27 March 1990 Ruling 74543 F - Part XIII Withholding Tax on Indemnity 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.

SUBJECT:  24(1) and Part XIII Tax Applicable to Indemnity Payments

This is in reply to the submission you received from the 24(1) concerning the above matter.  The 24(1) representation and not include actual agreements and therefore our discussion of the issues is based on the information submitted by the 24(1)

All references to statute, unless otherwise indicated, are references to the Income Tax Act (Canada) (the "Act").

Background

24(1)

Black's Law Dictionary defines payable as "a debt that is fixed and certain but the day for its payment has not arrived" and defines due as " a debt that is presently matured and enforceable".

In the case of the Attorney-General for Ontario v Barfried Enterprises Ltd (1963 SCR 570), the Supreme Court of Canada decision provided that "interest accrues on a day to day basis even if payable only at intervals, and is, therefore, apportionable in point of time between persons entitled in succession to the principal".

24(1)

(A)     Accrued Interest Payable

     24(1)

(B)     Accrued Interest Due

     24(1)   raises two issues in interpreting the application of paragraph 212(1)(b) with respect to interest that is accrued and due.  The first issue is whether the characterization of the payments is determined from the resident payor's or the non-resident payee's perspective.  The second issue is the characterization of the payment, i.e. is it interest or a payment in lieu of or in satisfaction of interest.

     It is 24(1) view that a plain reading of paragraph 212(1)(b) is that it imposes a tax on amounts a Canadian resident "pays or credits" to a non-resident and therefore the payor's characterization is relevant in determining whether paragraph 212(1)(b) applies.  It is our view that the liability for withholding is determined from the non-resident payee's perspective given that the tax is imposed on the non-resident as the amount is paid or credited to him.  As a comment it seems appropriate that "paid or credited" be used rather than "received" as it is the payor that is required to withhold.

     In The Queen V Roynat Ltd. (81 CTC 93) the taxpayer argued that that which is payable by a guarantor is not interest but something of an entirely different nature.  Addy, J. made the following comments in reply to this argument.  "A guarantee is always a contract of an accessory nature, ancillary and subsidiary to some other contract or liability on which it is founded. But it does not follow necessarily that no part of any payment made under such contract could ever be considered as interest in the hands of the recipient"   24(1)   , J. goes on to say that there exists jurisprudence to support the proposition that what a guarantor pays is not interest (Commissioner of Inland Revenue V Sir H.C. Holder, Bart and J.A. Holder (16 T.C. 540), Donald Preston McLaws V  MNR (70 CTC 420)"   24(1)  Addy, J. differentiates these cases from Roynat with the following comment "it is of some interest to note that these cases dealt with the nature of the payment made by the guarantor in so far as its deductibility as interest in the hands of the person disbursing the money is concerned and not as to the nature of the payment for taxation purposes qua the payee or recipient of the monies.  The same payment may frequently be considered as income for taxation purposes in the hands of the payee and capital in the hands of the payor and vice versa.  Also two sums identical in nature paid for identical purposes may also be treated quite differently for taxation purposes depending on other circumstances such as the occupation of the taxpayer".

     Addy, J. went on to conclude that "I could find nothing in the ordinary definition of interest which would make it essential that compensation for money lent where it otherwise meets the criteria of interest, be paid by the borrower in order for the payment to qualify as interest," and "the payment of interest even when provided for only in the collateral agreement, is, in so far as the payee is concerned, to be considered as interest provided for in the bond or trust agreement".

     We acknowledge the  24(1) comments indicating that the Roynat case dealt with different circumstances, nevertheless we still believe it is authority in support of the fact that the nature of the payment received by the recipient of a guarantee payment must be determined from the recipient's point of view.

     In The Canam Manac Group Inc. v. Minister of National Revenue (86 2CTC 2067) the taxpayer argued that they had no knowledge of the nature of the payment to the non-resident and therefore could not be required to deduct or withhold the amount of the tax from the payment.  Sarchuk, T.C.J. responded as follows:

     "I do not agree.  Section 215 cannot be read so as to make the withholding section applicable only if the person who pays or credits an amount to a non-resident does so with the knowledge that the amount is taxable in the hands of the non-resident.  The standard imposed by section 215 is consistent with the intent of the legislation.  When a person is paying an amount to a non-resident he is put on guard by the provisions of that section. If he is not certain of the nature of the payment then it is up to him to withhold the appropriate amount.  The non-resident may not be pleased with this action and may indeed argue that the amount received is not taxable in its hands.  In such case the non-resident may apply to the respondent pursuant to the provisions of subsection 227(6) to have the tax deducted or withheld repaid to it.  If the respondent disagrees then the matter comes before the courts.  When this procedure is followed the person withholding or deducting a sum of money is protected by the provisions of subsection 227(1) from any action against him even though such intended compliance was  in error."

