(2)-(14)

Table of Contents

Subsection 212(2) - Tax on dividends

Cases

Placements Serco Ltee v. The Queen, 84 DTC 6098 (FCTD), aff'd 88 DTC 6125 (FCA)

The withholding tax is exigible inter alia on the payment of amounts that are deemed by Part XIII (e.g., S.212.1(1)) to be dividends. S.212(2) refers only to Parts I and XIV, not Part XIII, because Parts I and XIV contain provisions which deem amounts to have been paid as dividends in situations where there has not in fact been a payment. This contrasts with S.212.1 which only deems an amount to be a dividend in situations where there has already been, as a factual matter, a payment (i.e., an "amount ... received").

The Canada Southern Ry. Co. v. The Queen, 82 DTC 6244, [1982] CTC 278 (FCTD), rev'd 86 DTC 6097, [1986] 1 CTC 284 (FCA)

Where the taxpayer agreed with an American parent ("Penn Central") that annual rentals, which Penn Central was in effect obligated to pay to the taxpayer, would be paid by Penn Central waiving its right to receive dividends from the taxpayer, the taxpayer was treated as crediting dividends to Penn Central (although a S.215(4) exemption applied).

Administrative Policy

10 February 2011 External T.I. 2010-0387151E5 - Deemed Disposition of Shares by a Non-Resident

On the redemption of shares of a non-resident which are taxable Canadian property, any resulting deemed dividend that is subject to Part XIII tax under s. 212(2) will not reduce the amount of withholding required under s. 116(5) where no s. 116 certificate is obtained.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 116 - Subsection 116(5) potential s. 116(5) withholding not reduced by Pt XIII tax 42

October 1992 Central Region Rulings Directorate Tax Seminar, Q. G (May 1993 Access Letter, p. 230)

The unreasonable portion of salaries or bonuses paid to non-resident shareholder-managers will be subject to Part XIII tax under ss.15(1), 214(3)(a) and 212(2).

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 15 - Subsection 15(1) 22

20 July 1992 External T.I. 5-921355 -

S.212(2) does not apply to a distribution of paid-up capital by a Canadian corporation to which s. 84(4.2) applies, because s. 84(4.2) does not deem the dividend to be paid by the Canadian corporation.

4 March 1992 T.I. (December 1992 Access Letter, p. 20, ¶C82-106, Tax Window, No. 17, p. 23, ¶1778)

The deemed dividend arising on the reduction of paid-up capital of term preferred shares of a Canadian-controlled private corporation held by a foreign specified financial institution will be subject to withholding tax under s. 212(2), because it applies to amounts paid on account of a dividend to a foreign shareholder.

4 October 1991 T.I. (Tax Window, No. 10, p. 16, ¶1498)

Where a public corporation plans to distribute, as a dividend in kind, all the shares of a wholly-owned subsidiary which have a fair market value to it of $1 per share but which, because of minority discounts, will have a fair market value of 80¢ per share after the distribution, the amount of the dividend will be $1 per share.

Locations of other summaries Wordcount
Tax Topics - General Concepts - Fair Market Value - Shares 57

Articles

Todd Miller, Ryan Morris, "Canadian Subsidiary Guarantees for Foreign Parent Borrowings", Tax Notes International Vol. 34, No. 1, 5 April 2004, p. 63.

Subsection 212(3) - Interest — definitions

Fully exempt interest

Administrative Policy

2012 Ruling 2011-0431891R3 - XXXXXXXXXX

A financial institution (the "Issuer") will accumulate a pool of mortgages [presumably CMHC-guaranteed in most cases] and sell an undivided interest in the mortgages to investors (the "Investors"). The mortgages will be sold, on a fully-serviced basis, by the Issuer for a single aggregate consideration, with respective undivided beneficial ownership interests in such pool represented by written instruments.

The ruling summary states that:

The interest paid is considered to be 'fully exempt interest' as defined in subsection 212(3) of the Act for the purposes of subparagraph 212(1)(b)(i) of the Act.

Paragraph (a)

Subparagraph (a)(i)

Subparagraph (a)(iii)

See Also

Laval Technopole v. Agence du revenu du Québec, 2018 QCCQ 6352

traditional common law tests of Crown agency applied in determining whether companies were agents of Canadian municipalities

The various appellants were companies that promoted commercial development, or cultural, sporting or tourist activities, in their respective municipalities. They were subject to a lower rate of Quebec health tax premiums if they constituted an employer with an establishment in Quebec provided that they were not an agent (“organisme mandataire”) of a Canadian municipality. They were not specifically designated in their letters patent as agents of their respective municipalities.

In finding that the appellants were such agents, Quenneville JCQ first referred to the common law function and control tests for determining crown agency (referencing “the nature and degree of control that the Crown exercises over the entity” (para. 58) ), and then stated (at paras. 165-168, TaxInterpretations translation):

To begin with, the municipalities themselves, with the exception of Longueil pour Sogerive et Agapac, confirmed that they controlled the entities.

In all cases, with the exception of CLLS, the majority of the members of their boards were named by the municipality or chosen from among a list proposed by the latter. In the case of CLLS, only two members of six of the board were named by the municipality, but it was it that named the president and vice-president.

