3 September 1992 External T.I. 9203335 F - Interest Free Loans- Reason For Withholding 7761-1

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.

24(1)     D. Patrick

          957-2125

     920333

Attention:  19(1)

September 3, 1992

Dear Sir

Re:  Interest-Free Loan - Subsections 15(2) and 15(9)

This is in reply to your letter of January 29, 1992, concerning the treatment of interest-free loans to non-residents.

Your inquiry concerns the Part XIII withholding tax requirements on deemed shareholder benefits which arise in connection with interest-free loans made by a Canadian resident corporation ("Canco") to its non-resident corporate shareholder ("Holdco").  You indicated that you wished to have the Departments views on why deemed shareholder benefits which arise under subsections 15(9) or 15(2) should give rise to non-resident withholding tax obligations on Canco. 

It is your position that no amounts are paid or credited by Canco nor are there any amounts deemed by Parts I or XIV to be paid or credited.

You have also asked why The Department takes the position that Canco must withhold and remit the required 25% tax imposed by subsection 212(2) even though no dividend was paid by Canco to Holdco. 

In your letter you point out that

     For the purposes of Part XIII tax, paragraph 214(3)(a) provides that where section 15 of the Income Tax Act requires an amount to be included in computing a taxpayer's income, then that amount shall be deemed to have been paid to the taxpayer as a dividend from a corporation resident in Canada. 

We agree with your comments above, however we do not accept the following statement where you appear to indicate that the deemed benefits are now characterized as dividends when you state:

     Thus both the deemed interest benefit that arises as a consequence of subsection 15(9) and the amount of any loan required to be included in income by virtue of subsection 15(2) are characterized as dividends .

While it is true that the Act deems certain amounts to be treated as dividends for tax purposes, it does not characterize the amount as a dividend per se.

It is our position that the legislation in this respect is clear.  Where a corporation resident in Canada grants an interest free loan to a non-resident shareholder, the deemed benefit, which would ordinarily be included in the recipient's income by subsection 15(9) or 15(2)  will be subject to non-resident tax under subsection 212(2), by virtue of paragraph 214(3)(a).  The benefit is for the "use" of Canadian corporate funds without the requirement to pay interest to the Canadian corporation.  While we agree that paragraph 214(3)(a) of the Act deems the amount of the benefit determined under subsection 15(1) of the act to be a "dividend" in the hands of the non-resident, this does not mean that the "benefit" was not for the "use" of the Canadian funds, interest free.  In other words the amount is still a "benefit" even though it is treated as a dividend for taxation purposes. 

Pursuant to subsection 215(1), the person paying or crediting an amount, or the person who is deemed to have paid or credited an amount, on which income tax is payable under Part XIII is required to deduct or withhold therefrom the amount of Part XIII tax applicable.  You should also be aware that where the payment of the tax on the deemed dividend is not recovered from the non-resident, such payment of tax by the Canadian corporation is itself a benefit which must be taken into consideration as to the amount of any deemed benefits flowing from the Canadian Company to its non-resident corporate shareholder.

The necessity to withhold tax on the deemed benefit would arise when the amount is deemed to have been paid to Holdco.  Section 214 (3.1) indicates when the time of the deemed payment would arise, and in our opinion it would arise in the taxation year when the benefit was conferred on Holdco (i.e. when the interest free funds were made available to the non resident.)

In your letter you also asked our view on whether (Article X) of the Canadian International Tax Treaties would allow for a reduced withholding rate to these "deemed dividends".

Your letter does not contain sufficient particulars to respond to your inquiry on the treaty issue, we however offer the following general comments.

The term "dividends" is defined in all Canada's tax conventions or agreements and generally includes the phrase "...as well as income which is subjected to the same taxation treatment as income from shares..."  It should be noted that paragraph 3 of Article 10 of the O.E.C.D. model (the "model") has similar wording and the commentary at paragraph 27 to the model indicates that the Article includes a number of items not traditionally thought of as dividends and a portion of that paragraph reads as follows:

Payments regarded as dividends may include not only distributions of profits decided by annual general meetings of shareholders, but also other benefits in money or money's worth, such as bonus shares,bonuses, profits on a liquidation and disguised distribution of profits

Accordingly in our view the wording of Canada's tax conventions and agreements is broad enough to include deemed dividends such as those discussed above.

Where the shareholders are from a country with which Canada has a tax treaty, it will be necessary to review the Article relating to dividends to determine if Canada has granted a reduced amount of withholding tax to its treaty partner.  In the event that Canada has granted this reduced rate of withholding tax, the deemed dividends referred to earlier would be covered by such a treaty provision. 

I trust the above comments are adequate for your purposes.

Yours truly,

for DirectorReorganizations and Foreign DivisionRulings DirectorateLegislative and Intergovernmental  Affairs Branch