18 October 1994 External T.I. 9404605 - DEDUCTIBILITE D'INTÉRET

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues:

whether withholding tax paid by a resident on behalf of a non resident is deductible interest

Position TAKEN:

question of fact

Reasons FOR POSITION TAKEN:

5-940460
XXXXXXXXXX (613) 957-8953

Attention:XXXXXXXXXX

October 18, 1994

Dear Sirs:

Subject: Technical interpretation
Paragraph 20(1)(c) of the Income Tax Act

This is in reply to your letter of February 22, 1993, requesting our opinion on the deductibility of Canadian non-resident withholding tax paid by a person resident in Canada, in respect of an agreement with a non-resident person that requires the cost of any withholding tax to be borne by the Canadian resident. Specifically, you requested that we provide comments as to whether the withholding tax payments made by the Canadian resident would be a deductible expense for tax purposes in the following situations.

Situation 1

-A Canadian corporation (Canco) borrows $100,000 at an interest rate of 10% per annum from a non-resident with whom it deals at arm's length.

-The loan agreement provides that, if Canadian non-resident withholding taxes apply to the interest payments, Canco is required to gross up the interest payment such that the amount received by the non-resident, net of withholding taxes, equals the amount of interest that would have been received by the non-resident if withholding taxes did not apply (i.e."gross-up" clause).

-The interest payments are subject to withholding taxes, at a reduced rate of 15% by virtue of a tax treaty between Canada and the non-resident's country of residence, and then the gross-up clause applies.

-The interest is deductible pursuant to paragraph 20(1)(c) of the Income Tax Act (the "Act"), and no other provision of the Act applies to disallow the deduction.

It is your understanding that the amount of tax to be withheld should be calculated as follows:

Interest prior to withholding tax ($100,000 x 10%) $10,000

Gross-up of interest ($10,000/1.00-.15) $11,765
Non-resident tax withheld $1,765

You ask if, in Revenu Canada's opinion the withholding tax payment of $1,765 made by Canco, is deductible for tax purposes on the basis that it represents additional interest, or is denied by virtue of paragraph 18(1)(t) of the Act?

Comments

Interest is generally considered to be on account of capital. Accordingly, it is generally not deductible pursuant to paragraph 18(1)(b) of the Act unless a deduction is specifically provided for under the Act. It is usually paragraph 20(1)(c) of the Act that is relied upon in claiming a deduction in respect of interest. In order to obtain a deduction for interest payments under paragraph 20(1)(c) of the Act, it must be demonstrated that the payments constitute "interest". Whether or not a payment constitutes interest is a question of fact. The expression "interest" is not defined in the Act and the legal definition of interest in Canada is narrow. The Department has previously stated, that:

"Generally, where the amounts accrue from day to day, represent compensation for the use of borrowed money, and are referable to the principal amount borrowed, the Department considers the payments to be interest. The Department considers that an amount is referable to a principal amount if it is determined as a percentage of the principal amount. If the amount is determined in some other manner - for example, by reference to cash flow, revenue, or profit - it is not considered to be referable to a principal amount even if the amount is, subsequent to its determination, expressed as a percentage of the principal amount. If the amount is not determined as a percentage of the principal amount but is limited to a percentage of the principal amount, the Department considers the amount to be referable to the principal amount if the limiting percentage reflects prevailing commercial rates in the circumstances."¹

Whether a payment can be regarded as accruing from day to day, as compensation for borrowed money and as being referable to the principal amount borrowed, are questions of facts that will ultimately depend in our view on the structure of the agreement.

It is our opinion that paragraph 20(1)(e) of the Act does not generally provide a deduction for compensation paid for the use of borrowed money. The expense may be considered as "eligible capital expenditure" if it meets the definition in subsection 14(5) of the Act.

On the issue of whether a deduction is denied by virtue of paragraph 18(1)(t) of the Act, we are of opinion that in order for a deduction to be denied in respect of an amount, that amount must be paid or payable under the Act. The tax is payable by virtue of an agreement between Canco and the non-resident, rather than by virtue of the Act. Accordingly, under Part XIII of the Act, it is the non-resident that is liable to tax and certainly not Canco. Consequently, we do not consider that paragraph 18(1)(t) of the Act would be applicable in the circumstances to preclude a deduction.

Situation 2

The same facts apply as in Situation 1 above, except that the loan agreement does not require Canco to gross-up the amount of interest but rather, requires Canco to pay the interest without withholding any non-resident income tax. In this situation, the Canadian non-resident withholding tax is calculated on the interest as stipulated in the agreement, as follows:

Interest prior to non-resident ($100,000 x 10%) $10,000
income tax
Non-resident income tax ($10,000 x 15%) $1,500
remitted by Canco

More specifically you asked if in Revenue Canada's opinion;

i)the amount of tax to be remitted by Canco is calculated correctly, and

ii)the amount of tax of $1,500 paid by Canco is deductible for tax purposes?

Comment

As in Situation 1, the deductibility of the interest could vary depending on the structure of the agreement.

It is our opinion that paragraph 20(1)(e) of the Act does not generally provide a deduction for compensation paid for the use of borrowed money. The expense may be considered as "eligible capital expenditure" if it meets the definition in subsection 14(5) of the Act.

These comments represent our opinion of the law as it applies generally. As indicated in paragraph 21 of Information Circular 70-6R2, this opinion is not a ruling and accordingly it is not binding on Revenue Canada, Taxation.

We trust this information will be of assistance to you.

Yours truly,

for Director
Rulings Directorate
Reorganizations and Foreign Division
Policy and Legislation Branch

¹ Conference Report 1987, at page 47:32
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