It is important to emphasize that it is not actual control which must be considered, but rather the potential for the municipality to exercise such control. ...

The Councils of all the municipalities approved the financial statements, the budgets and the expenses of the entities. It was also the municipalities that financed a very large portion of the appellants’ activities. Furthermore, in all instances, their activities were integrated with those of the municipalities.

Words and Phrases
Crown agency
Locations of other summaries Wordcount
Tax Topics - General Concepts - Agency 184
Tax Topics - Income Tax Act - Section 149 - Subsection 149(1) - Paragraph 149(1)(c) municipally influenced companies were agents of the municipality 80

Participating debt interest

Administrative Policy

2018 Ruling 2018-0766771R3 - Commodity linked notes

a note whose repayment obligation is 100% linked to a commodity does not bear participating debt interest

In order to fund general corporate purposes, ACo will issue senior unsecured notes for 100% of their principal amount and bearing an annual coupon of a stipulated percentage of the principal. On maturity, the “Final Redemption Amount” required to be paid by ACo will equal the product of the Principal Amount, and an index reflecting the price performance of the specified commodity (the “Underlying”) between the “Strike Date” (shortly before the issue date) and the “Final Redemption Date” (shortly before maturity). The Final Redemption Amount will be payable in cash unless a Noteholder timely elects for physical settlement. A calculated “Early Redemption Amount” is payable on default. ACo likely will hedge its exposure under the Notes through options.

CRA ruled that s. 212(1)(b)(ii) will not apply to any payments of the interest coupons or to any payments on maturity or earlier redemption. The rationale stated in the CRA headnote is that:

The commodity is not sufficiently linked to the profitability of the issuer’s business.

2016 Ruling 2016-0664041R3 - Participating debt interest - contingent payment

interest that can increase with commodity price is not participating debt interest until this occurs
Loan terms

Canco will borrow funds from an arm’s length lender resident in a Treaty country under a term loan (the “Loan”) with required periodic principal repayments. The Loan Agreement (which contains a gross-up clause provides for the payment of regular “Periodic Interest”, which will be equal to a “Quoted Rate” for specified types of deposits at the commencement of each interest period plus a specified number of basis points. In addition, if at the end of any “Additional Payment Period” (of a specified number of months), the trailing average of the reference commodity exceeds the specified trigger price, an “Additional Payment” calculated by applying the “Applicable Rate” for that period to the outstanding principal at the start of that period, will be required to be made. The Applicable Rate is a minimum of X%, and increases in specified increments as the reference price crosses specified thresholds. The proceeds will be lent by Canco to its subsidiary to fund work on a project, and will be secured by property of Canco in addition to property of the subsidiary. Canco also may be required to prepay the loan if the reference price exceeds specified levels.

Ruling

S. 212(1)(b)(ii) will not apply to any payment of Periodic Interest provided that at the time of payment no Additional Payment had become payable by Canco at or before that time as a result of the trigger date therefor having occurred - and once such Trigger Date has occurred such that an Additional Payment is paid or becomes payable on the Loan, all subsequent payments of Periodic Interest will be subject to Part XIII withholding tax.

CRA reasons (in its summary)

The definition of a "participating debt interest" refers to interest "that is paid or payable on an obligation, all or any portion of which …". Since a contingent amount would not be considered "payable," until an additional payment is paid or becomes payable, the periodic interest would not be considered participating debt interest. However, once an additional payment is paid or becomes payable, the periodic interest on such obligation would be considered participating debt interest from that point of time onwards.

2016 Ruling 2015-0602711R3 - Interest on Notes to Non-Residents

interest ceasing after insolvency event not problematic

CRA ruled that interest was not participating debt interest respecting subordinated notes with conventional terms other than that, on a redacted specified event (presumably respecting a shaky financial condition, as defined) the notes would be automatically converted into preferred shares based on a pre-determined conversion ratio. In particular, the notes were to bear interest at a fixed annual rate until the Interest Reset Date, after which they will bear interest on a specified basis plus a fixed spread. No interest on the Notes will accrue or be payable after the “Mandatory Event.”

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 20 - Subsection 20(1) - Paragraph 20(1)(c) - Subparagraph 20(1)(c)(i) deductible interest on subordinated debt with mandatory insolvency conversion 202

21 January 2015 Internal T.I. 2014-0547431I7 - "Excluded amount" under clause 20(1)(e)(iv.1)(C)

payment to creditor excluded under s. 20(1)(e)(iv.1) as based on negotiated estimate of formula approximating share value

An amount payable to a lender on specified events such as an IPO and computed as X% of a modified computation of NAV was found by CRA (after referring to its positions on the predecessor of the similarly worded participating interest definition) to be excluded from eleigibility for deduction udner s. 20(1)(e)(iv.1) as being computed by reference to a "similar criterion," i.e., the equity value of the enterprise was a function of profitability and cash flow. A factual finding of Audit that this amount “was used as a substitute for a direct equity investment that the Lender originally wanted but could not acquire” was also germane. Finally, it did not make any difference that the borrower resisted paying the amount, so that what it ended up paying was pursuant to a negotiated settlement of what it owed under the formula.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 20 - Subsection 20(1) - Paragraph 20(1)(e) payment to creditor excluded as based on negotiated estimate of formula approximating share value 318

2014 Ruling 2014-0539791R3 - Paragraph 212(1)(b)

interest paid on limited recourse debt to the extent of available debtor was not participating debt interest

CDS trust entered into credit default swaps with a counterparty (a non-resident Bank) desiring credit protection for its bond portfolios and funded its purchase of the required collateral for its CDS obligations by issuing short-term notes. It defaulted on the notes in the 2008 financial crisis.

