27 February 1986 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.

February 27, 1986

K.B. Harding

Dear Sirs:

This is in reply to your letter of December 19, 1985, concerning the Canada-Brazil Income Tax Convention (Convention).

The Convention was ratified on December 23, 1985, and will be effective in accordance with Article 27 with respect to taxes withheld at source to amounts paid or remitted on or after January 1, 1986.

Your letter stated that the Bank does not have a permanent establishment in Brazil and all interest received on loans made to Brazilian borrowers will be subject to paragraphs 1 and 2 of Article 11 of the Convention. It is your view that the amount of Brazilian tax paid, for purposes of determining the foreign tax credit to the Canadian Bank with respect to a loan, will be determined in accordance with paragraph 3 of Article 22 of the Convention.

You outlined a hypothetical situation where the Bank makes a loan of one million dollars to a Brazilian borrower at 10 per cent and the Bank will receive $100,000 per year nil of withholding tax. Tax paid to the Brazilian government by the borrower is considered to have been paid on behalf of the Bank and regarded as additional interest.

Paragraph 3 of Article 22 of the Convention states that for purposes of determining foreign tax credit of the Bank which is resident in Canada, the income tax paid in Brazil shall always be considered as having been paid at the rate of 20 per cent of the gross amount of the income paid in Brazil. Accordingly, in our view, the Bank would report income of $125,000 in Canada and be considered to have paid tax to Brazil of $25,000 in accordance with the second example set out in item 1 on page 2 of your letter.

We are of the view that the same treatment should apply to certain loans made to Brazilian borrowers which are exempt from withholding tax in Brazil pursuant to domestic law, since paragraph 3 of Article 22 also applies to such loans.

In the case where interest arises in Brazil and is paid to a permanent establishment of a Canadian enterprise which is situated in a third State, paragraph 6 of Article 11 clearly indicates that paragraph 2 of that Article shall not apply to the interest. Accordingly, paragraph 3 of Article 22 of the Convention does not apply in this situation. Paragraph 2 of Article 22 states that where a resident of Canada derives income which may be taxed in Brazil, Canada shall allow as a deduction from tax on income of that person an amount equal to the income tax paid in Brazil, including business income tax and non-business income tax. It is our view that the above terms are not defined in the Convention and therefore have the meaning which they have under domestic law in accordance with paragraph 2 of Article 3 of the Convention. Therefore to the extent that the taxes paid to Brazil qualify as a business income tax or a non-business income tax pursuant to paragraphs 126(7)(a) and (c) of the Income Tax Act, such amounts would qualify for a foreign tax credit.

Where a Canadian borrower makes a loan to a Brazilian borrower through a permanent establishment in a third country, any portion of amounts of the tax which may be reimbursed to Brazilian borrowers will reduce the amount of tax paid to Brazil for purposes of calculating a foreign tax credit in Canada in accordance with paragraph 126(7)(a) of the Income Tax Act, and please be advised that the above are only expressions of opinions and are not binding on the Department.

We hope that the above is satisfactory for your purposes.

Yours sincerely,

Director Provincial and International Relations Division