2 May 1984 Income Tax Severed Letter RRR38 - Tax implications to a Canadian corporation who has to make good on the guarantee of its foreign parent's bank loan

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.

Dear Sirs:

This is in reply to your letter of July 15, 1980 concerning the income tax implications to a Canadian corporation who has to make good on the guarantee of its foreign parent's bank loan.

You outlined the following hypothetical situation in your letter:

A British bank (the "Bank") which maintains no permanent establishment in Canada, proposes to make a loan to a U.K. corporation (the "Parent") which loan is to be guaranteed by the Parent's subsidiary (the "Guarantor") which is a Canadian resident corporation. The Guarantee is to be supported by a charge on real estate situated in Canada.

Upon a review of the Income Tax Act (the "Act"), the Canada-U.K. Income Tax Agreement (the old treaty) and the Canada-U.K. Income Tax Convention, 1978 (the new treaty), you conclude that in the event of a default by the Parent the income tax consequences of the Guarantor making payments to the Bank on the guarantee will be as follows:

• 1. Any payments made by the Guarantor to the Bank on account of the principal portion of the Parent's indebtedness would not be subject to Canadian income tax.
• 2. The "interest portion" of the payments made by the Guarantor to the Bank on account of the Parent's indebtedness would, in the absence of any treaty exemption, be subject to tax under paragraph 212(1)(b) of the Act. Therefore, the Guarantor would be required to withhold such tax pursuant to subsection 215(1) of the Act.
• Notwithstanding the fact that no portion of the payments made by the Guarantor may be considered as interest insofar as it is concerned, the Guarantor would nevertheless be making payments to the Bank on the Guarantee "on account or in lieu of payment of or in satisfaction of interest" owing by the Parent to the Bank.
• 3. Any exemption contained in subparagraph 212(1)(b)(vii) of the Act would be inapplicable in the case of payments made by the Guarantor because insofar as it is concerned no interest is payable by it to the Bank.
• 4. Apart from the reduced interest rate, there is nothing contained in the old treaty which would preclude the imposition of Canadian withholding tax on the "interest portion" of any payments made by the Guarantor to the Bank.
• 5. Upon the new treaty coming into force, the "interest portion" of the payments made by the Guarantor to the Bank will be exempted from Canadian income tax.

You requested our views on the validity of your conclusions.

We agree with your conclusions insofar as items 2, 3 and 4 are concerned. However, insofar as item 1 is concerned, it is our view that section 15 may apply to the principal portion of payments made by the Guarantor which would result in the application of paragraph 214(3)(a) and subsection 212(2) to such payments. It is also our view that section 15, paragraph 214(3)(a), and subsection 212(2) may apply to the "interest portion" paid by the Guarantor.

We do not agree with your conclusion in item 5. It is our opinion that a subsequent ratification of the new treaty will not exempt the "interest portion" of any payments made by the Guarantor.

As you are aware, this reply is based on the information outlined in your letter. The tax consequences of an actual situation may be different than outlined above, depending on an examination of all the facts surrounding the transaction. Consequently, if you have a specific situation in mind, you may wish to consider submitting all the relevant facts and documentation and requesting a binding advance income tax ruling.

We trust that this reply will be of assistance to you.