It settled litigation with the bank under a compromise which was voted on and approved by the Noteholders under a CCAA plan. Under this settlement, the Bank (which in the meantime had acquired some of the Notes directly and through non-resident subsidiaries) made payments under the CDS, which were applied by the Trust to repay all of the unpaid Note principal but only a portion of the unpaid interest (with recourse for such interest obligations being specified in the CCAA plan to be only to the Trust assets.)

CRA ruled that the payments of interest by the Trust to the Bank (and non-resident subsidiaries of the Bank) will not be "participating debt interest," stating:

The fact that interest would be paid by the Trust based on the available cash in the Trust…(i.e., the fact that the Trust will not be able to pay all the interest it owes…) does not impact the conclusion that the interest on the Notes is not being computed by reference to revenue, profit, cash flow, commodity price or any other similar criterion.

See more detailed summary under s. 212(1)(b).

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 212 - Subsection 212(1) - Paragraph 212(1)(b) creditors' approval of CCAA plan of compromise for the debtor trust did not cause them to not deal at arm's length with trust 365
Tax Topics - Income Tax Act - Section 251 - Subsection 251(1) - Paragraph 251(1)(c) creditors' approval of CCAA plan of compromise for the debtor trust did not cause them to not deal at arm's length with trust 188

2014 Ruling 2014-0523691R3 - Non-Viable Contingent Capital

non-viable contingent capital sub debt of bank respected as non-participating interest debt

Aco, a public corporation, will issue (at no discount or only a shallow discount) the "Notes" which: will rank equally with its other unsecured debt; will bear interest at specified fixed or floating rates, will not (in the case of the fixed rate Notes) be redeemable before the first interest reset date (except on the occurrence of specified events) and will be automatically converted into common shares based on a predetermined conversion formula (presumably at the point of non-viability as defined by OSFI, subject to regulatory discretion), so that there is no assurance that the conversion formula would result in the issuance of common shares having a fair market value at least equal to the principal.

Rulings

: Interest is not participating debt interest; s. 20(1)(c) deductibility of interest (subject to standard conditions);.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 20 - Subsection 20(1) - Paragraph 20(1)(c) non-viable contingent capital sub debt of bank respected as non-participating interest debt 158

2014 Ruling 2013-0514551R3 - Convertible Debentures and Paragraph 212(1)(b)

Cdn$ convertible debenture with interest and make-whole payable in common shares or potentially cash and make-whole amount dependent on share price
  • mature XX years from the issue date
  • bear fixed interest payable semi-annually, at the option of Aco, in cash or in class A shares ("common shares") calculated by dividing each interest amount by the current market price on the date falling XX days prior to the interest payment date
  • convertible into common shares at the option of the holder until shortly before maturity at a fixed conversion price (subject to anti-dilution protection)
  • on conversion holders will receive accrued but unpaid interest and a "Make-Whole Amount" (payable in common shares or in cash where the Exchange limits payment in shares) in respect of lost future interest, but with a reduction of XX% for each XX% that the current market price at the time of conversion exceeds the conversion price
  • Aco has the right to require conversion following the X anniversary

Concurrently with the above public offering Aco makes placement of subscription rights by private placement to "USco" comprising "Private Debentures" and warrants with "substantially similar" terms (but with expanded ability to pay the make-whole in cash). The Private Debentures and warrants may not be converted or exercised if that would result in USco holding more than XX% of the common shares.

Rulings

The payments made by Aco to the Debenture holders are not "participating debt interest." S. 212(1)(b) of the Act will not apply to the conversion of any of the Public Debentures or Private Debentures held by a non-resident of Canada or by virtue of any interest payment or any Make-Whole Amount under the Public Debentures or the Private Debentures, provided that the holder of the debenture deals at arm's length with Aco.

26 November 2013 Annual CTF Roundtable, 2013-0509061C6 - Part XIII Tax & Standard Convertible Debentures

interest and premium on standard convertible debenture not participating

[R]egular periodic interest payments made by public corporations pursuant to the terms and conditions of standard convertible debentures do not generally constitute "participating debt interest"… .

