30 August 1990 Income Tax Severed Letter AC74562 - Non-resident Withholding Tax on Stock Loan Interest

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.

DATE August 30, 1990

TO  Non-Resident Taxation Division     FROM  Financial Industries
    Source Deduction Programs Section  DE      Division
        Room 200C                              C. Robb
        J.H. Ivey, Chief                       957-2744
        Attention:  R.F. Power

                                       FILE   Your File : HAK
7335-1
                                              Our File:  7-4562

SUBJECT: Part XIII Tax on Stock Loan Interest

We are writing in response to your memorandum of November 28, 1989 wherein you requested our comments concerning the liability for withholding of Part XIII tax with respect to payments made under securities lending arrangements as "stock loan interest", prior to the intended date of application of proposed subsection 260(8) of the Income Tax Act (the "Act")

The following is a brief summary of the facts set out in the Toronto District Office's memorandum of September 18, 1989.

I.        Definition of stock loan interest, or stock loan rebate:

          1. A "short sale" involves the sale of a security not
          owned by the seller.  It is a technique used to take
          advantage of an anticipated decline in the price of the
          security or commodity.  A broker acting for a short
          seller may borrow stock certificates for delivery at the
          time of the "short sale".  If the seller can buy that
          stock later at a lower price, a profit results.

          2. When a broker lends securities in a stock loan
          transaction to another broker to cover a "short         
          position" taken by a customer of the borrowing broker, 
          a charge may be imposed by the lending broker for the  
          stock loaned.

          3. In a stock loan transaction, the borrowing broker may 
          deposit with the lending broker an amount of money equal 
          to the market value of the security as collateral.  It  
          is our understanding that securities may also be   
          assigned by the borrower to the lender as collateral. 
          Interest earned on the collateral by the lender may     
          result in a reduced fee charged to the borrower for the 
          use of the securities.

11.       According to information obtained from           24(1)  
          the lender's charge for the borrowed stock is based on a
          percentage of the market value of the stock for the
          period of the stock loan. 

III.      The stock loan interest charge paid by a broker for stock 
          borrowed from another broker is treated for both
          accounting and for tax purposes in the cases,           
                           24(1)

In your view, Part XIII of the Act does not require withholding of tax on an amount described above as stock loan interest which is paid or credited to a non-resident lending broker.

Brokers' Opinion

                                24(1)

Toronto District Office Opinion

In the view of Source Deductions, Toronto District Office, the payment could be considered interest for purposes of paragraph 212(13(b). The basis for this opinion is that the payment is made by the broker for the use of borrowed stock which has a specified market value at the time of the transaction and that the amount paid is based on a percentage of the market value of the borrowed stock.

Alternatively, it is the district office's opinion that the payment could be treated as a rent, royalty or similar payment or a payment for the right to use in Canada any property which would result in a withholding liability pursuant to subparagraph 212(1)(d)(i).

Our Comments

As we do not have copies of the agreements between the borrower and the lender in a typical case, we are not able to express an unconditional opinion as to whether the amounts paid as stock loan interest by a resident borrowing broker to a non-resident lending broker could be interest. The following comments are therefore general in nature.

An amount described above as stock loan interest would be subject to withholding pursuant to paragraph 212(l)(b) if it is interest.

Canadian jurisprudence (Miller v. The Queen, 85 DTC 5354 (FC-TD) has established that a payment will be characterized as interest if it meets all three of the following criteria:

(a) it must be calculated on a daily accrual basis:

(b)       it must be calculated on a principal sum of money or a
          right to a principal sum of money; and

(c)       it must represent compensation for the use of the
          principal sum of money or the right to the principal sum
          of money

The Department has taken the position that in a typical case a loan of securities is a disposition for tax purposes and that a broker which is a borrower is considered to have acquired the securities at the time the so- called loan is made.

In effect, it is our view that a Canadian broker as borrower would become indebted to the non-resident lender at the time the borrowed stock is acquired. We understand that in a typical stock loantransaction, the borrower's obligation to the lender would eventually be settled by a return of identical securities to the lender. Subject to the results of an examination of the documents effecting a particular transaction, our general understanding of a typical stock loan transaction is that `it could involve a principal sum or a right to a principal sum and payment computed with reference to a principal sum or right to a principal sum.

We understand that the payment may be a percentage of the fair market value of the stock being loaned and may be computed with reference to the length of time the Canadian broker is obligated to the foreign broker. It is probable that the payment would represent compensation for the use of the principal sum or the right to the principal sum.

If an examination of specific agreements indicated that the three criteria cited above were in fact satisfied in a particular transaction, the payments involved would be interest subject to Part XIII tax under paragraph 212(1)(b) of the Act. We would be pleased to comment on a particular case in response to a submission from you which includes the agreements governing the transaction. In our opinion, the stock loan interest in a typical transaction as described herein would not be subject to withholding under paragraph 212(1)(d) of the Act as a rent, royalty or similar payment, since the Department's view is that the borrower has acquired the stock.

J.C. Clark Chief Leasing & Financing Section Financial Industries Division Rulings Directorate