     Our view that the liability for withholding is determined from the non-resident payee's perspective and not from the resident payor' s perspective is supported by the comments in the above cases.

With respect to the issue of whether any portion of the indemnity payment is interest.

24(1)

The issues to be decided in the McLaws case were whether the shareholder's guarantee of the corporation's bank loan was an adventure in the nature of trade and whether the interest content of the debt was deductible by the guarantor.  After concluding the guarantee payment was on capital account, the Supreme Court of Canada dealt with the issue of interest deductibility as follows:

     "There remains the appellant's contention that the interest portions of the $18,750 annual payments to the bank are, in any event, deductible under subparagraph 11(1)(c)(i) (now paragraph 20(1)(c)) which reads:

     11.  (1) Notwithstanding paragraphs (a), (b) and (h) of subsection (1) of section 11, the following amounts may be deducted in computing the income of a taxpayer for a taxation year:

     c)  an amount paid in the year or payable in respect of the year (depending upon the method regularly followed by the taxpayer in computing his income), pursuant to a legal obligation to pay interest on

     (i)  borrowed money used for the purpose of earning income from a business or property (other than borrowed money used to acquire property the income from which would be exempt),

     The interest paid by the appellant and which he claims should be allowed as a deduction is not, in my view, an amount paid pursuant to a legal obligation to pay interest on borrowed money used for the purpose of earning income.  The interest paid by the appellant was not an advance made to him but was paid on the principal sum remaining unpaid under his guarantee, As Viscount Dunedin said in Commissioners of Inland Revenue v Sir H C Holder, Bart and J A Holder, 16 TC 540 at 564:

      ...It is true that he pays a sum which pays all interest due by the person to whom the advance is made, but his debt is his debt under the guarantee, not a debt in respect of the advance made to him...  The appeal must, accordingly, be dismissed with costs."

It is our view that this decision does not necessarily support, 24(1) view that what was paid by the guarantor in this case was not interest.  Hall, J, clearly identified the payment as interest paid by the guarantor although not deductible because the shareholder was not the one who borrowed the money for the purpose of earning income.

His citation from Holder does not detract from our view.  Holder dealt with a situation similar to McLaws wherein the United Kingdom tax laws allowed a deduction for a specific type of interest i.e. interest paid on an advance from a bank.  Although Lord Thankerton was of the opinion "that the guarantor cannot be said to be paying interest to the creditor..", Lord Atkin expressed the opposite view on this aspect, and the unanimous decision of the House of Lords was that the deduction was only available to the person to whom the advance was made and accordingly the guarantor did not pay interest within the meaning of that section.  This decision did not deny that such a payment was interest, and it would have been easy for Mr. Justice Hall to quote Lord Thankerton's explicit statement above in McLaws if he felt that such was the case.

In Westminster Bank v. Bank of Greece (1969) 3 All E.R. 504 (CA), the Master of the Rolls, Lord Denning distinguished Holder, stating that it was not an authority on the words "interest of money" and that

     "When they pay under the guarantee, they pay the interest which the principal debtor should have paid.  The indebtedness for interest is then discharged.  So the payment is truly payment of 'interest'."

This reasoning appealed to Lord Hailsham who wrote the unanimous decision for the House of Lords in the case (1971) 1 ALL E.R. 233, and he too seemed to feel that Holder should be limited.

     "it may well be on a subsequent occasion both the reasoning in Holder's case and the distinction drawn between that case and the present by Lord Denning MR may deserve further consideration." Lord Hailsham, however, dismissed the appeal on other grounds.

Two further English cases, Re Hawkins (deceased) (1972) 3 All E.R. 386 and Re Amalgamated Investment and Property Co. Ltd. (1984) 3 All E.R. 272, both Chancery Division decisions, attempted to further restrict Holder and held that where the guarantor specifically guaranteed interest, such payment was a payment of interest.

24(1)

The final argument is that a true guarantee indemnity payment cannot be considered to be on account of or in lieu of payment interest for purposes of subsection 212(1).

24(1)

24(1) argues that although Sheppard, D.J. In C.E. implied that the distinction between amounts which had become payable and those that had not, would not be applicable in Canada due to the fact that "Section 6(1)(b) (now paragraph 12(1)(c)) is wider and includes as income not only the amounts received or receivable "as interest" but also a payment "in lieu of payment of...interest" and "in lieu of" must be read as meaning "instead of"," this conclusion is open to doubt for two reasons.  Firstly, paragraph 20(14)(a) was enacted by Parliament to specifically include in a transferor's income accrued bond interest that a transferee has become entitled to. If Sheppard, D.J.'s conclusion regarding the operation of paragraph 6(1)(b) were correct, there would have been no need for Parliament to enact paragraph 20(14)(a).  Secondly, there is the decision of Addy, J. in The Queen v. Immobiliare Canada Ltd., (77 C.T.C 481, (F.C.-T.D.))."

In our view the decision in Coleman E. Hall v. Minister of National Revenue (70 DTC 6333) clearly supports that payments received from a third party on account of interest that is due and payable would be in lieu of or in satisfaction of interest. The taxpayer in this case sold matured bond coupons and claimed the payments were not interest but capital receipts from the sale of rights to interest.  Sheppard, D.J. made the following comments:

     "The monies received from the trust company were "received-as interest".  The Appellant's right under the bonds was to receive interest as compensation for the use of his money and that right could be realized by surrendering the coupons to any agent of Canada or equally by selling to the Trust company the matured coupons; in either event the proceeds in the Appellant's hands represent the sum received by him as compensation for the use of his money which he had lent to Canada and which sums would be held by him as compensation for the money lent and therefore "as interest" "received".  The sums received from the trust company are included in the words "in lieu of payment of...........interest"  and therefore have been received by the Appellant "instead of"  the sums to be received from an agent of Canada on presenting the coupons to such agent of Canada therefore are declared (interest) income."

In Immobiliare, bonds were issued by a Canadian resident company to its U.S. parent ("SGI").  Before the interest had become due on the bonds it had been agreed between the parties that the interest payments would be postponed for two years.  During this two-year period, i.e. before any of the interest became due, the U.S. parent sold the bonds to another Canadian subsidiary, "Immobiliare", together with accrued interest thereon.  At issue was whether withholding tax was exigible on the portion of the sale price that included accrued interest payable.

The Court concluded that as the accrued interest was not then payable the requirements of subsection 24(1) and therefore subsection 108(7), both of the former Act, would not be satisfied.  This is the circumstance or situation to which subsection 214(6) may have application.

It is interesting in the Immobiliare case that Addy, J. concluded that a taxable benefit was received by SGI as the amount received included accumulated interest which would have been subject to withholding.  "As to the receipt of the full value of the accumulated interest, without having deducted therefrom 15% of same for non-resident tax, this, in my view, constitutes a definite, tangible, identifiable and measurable benefit which "SGI" received in 1966 and which the defendant conferred upon it, for, without the purchase by the defendant, the vendor "SGI" at some time in the future would otherwise be obliged to suffer a 15% reduction of total amount of interest to which it would have been entitled."

While Addy, J. indicated that as the debtor still owed every penny of the interest the payment would not be paid in lieu of or in satisfaction of interest this is somewhat difficult to reconcile with his assessment of a taxable benefit with respect to accumulated interest.

Summary

Where loans are not renegotiated and rescheduled it is our view that the portion of the indemnity payment which is in respect of accrued interest that is due is subject to Part XIII withholding tax pursuant to paragraph 212(1)(b) as the non-resident payee receives these payments as interest.

We do not have the appropriate documentation to determine whether withholding tax pursuant to Part XIII is exigible where loans are renegotiated and rescheduled and 24(1) provides advances to the borrower.

It is our view that where loans are renegotiated and rescheduled and the subsidiary provides advances to the borrower which must be used to extinguish the outstanding accrued interest, the advance does not result in an actual payment by the borrower in satisfaction of interest but rather simply capitalizes interest. The portion of the indemnity payment made by 24(1) in respect of capitalized interest is therefore subject to Part XIII withholding tax pursuant to paragraph 212(1)(b).

We hope our comments are of assistance to you.

for DirectorFinancial Industries DivisionRulings Directorate