[T]he deemed payment of interest on standard convertible debentures under subsection 214(7) of the ITA that arises because of a transfer or assignment of standard convertible debentures by a non-resident person to a person resident in Canada (including the issuer of the debenture), does not generally constitute "participating debt interest". …

CRA is not inclined at this time to take the position that standard convertible debentures would in general constitute "excluded debt obligations" pursuant to paragraph 214(8)(c) of the ITA.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 214 - Subsection 214(8) - Paragraph 214(8)(c) interest and premium on standard convertible debenture not participating 77

18 March 2014 External T.I. 2013-0515631E5 - Criteria for Standard Convertible Debentures

no guidance provided on convertible debentures

"CRA cannot provide certainty concerning the application of Part XIII tax to the very broad range of situations in which convertible debentures can be issued" and taxpayers are encourage to seek advanced income tax rulings to resolve any concerns.

2013 Ruling 2013-0475701R3 - MIC deemed interest & participating debt interest

applies to dividends deemed to be interest

The Corporation, a "mortgage investment corporation" under s. 130.1(6), pays dividends which take into account, inter alia, its income and financial conditions. Such dividends are deemed by ss. 130.1(2) and 214(3)(e) to be paid to the shareholders "as interest on a bond." In refusing to rule that the interest was not participating debt interest, CRA stated:

[T]he dividends paid from the Corporation, which are deemed to be interest, were computed by reference to the income, profit, cash flow or other similar criterion described in the definition of PDI. Accordingly, the deemed interest payments would meet the condition that they are interest paid on an obligation and that they are of a participatory nature described in the definition of PDI.

2012 Ruling 2011-0418721R3 - Convertible Notes

U.S. dollar convertible debenture with cash payment option on conversion
amendments made by 2014-0532411R3 shown in red italics

PUBCO, which is a listed public corporation and a taxable Canadian corporation, completed an offering of Convertible Notes, including Convertible Notes ("Class XX Notes") purchased on behalf of ACO, which is a non-resident corporation which deals at arm's length with PUBCO.

The Class XX Notes:

  • were not issued at a discount and pay no premium
  • are payable in US dollars
  • have a specified maturity date for payment of the aggregate principal together with accrued interest
  • bear interest of XX% payable semi-annually, subject to a gross-up clause
  • are convertible into common shares (having a stated capital equal to the converted principal) at the option of the holder at the conversion price at any time prior to the earlier of the maturity date and the business day preceding the date which PUBCO has specified for their redemption (see below)
  • a cash payment is made in lieu of the issuance of a fractional share on conversion
  • accord PUBCO, in the case of a conversion request received from the BCO group, to elect to satisfy its obligations by delivering common shares in its capital stock at the Conversion Price or the cash equivalent thereof (based on their then market price)
  • are redeemable by PUBCO for their principal and accrued interest at any time before maturity provided that the current market price of the PUBCO common shares is at least x% of the conversion price
  • do not give PUBCO the right to pay the redemption price with common shares
Rulings

that the regular semi-annual interest payments will not be "participating debt interest" and that their payment to ACO will not be subject to Part XIII tax provided PUBCO deals at arm's length with ACO at the time of the payments. Supplementary ruling that "any amount deemed to be a payment of interest on a Class XX... Note under subsection 214(7) as a result of a conversion of the ... Note into Common Shares ... will not be subject to Part XIII withholding tax under paragraph 212(1)(b)" on the same arm's length assumption.

Opinion.

[On] a disposition of a Class XX... Note by ACO to a person resident in Canada (other than PUBCO) for proceeds of disposition payable in cash, any amount deemed to be a payment of interest on a Class XX...Note under subsection 214(7) would not in general constitute "participating debt interest"... .

23 May 2013 IFA Round Table, Q. 9

convertible and exchangeable debentures
  • What is the CRA's current position with respect to the application of Part XIII tax to convertible and exchangeable debentures owned by foreign lenders (s. 212(1)(b), the definition of "participating interest" in s. 212(3), s. 214(7) and their qualification as an "excluded obligation" under s. 214(8)(c) of the ITA)?
  • Is there anything new to report?

CRA responded:

Convertible Debentures

In June 2012, the Directorate issued 2011-0418721R3, stating that the regular periodic interest payments on a convertible debt issued by a taxable Canadian corporation to a non-resident would not be "participating debt interest." The Joint Committee would like CRA to establish guidelines that would apply to "standard convertible debentures." The Directorate has written to Finance for guidance respecting the tax policy of ss. 212(1)(b), 214(7), 214(8)(c) and the definition of "participating debt interest." Although CRA's analysis is substantially advanced, it is important to obtain the views of Finance. CRA is unable to provide any guidance as to when it will respond to the Joint Committee.

Exchangeable Debentures

Exchangeable debentures have been used in the past in the context of the "monetization" of shares of the capital stock of public corporations owned by the issuers of debentures. The interest paid on exchangeable debentures could be a proxy for the dividends paid on the shares into which the debentures are convertible. Accordingly, it may be relevant to determine whether the interest paid on exchangeable debentures constitutes "participating debt interest." The Directorate is not prepared to provide additional comments (outside the context of any ruling request) concerning the potential application of Part XIII tax with respect to exchangeable debentures without knowing all the relevant facts in relation to particular situations (including the terms and conditions of the exchangeable debentures).

