23 June 1997 Internal T.I. 9712046 - SUBSECTION 227(6.1) AND ARTICLE X OF U.S. TREATY

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:

Determining the amount of refund under subsection 227(6.1) when threre is a change in the tax rate on dividend under the Canada-U.S. Income Tax Convention (the "Convention")

Position:

The lesser of the two amounts described in (a) and (b) of subsection 227(6.1)

Reasons:

The law is very specific in this regard. The rationale of allowing refund only on the lesser of the two amounts may be that (i) it is sufficient to avoid possible double taxation by allowing the lesser amount; and (ii) to discourage taxpayer to receive loan instead of dividend in anticipation of a reduction of the dividend tax rate under the Convention

June 23, 1997

M. Quebec, Director International Section
International Tax Services Office S. Leung
957-2115
Attention: Claude Vincent
Non-Resident Withholding
Accounts Division
971204

Subsection 227(6.1) of the Income Tax Act (the Act) and Article X of the Canada-U.S. Income Tax Convention (the "Convention")

We are writing in response to your memorandum of May 6, 1997 in which you requested our interpretation of subsection 227(6.1) of the Income Tax Act (the "Act") in determining the amount of refund payable to a non-resident person on repayment of a shareholder's loan in respect of which Part XIII tax has previously been paid pursuant to paragraphs 214(3)(a) and 212(2)(a) of the Act. Specifically, your request concerns the determination of the amount of the refund where there is a change in the tax rate on dividend under the Convention between the time the Part XIII tax was payable and the time the shareholder's loan was repaid. The change in the tax rate may either be caused by an amendment to Article X (Dividends) of the Convention with respect to the tax rate or by a change in the percentage of ownership of the voting stock of a company described in paragraph 2 of Article X of the Convention.

Our Comments

Subsection 227(6.1) of the Act is very specific with respect to the determination of the amount of refund of Part XIII tax. The amount is limited to the lesser of the tax originally paid in respect of the amount of the shareholder's loan repaid and the amount of the Part XIII tax that would be payable at the time of the repayment if a dividend equal to that amount of repayment were paid to the non-resident person at that time. The second amount would, therefore, take into consideration the tax rate at the time the loan was repaid. While we do not know for certain why subsection 227(6.1) of the Act restricts the amount of the refund, it is our understanding that that subsection was introduced to avoid the possible double taxation that would occur if the amount of the repayment of the loan was paid out as a dividend. In such a case, the double taxation could only occur up to the lesser of the tax paid when subsection 15(2) of the Act applied and the tax paid if the dividend was paid at the time of the repayment of the loan. In addition, it is the scheme of the Act to discourage loans to shareholders in lieu of dividends by treating such loans as income under subsection 15(2) of the Act and as dividends under paragraphs 214(3)(a) and 212(2)(a) of the Act. If the refund under subsection 227(6.1) of the Act was equal to the original tax amount when the loan was made, it may encourage a non-resident shareholder to receive a loan rather than a dividend if there is an expectation of a reduction in the dividend tax rate under the Convention. Restricting the amount of the refund under subsection 227(6.1) of the Act to the lesser of the two amounts described in (a) and (b) of that subsection discourages such a practice.

In the two scenarios described in your memorandum, we assume that the loan was repaid in 1997 and the repayment was not made as part of a series of loans or other transactions and repayments. In scenario #1 where the non-resident corporate shareholder owned at least 10% of the voting stock of the lender corporation both at the time the Part XIII tax was exigible and at the time the loan was repaid, the refund amount would be equal to 5% of the amount of the repayment notwithstanding that the withholding tax paid in 1993 was 10% of the shareholder's loan. In scenario #2 where the non-resident corporate shareholder owned less than 10% of the voting stock of the lender corporation at the time the Part XIII tax was exigible but owned 10% or more of the voting stock at the time the loan was repaid, the refund would also be equal to 5% of the repayment notwithstanding that the withholding tax paid in 1993 was 15% of the shareholder's loan.

We trust you will find the above to be of assistance.

for Director
Reorganizations and International Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch