prior instructions.

The borrower is obligated to the lender with respect to all distributions made to the holders of the borrowed security. Upon the happening of any event of default the lender may immediately purchase securities identical to the borrowed shares and apply the collateral to the payment of the purchase price including related costs and the borrower is entitled to retain the borrowed securities.

You have indicated that where the lending institution is a pension' fund, which is exempt from withholding tax in Canada on dividends paid on Canadian shares pursuant to Article XXI of the Canada-U.S. Income Tax Convention (the "Convention"), they are requesting a refund of the Part XIII tax which was withheld when the Canadian payor made the dividend payment to the borrower of the securities.

Draft amendments outlining proposed amendments to the Income Tax Act (the II Act II) with respect to the treatment of "securities lending arrangements" were issued with the recent Budget (copy attached). Subsection 206(8) dealing with withholding tax is applicable with respect to payments made after April 26, 1989.

Dividends or Interest Paid Prior to April 27, 1989

It is our opinion that when a dividend is paid by the Canadian payor to a non-resident borrower of the security that there is an obligation to withhold 15 per cent tax on the gross amount of the payment since the borrower is the beneficial owner of the dividend. Therefore, this withholding tax would not be refundable.

Since the non-resident borrower is obligated under the securities lending arrangement to pay an amount equivalent to the dividend it receives on the borrowed securities, the non-resident lender is claiming a refund of withholding tax pursuant to paragraph 2 of Article XXI of the Convention on the basis that it is the beneficial owner of the dividend. In our view when the non-resident borrower pays an amount equivalent to the dividend it received on the security to the non-resident lender this would constitute a payment from a non-resident to a non-resident and would not affect Canadian tax and accordingly the treaty would have no application on this secondary dividend.

Dividends or Interest Paid After April 26, 1989

The proposed subsection 260(8) deals with the situation where a payment is made by a Canadian borrower of securities under the securities lending arrangement to a non-resident lender and does not deal with the situation set out in your memorandum. Accordingly, the proposed changes to the Act would not affect the position set out above affecting payments made prior to April 27, 1989.

In summary, the payments of a dividend either before or after April 26, 1989 will be subject to withholding tax since the Canadian payor is making a payment to the borrower of the securities and not to the exempt entity. It is our view that the borrower is the beneficial owner of the shares it has borrowed and is entitled to the benefits of the reduced rates under the Convention. The fact that the non-resident borrower has agreed to pay an amount equivalent to the dividend to the exempt organization does not make it the beneficial owner of the dividend.

We trust that counts are suitable for your purposes.