1 May 2009 IFA Roundtable Q. 12, 2009-0320231C6 F - Convertible Debt Obligations

no deemed interest on conversion of traditional convertible debenture

Traditional convertible debentures are: unsecured subordinated obligations of a public corporation issued in Canadian dollars for their face value; bear interest (payable at least annually) at a fixed rate; provide a fixed conversion price (or ratio) in excess of the current market price on the issue date; and are redeemable by the issuer at the face value, plus accrued and unpaid interest, on the specified maturity date. CRA stated:

Where there is a conversion of a traditional convertible debenture by its original holder for common shares of the issuer, … in general there would be no Excess under subsection 214(7)… . Accordingly, no amount is deemed to be a payment of interest by the issuer (person resident in Canada) to the non-resident person for the purposes of Part XIII. For the purpose of paragraph 214(7)(d) of the ITA, the price for which the traditional convertible debenture is assigned on the conversion, is the amount determined by multiplying the fixed conversion price by the number of shares received on the conversion, that is, an amount corresponding to the face value of the traditional convertible debenture.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 214 - Subsection 214(7) no deemed interest on conversion of traditional convertible debenture 180

Income Tax Technical News, No. 41, 23 December 2009 Under "Convertible Debt", Q. 2

convertible premium taints all other interest

If a particular premium on a convertible debt obligation represented participating debt interest, all interest on the obligation would be participating debt interest under an initial analysis of the CRA.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 214 - Subsection 214(7) convertible premium taints all other interest 53

29 May 2009 External T.I. 2008-0301391E5 - EBITDA

variable interest tracked creditworthiness

Where (in order to reflect the resulting increased credit worthiness of the borrower) the interest on a loan decreases as the ratio of debt to EBITDA of the Canadian borrower decreases, such interest will not be considered to be participating debt interest.

2006 Ruling 2006-0208001R3 - Post-amble to paragraph 212(1)(b)

participation based on mutual funds

Where holders of notes receive at maturity a return linked to the performance of three mutual funds, the post-amble under s. 212(1)(b) will not apply so as to deny the availability of exemption in s. 212(1)(b)(vii). The issuer was not related to the mutual funds nor were the profits of the mutual funds linked to the issuer.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 212 - Subsection 212(1) - Paragraph 212(1)(b) participation based on mutual funds 58

2005 Ruling 2005-0161521R3 - Postamble of 212(1)(b)

variable interest tracked creditworthiness, not profitability

An interest rate under a term facility intended to qualify for the exemption under s. 212(1)(b)(vii) was equal to LIBOR plus a spread which decreased as the leverage (measured by the ratio of funded debt of the borrowers to EBITDA) decreased. CRA ruled this arrangement did not cause the post-amble to s. 212(1)(b) to apply. Although the interest payable varied as a result of changes in EBITDA, the extra amounts payable simply used EBITDA as a tool to assess creditworthiness and, as the borrower became more profitable, payments decreased, which was the opposite of participating debt.

8 January 2003 External T.I. 2002-017313 -

"A loan agreement that contains a provision for increased payments to the lender that are based on the ratio of certain debt to EBITDA ... of the borrower may fall within the ambit of the broad wording in the postamble ... ."

9 October 2001 External T.I. 2001-009665 -

acceptable to link to stock index or price of shares of dissimilar corporation

CCRA "would not generally consider interest that is computed by reference to a stock index as satisfying the exception conditions described in the postamble to paragraph 212(1)(b) ... as long as the Agency is satisfied that the particular index chosen is not influenced by the inclusion in that index of the shares of the issuing corporation, corporations related to the issuing corporation or a corporation or corporations whose primary business is substantially similar to that of the issuing corporation ... [O]ur response is predicated on the understanding that the return on the obligation does, in fact, represent 'interest' on the obligation."

22 November 2000 External T.I. 2000-004941 -

stock index link

The Agency would not generally consider the return computed by reference to a foreign stock index to be "computed by reference to revenue, profit, cash flow, commodity price or any other similar criterion" as long as the Agency is satisfied that the particular index chosen is not influenced by the inclusion in that index of the shares of the issuing corporation, corporations related to the issuing corporation or a corporation or corporations whose primary business is substantially similar to that of the issuing corporation. "Also, the Agency would want to be satisfied that the debt obligation is not used by a non-resident of Canada as a substitute for direct investment in the underlying securities in an index where dividends or gains on those securities will be subject to tax in Canada if held directly by that non-resident."

16 May 2000 External T.I. 2000-001101 -

link to FX fluctuation acceptable

Before concluding that it generally would be acceptable for the interest rate on a debt instrument to vary in accordance with the value of a foreign currency, the Directorate stated "although foreign currency can be bought and sold and as such could be considered a commodity, it is our position that in the context of the paragraph 212(1)(b) postamble, 'commodity price' should not be considered to include foreign currency fluctuations, but rather in general is to be limited to, for example, prices for tangible commodities ...&nbsp."

To date the Directorate has not adopted a position that would extend the position in ITT in No. 11 to debt linked to a stock index such as the Dow Jones Industrial Average.

