27 May 1982 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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May 27, 1982 The Director Revenue Canada Taxation Non-Corporate Rulings Division 375 Heron Road Ottawa, Ontario K1A 0L8

Dear Sir

We would appreciate your views on the following matters concerning the Canadian taxation of a U.S. corporation operating in Canada through a branch.

The hypothetical fact situation is as follows:

1. USCO 1 and USCO 2 are related corporations incorporated and resident in the United States.

2. USCO 1 operates in Canada through a branch which sells merchandise to Canadian customers.

3. As part of a financing package to promote its merchandise sales USCO 1 loans money to its customers and charges interest on these loans at attractive financing rates. All customers of USCO 1's Canadian branch deal at arm's length with USCO 1.

4. The funds which USCO 1 uses to loan to its customers in Canada are borrowed from USCO 2. USCO 2 charges USCO 1 interest on these loans at the same rate at which USCO 1 charges its customers.

5. USCO 1 carries on no other business in Canada other than through its Canadian branch. All directors meetings and shareholders meetings of USCO 1 are held in the United States and the policies governing the operations and the supervision of the corporation are settled in the United States even though the daily supervision of the branch is exercised in Canada.

6. USCO 1 also owns 100% of the shares of Canco a corporation incorporated, resident in and carrying on business in Canada. The shares of Canco are held separately from the corporation's Canadian branch operations and the shares would not be considered connected to those business operations.

The questions which arise given this scenario are:

(a) Do the Canadian customers of USCO 1's Canadian branch have to withhold Part XIII tax on interest payments to USCO 1?

(b) Does USCO I have to pay Part XIII tax on the interest which its Canadian branch pays to USCO 2?

(c) What rate of Part XIII tax is applicable to any dividends paid by Canco to USCO 1?

As to (a), USCO 1 will be subject to Part I tax in Canada in respect of its branch operations. The interest income which it earns from its Canadian customers would seem to be incidental to its business operations and as such similarly taxable under Part I of the Act. The interest would therefore seem to come within the provisions of paragraph 214(13)(c) and regulation 802 which would then exempt USCO 1 from Part XIII tax.

We would be grateful if you would confirm that no Part XIII tax would be exigible on the payment of interest from the Canadian customers to USCO 1 on the financing loans.

As to (b) the interest which USCO 1 pays to USCO 2 would seem to be a direct expense of USCO 1's Canadian branch operations and as such should be deductible under paragraph 20(1)(c) in computing the income of USCO 1's Canadian branch for the purposes of Part I tax. Because this interest is so deductible it would seem that the provisions of subsection 212(13.2) would apply to deem USCO 1 to be a person resident in Canada and so to subject the interest payment from USCO 1 to USCO 2 to Part XIII tax.

However Article XII paragraph 2 of the Canada-U. S. Tax Convention exempts from all taxes imposed by Canada interest paid by a U.S. corporation, whose business is not managed and controlled in Canada to another non-resident of Canada. It would seem in this case because the effective direction of USCO 1 is outside Canada its business would not be considered "managed and controlled in Canada" and so the interest which it pays to USCO 2 would seem covered by this exemption.

We would appreciate confirmation that no Part XIII tax would be exigible on the interest paid from USCO 1 to USCO 2.

As to (c) the normal Part XIII tax rate of 25% on dividends is reduced to 15% where the recipient is a corporation organized under the laws of the United States under Article XI of the Canada-U.S. Tax Convention. A condition for this reduction is that the recipient corporation must not have a permanent establishment in Canada. Although a strict interpretation of this condition might mean that a 25% rate would be appropriate when Canco paid dividends to USCO 1, i.e. because USCO 1 has a permanent establishment in Canada, namely its branch, the more reasonable interpretation would seem to be to deny the reduction to 15% only in those situations where the holding of the shares of the Canadian corporation was "effectively connected" or otherwise attributable to the U.S. corporation's Canadian branch. There seems no reason why a U.S. corporation should be denied the reduced rate of Canadian withholding tax on a Canadian share investment merely because it operates a completely separate and independent business in Canada through a permanent establishment.

In addition it would be simple for USCO 1 to form a separate U.S. subsidiary whose sole purpose would be to hold these shares of Canco. Such a reorganization would mean that the 15% rate would certainly apply to dividends from Canco to the U.S. subsidiary.

In the circumstances, we would be grateful if you would confirm that under the more reasonable interpretation of Article XI of the Convention or as a matter of assessing policy Revenue Canada would apply the reduced rate of Part XIII tax on dividends from Canco to USCO 1.

If you have any queries or require further information please contact the writer at XXXX

Yours very truly

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