1 August 1988 Income Tax Severed Letter

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.

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August 1, 1988

Mr. Ken Major Chief, Foreign Section Specialty Rulings Directorate Legislative and Inter-Governmental Affairs Branch Revenue Canada, Taxation 875 Heron Road Ottawa, Ontario K1A OL8

Dear Sir:

RE: REQUEST FOR AN OPINION ON BEHALF OF XXXX ("THE BANK")

We are writing to obtain your confirmation that, under the circumstances described below, no Canadian withholding tax will be levied on interest paid to a U.K. subsidiary of the Bank in respect of funds on deposit with a U.K. branch of the Bank by virtue of the income tax treaty between Canada and the United Kingdom.

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In conformity with subparagraphs 212(l)(b)(iii) and (ix) of the Income Tax Act ("the Act"), interest on foreign currency deposits with Canadian bran- ches and on all (i.e., Canadian and foreign currency) deposits with foreign branches of Canadian banks is exempt from Canadian withholding tax. However, these exemptions only apply where the payment of interest is made to a person who is dealing at arm's length with the paying bank. Since the Bank and its wholly-owned subsidiaries are related persons with- in the meaning of section 251 of the Act, they do not deal with each other at arm's length. Accordingly, if a U.K. subsidiary of the Bank were to place funds on deposit with any branch of the Bank, the interest payments thereon would be subject to Canadian withholding tax at a rate of 25 per- cent unless such tax is reduced or eliminated by way of a tax treaty.

In the case of a U.K. subsidiary of the Bank that has funds on deposit with a U.K. branch of the Bank, the applicable treaty is the Canada-United Kingdom Income Tax Convention (1978).

Article VII of the Convention is entitled "Business Profits" and paragraph 1 thereof provides that the profits of an enterprise of a Contracting State (in this case, the U.K.) shall be taxable only in that state (i.e., the U.K.) unless the enterprise carries on business in the other Contract- ing State (i.e., in Canada) through a permanent establishment situated therein. If the enterprise carries on or has carried on business as aforesaid, the profits of the enterprise may be taxed in the other state (i.e., in Canada) but only so much of them as is attributable to that per- manent establishment. The term "enterprise of a Contracting State" is defined in Article III as meaning an enterprise carried on by a resident of a Contracting State.

Paragraph 7 of Article VII provides that where profits include items of income which are dealt with separately in other Articles of the Conven- tion, the provisions of Article VII shall not prevent the application of the provisions of those articles with respect to the taxation of such items of income.

Article XI deals with the taxation of interest. Paragraph 1 thereof pro- vides that interest arising in Canada or in the United Kingdom and paid to a resident of the other State may be taxed in the latter State. Paragraph 2 provides that such interest may be taxed in the Contracting State where it arises, but if a resident of the other Contracting State is the bene- ficial owner, the tax imposed by the State of source is limited to 10 percent of the gross amount of the interest.

Paragraph 7 of Article XI establishes the source of interest. Interest is considered to arise in a Contracting State if the payer is that State, or a political subdivision, local authority, or resident of that State. How- ever, in the cases where the person paying the interest has in a Contract- ing State a permanent establishment in connection with which the indebted- ness on which the interest was paid was incurred, and such interest is borne by the permanent establishment, then such interest is deemed to arise in the Contracting State in which the permanent establishment is situated.

Under the rule of paragraph 7 of Article XI, where a deposit is connected with, and the interest is borne by, a U.K. branch of the Bank and the funds are used in the normal course of that branch's lending business, the interest is deemed to arise in the country where the branch is located, i.e., in the U.K. (and therefore not in Canada). Since paragraphs 1 and 2 of Article XI do not deal with interest arising in the U.K. and paid to a resident of the U.K., Article XI is therefore silent as to Canada's ability to tax such interest.

In the Bank's case, the U.K. subsidiaries earn the interest in the normal course of their business carried on in the U.K. In our view, such inter- est therefore constitutes business profits within the meaning of Article VII. It also appears that since the interest is not attributable to a permanent establishment situated in Canada, according to paragraph 1 of Article VII such interest is taxable only in the U.K. and is therefore exempt from Canadian withholding tax.

We would appreciate receiving your confirmation of our view on this matter and we look forward to receiving your reply within the shortest delay possible.

If you have any questions on the foregoing, I would be pleased to discuss them with you. My telephone number is XXXXXXXX