Articles

Daniel Lang, Larissa Tkachenko, "Withholding Tax Implications of Participating Interest in Convertible Debt", CCH Tax Topics, No. 1916, November 27, 2008, p. 1.

Subsection 212(3.1)

Articles

Ian Bradley, Denny Kwan, Dian Wang, "Is The Back-to-Back Withholding Tax Regime an Effective Anti-Treaty-shopping Measure? ", Canadian Tax Journal, (2016) 64:4, 833-58

Non-application of B2B rules to dividends paid by Canadian (p. 856)

The back-to-back rules do not apply to dividends paid by Canadian taxpayers This is interesting, given that back-to-back dividend arrangements were challenged by the minister in Prevost Car and were cited by Finance as an arrangement that would be caught by the 2014 proposal. There may be policy reasons for not extending the back-to-back rules to address dividends. Unlike interest, rents, and royalties, dividends are not deductible by the payer, so back-to-back dividend arrangements may pose less of a threat to the Canadian tax base. Furthermore, while interest, rents, and royalties typically involve clearly defined payment obligations, dividends are often discretionary. This could make it more difficult to establish the requisite connection between equity investments (although the back-to-back rules do address some connections involving equity investments—for example, in the character substitution rules)….

Paragraph 212(3.1)(c)

Administrative Policy

17 November 2015 Roundtable, 2015-0614241C6 - 2015 TEI Liaison Meeting Q.6 - Specified Right

cross-border notional cash-pooling arrangement engages the B2B loan rules

Non-resident Parentco and its subsidiaries, including Canco, have a notional cash pooling arrangement that has been established with an arm’s-length financial institution (the “Bank”) not resident in Canada, under which the Bank has the right to offset overdraft balances of any pool participants against deposit balances of other pool participants without prior notice. In the absence of this set-off ability, the Bank could be required to treat the overdraft balances as non-performing loans for regulatory purposes. Canco has an overdraft balance on its pool account and has overdraft interest charges owing to the Bank. Does the Bank’s right to offset the deposit balances of other pool participants against Canco’s overdraft balance constitute a “specified right” within the meaning of subsection 18(5)? CRA responded:

[T]he deposit balances of the non-resident pool participants would be considered “intermediary debts” for the purposes of subparagraphs 18(6)(c)(i) and 212(3.1)(c)(i), with the result that the back-to-back loan rules would be engaged, provided its other conditions are met. We find support for this position…in the Department of Finance Explanatory Notes…which contain an example that seems…exactly on point.

…[Given] that such notional cash pooling arrangements would be caught under subparagraphs 18(6)(c)(i) and 212(3.1)(c)(i), it is not necessary to consider the possible application of the specified right rules contained in subparagraphs 18(6)(c)(ii) and 212(3.1)(c)(ii).

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 18 - Subsection 18(6) - Paragraph 18(6)(c) cross-border notional cash-pooling arrangement produced intermediary debt 93

Articles

Mark Coleman, "Treaty Shopping and Back-to-Back Loan Rules", Power Point Presentation for 28 May 2015 IFA Conference in Calgary.

Where CanCo receives an interest-bearing loan from its immediate parent (Treaty Co 1), which is funded by equity from the parent (Non-Treaty Co 1) of Treaty Co 1 residing in a non-Treaty county which, in turn, is funded by a loan from a non-Treaty affiliate of Non-Treaty Co 1, this latter loan will be described in s. 212(3.1)(c)(i)(B) as a loan owing by a person (Non-Treaty Co 1) who does not deal at arm's length with the intermediary (Treaty Co 1).

Non-Treaty Co makes a non-interest-bearing loan to its parent (Treaty Co) to fund an interest-bearing loan to the Canadian-resident parent of Treaty Co (CanCo). The interest on the latter loan will be subject to 25% withholding tax on the basis that it is deemed by s. 212(3.1) to be paid to a non-arm's length person (Non-Treaty Co). The interest received by Treaty Co will be foreign accrual property income to it. Quaere whether CanCo will be entitled to a foreign accrual tax deduction under s. 91(4) for the s. 212(3.1) withholding tax which is factually applicable to the interest received by Treaty Co but which may be considered to be payable by Non-Treaty Co under s. 212(1)(b).

Steve Suarez, "Canada Releases Revised Back-to-Back Loan Rules", Tax Notes International, October 27, 2014, p. 357.

Introduction of requirement for strong causal connection (p. 361)

Two aspects of the revised secondary obligation definition merit further comment. First, both the Creditor Party [intermediary] debt and Creditor Party [specified] right elements of the revised definition now use the term ''because'' to delineate what causes a secondary obligation [intermediary debt] to exist. This represents a significantly higher standard than was the case under the August 29 version of the term, and the concept appears to have been imported from another ''indirect loan'' rule in the ITA [in s. 17(2)].

[I]n AG of Canada v. Hoefele ... [fn 15: 95 DTC 5602 (FCA)…] the Federal Court of Appeal interpreted the ''because'' standard as implying a ''strong causal connection''… .

