20 September 1985 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.

XXXX

Martin Carsley (613) 995-1787

September 20, 1985

Dear Sirs:

This is in reply to your letter of May 24, 1985 wherein you requested our opinion on the application of certain provisions of the Canada-United Kingdom Income Tax Convention (1978) ("the Treaty").

In the example described in your letter a U.K. company, which would have more than 50% of its outstanding and issued voting equity shares owned by a Canadian company, would owe amounts under an interest-bearing debt instrument to its Canadian parent corporation. The debt instrument would provide that interest would be paid only if the U.K. company has sufficient profits. For U.K. income tax purposes, such interest payments would be characterized as dividends and would not be deductible in computing the U.K. corporation's taxable income. Such interest would be characterized as a dividend by virtue of paragraph 4 of Article X of the Treaty and would not be subject to U.K. non-resident withholding tax by virtue of subparagraph 3(a)(iii) of Article X of the Treaty.

As the debt instrument was issued after November 16, 1978 it would not meet the deflation of "income bond" or "income debenture" as defined in subsection 248(1) of the Income Tax Act (Canada) ("the Act"). Therefore, subsection 15(4) of the Act would not deem the interest to be received by the Canadian corporation as a dividend on a share of the capital stock of the U.K. company, nor would subsection 95(5) of the Act deem the debt instrument to be a share of the capital stock of the U.K. company. Thus, the Canadian parent corporation would not be entitled to any deduction pursuant to paragraph 113(1)(a) of the Act to the extent that it is possible to characterize the interest as a dividend out of exempt surplus of the U.K. corporation.

It is your opinion that the interest payments made by the U.K. company should be treated for Canadian income tax purposes as being paid out of the exempt surplus of a foreign affiliate. It is your view that this is the intended effect of subparagraph 1(b) of Article XXI of the Treaty. Since the U.K. company would not have taken a tax deduction for the interest it pays to its Canadian parent corporation, its taxation in Canada as interest and not as a dividend has the effect of subjecting the income to double taxation, once in the U.K. and again in Canada, contrary to what you believe to be the intended effect of the Treaty.

It is our opinion that the interest payment made by the U.K. company could not be treated for Canadian income tax purposes as being paid out of exempt surplus because the payment made by the U.K. company is not a dividend. Subparagraph 1(b) of Article XXI of the Treaty deals with the situation of a U.K. company paying a dividend out of exempt surplus, it does not deem interest payments to be dividends. If your analysis was correct there was never any need for subsection 15(4) of the Act to be included in the Act. As subsection 15(4) of the Act was not amended when the definition of income bonds was amended we can only conclude that it was intended that the Canadian company which receives the interest payment must include the amount in its income for income tax purposes.

If you conclude that this is an unfair result, in an actual case a taxpayer may wish to make a request for competent authority consideration. In this regard we refer you to Information Circular No. 71-17R2.

We trust this is the information that you require.

Yours truly,

for Director Specialty Corporations Rulings Division Corporate Rulings Directorate Legislation Branch

MC/as

SCRD CRD