Expansion of permitted security rights under s. 18(5) - "specified right"(p. 362)

Second…[t]he revised ''specified right'' definition appears to have been improved in two ways, both of which in general seem to accommodate normal course secured guarantees and similar security arrangements typically found in commercial lending agreements. First, the party holding the security can pledge the secured property to secure the repayment of other debts, as is sometimes provided for in secured property legislation and some derivatives agreements….

Second, earlier versions of the ''specified right'' definition seemed to cause an event of default under the Canco debt (which typically gives a Creditor Party the immediate right to sell the secured property) to itself result in a specified right,…[whereas] the revised definition seems to prevent this if it can be shown that the Creditor Party must use any sale proceeds from the secured property to repay the Canco debt (or certain related debts)….

Steve Suarez, "An Analysis of Canada's Latest International Tax Proposals", Tax Notes International, September 29, 2014, p. 1131.

29 August revised version of description of intermediary ("secondary") debt (pp. 1134-5)

[T]he revised proposal deletes a requirement in the original proposal that the secondary obligation has been entered into as part of the same series of transactions that includes the creation of the Canco debt. Moreover, the scope of Creditor Party debt that can constitute a secondary obligation is actually greater under the revised proposal compared with the original version, since under the revised version now a secondary obligation will exist if:

  • recourse under the Creditor Party debt is limited to the Canco debt in whole or in part;
  • the Canco debt was entered into on condition that the Creditor Party debt be entered into; or
  • it is merely reasonable to conclude that if the Creditor Party debt did not exist, some or all of the Canco debt would not be outstanding or its terms and conditions would be different.

The last of these is especially troubling because there are many benign circumstances imaginable in which the presence of the Creditor Party debt might conceivably have affected the terms and conditions of the Canco debt in some way or another. As a result, very little nexus between two debts is required to create a secondary obligation, particularly with (1) the removal of the requirement in the original version that the Canco debt and the Creditor Party debt be part of the same series of transactions, and (2) the absence of any materiality threshold for the Creditor Party debt's effect on the terms and conditions of the Canco debt….

Subparagraph 212(3.1)(c)(ii)

Articles

Nik Diksic, Sabrina Wong, "Cross-Border Lending Practices", 2017 CTF Annual Conference draft paper

Loss of specified right exclusions where a NR bank lends to Canco through a non-resident affiliate (pp. 12-13)

NR1 borrows from a third-party bank and on-lends the funds to CA…CA and NR2, another company in the group, provide security (in the form of pledged assets) in support of NR1's borrowing. In this situation, NR1 is the "immediate funder" and a "relevant funder" [fn 68: Paragraph (a) of the definition of “relevant funder” in subsection 212(3.8).] and the bank is also a "relevant funder" [fn :69: The bank would be a "relevant funder" under paragraph (a) of that definition in subsection 212(3.8) as the creditor in respect of the debt or other obligation referred to in paragraph (b) of the definition of "relevant funding arrangement" in subsection 212(3.8).] and may be an "ultimate funder". This in and of itself would not be problematic as the interest withholding tax applicable on a direct payment from CA to the bank would presumably be nil [fn 70: Paragraph 212(1)(b).], such that the B2B rules would not apply. However, if the bank has a "specified right" granted by NR2 which secures repayment of NR1's borrowing, then the bank would not be an "ultimate funder". As the grantor of a specified right, NR2 would become a "relevant funder" [fn 71: Paragraph(b) of the definition of “relevant funder” in subsection 212(3.8).] and an "ultimate funder". Therefore, if the B2B rules applied, the withholding tax would be determined from NR2's perspective (and a 10% rate would apply). The issue is whether the carve-out in the definition of "specified right" can apply, in these circumstances.

[T]he bank only has the right to enforce its security and sell the pledged assets on default, such that the second part of the definition is relevant…

[T]he NR2 pledge supports NR1’s borrowing, and not CA’s borrowing (as the latter is an internal borrowing). The question therefore is whether NR1’s borrowing from the bank is an amount described in subparagraph (6)(d)(i) or (ii). The amount referred to in subparagraph 18(6)(d)(i) is the "particular amount", which in the context of subsection 18(6), is presumably the amount owing by CA. The amounts referred to in subparagraph 18(6)(d)(ii) are amounts (other than the particular amount) that the taxpayer, or a non-arm's length person, owes to the "intermediary". The bank is not the "intermediary" in the context of subsection 18(6), and therefore the arrangement appears to be outside of the scope of the carve-out in the "specified right" definition. Had the bank loaned the funds directly to CA and had NR2 provided security in support of that borrowing, the carve-out would have presumably applied.

Paragraph 212(3.1)(d)

Articles

Nik Diksic, Sabrina Wong, "Cross-Border Lending Practices", 2017 CTF Annual Conference draft paper

Cannot benefit from ultimate funder withholding rate if immediate funder rate is higher (p. 11)

Consider … where NR1 (treaty country [with 10% withholding rate]) has funded CA through NR2 (non-treaty country) and NR3 ([held by NR2 and in a] treaty country [with 0% withholding rate]). In this case, the B2B loan arrangement rules will apply and deem NR1 to receive a notional interest payment on which 10% withholding tax will apply. The interposition of non-treaty NR2 in the funding chain will not affect this result as NR2 will not qualify as an "ultimate funder”….

[C]onsider…where NR1 (treaty country) funds CA through NR2 (non-treaty country). In this case the 25% withholding tax rate on the payments to NR2 will simply apply as the B2B rules cannot be used to reduce the withholding tax rate that applies to the immediate funder…

Upper-tier common equity can create benefit of ultimate funder status to access lower withholding rate (p. 12)

NR1 provides some level of common equity funding to NR2 as part of the overall funding arrangement. As we have seen above, this could result in the common shares being deemed to be a relevant funding arrangement, and for NR1 to be owed a debt obligation that is equal to the full amount of the particular debt or other obligation owed by CA. If that is the case, then this structure would ensure "ultimate funder" status for NR1, which would preserve the 10% withholding tax rate on payments from CA to NR3.

Mark Coleman, "Treaty Shopping and Back-to-Back Loan Rules", Power Point Presentation for 28 May 2015 IFA Conference in Calgary.

If a loan by U.S. Parent to its "grandchild" Canadian ULC sub (held e.g.,, through a C-Corp sub) is funded by a loan by an LLC sub ("Opco") of U.S. Parent, 25% withholding tax will apply under s. 212(3.1)(d) given that a direct loan by Opco to ULC would be subject to the hybrid entity rule (Art. IV (7) of the Canada- U.S. Treaty).

Michael N. Kandev, "Canadian Interest Anti-Conduit Rule Soon to Be Law", Tax Notes International, December 15, 2014, p. 1027

Back-to-back ("B2B") rule in s. 212(3.1) is anti-conduit rule (p. 1028)

The absence of a safe harbor for non-resident non-arm's-length intermediaries shows that the withholding tax B2B rule goes beyond being a specific anti-avoidance rule intended to protect the domestic withholding tax exemption on arm's-length nonparticipating interest. This is because a non-arm's-length non-resident intermediary would not enjoy such domestic exemption. This missing carve-out transforms the rule in section 212(3.1) into a broader anti-conduit rule targeting cases when the intermediary, though not eligible for the domestic interest withholding tax exemption, may still enjoy a better treaty rate than would the non-resident parent.

Effect on cash pooling (p. 1029)

The… anti-conduit rule in the withholding tax B2B regime is… purely mechanical in its operation and, therefore, may adversely affect either non-tax-driven structures or transactions that have a tax motivation but that arguably are not abusive.

First, cash pooling/treasury companies may be subject to the rule if the 25 percent de minimis rule does not apply and an incidental treaty benefit would otherwise be present.

B2B rule causes U.S. Treaty anti-hybrid rule to apply (p. 1029)

Second, the rule may have a perverse application in the context of the Canada-U.S. tax treaty. Picture two U.S. residents and qualifying persons forming a joint venture limited liability corporation. Assume the LLC borrows from an unrelated bank to make various investments. One of the investments is in Canada and is made for U.S. tax purposes through a Canadian unlimited liability corporation (ULC). The LLC would like to ‘‘push down'' the bank debt into the ULC by lending to it in accordance with Canada's thin capitalization ratio.

…Article IV(7)(b) of the treaty… den[ies] the treaty exemption… . To avoid this effect, assume the two U.S. partners form a parallel financing LLC through which the debt financing is routed to the ULC. [V]arious Canada Revenue Agency rulings… suggest that such planning is acceptable... . However, the new rule in section 212(3.1)ff would push this structure right back into Article IV(7).

Application to indirect loan from 15% Treaty jurisdiction (p. 1029)

Third, the B2B rule would deny simple treaty self-help, which arguably is not abusive. For example, assume a Spanish multinational has borrowed from an unrelated local financial institution and would like to use some of its capital to finance a Canadian subsidiary. If it borrowed directly, a 15 percent Canadian withholding would apply under the current treaty [cf. announced Protocol]. However, if the Spanish company routed the debt financing through a Luxembourg company, it would lower this tax cost to 10 percent…. [S]ection 212(3.1)ff would now bring back the 15 percent withholding... .

Paragraph 212(3.1)(e)

Articles

Edward A. Heakes, "The Proposed Revisions to Back-to-Back Loan Rules", International Tax Planning (Federated Press), Vol. XIX, No. 4, 2014, p. 1357.

Narrowness of aggregation rule in s. 212(3.1)(e)(ii)(B) (p.1359)

[T]he basic thrust of this [de minimis] rule is that if the amount that is provided to the intermediary (i.e., for example, the fair market value of property in which there is a specified right or the amount of the limited recourse obligation of the intermediary or non-arm's length person[f.n. 3 The actual proposed wording refers to a security interest being provided to the intermediary in respect of an intermediary debt. … [I]t is not clear…why the intermediary would ever be granted a security interest in respect of its own obligation]) is less than 25% of the amount owing by the Canadian taxpayer to the intermediary, the back-to-back rule will not apply. In addition, if certain requirements are met, the amount of indebtedness to the intermediary owing by persons that do not deal with the taxpayer at arm's length can also be included in the 25% threshold. Basically, the requirements are that the other amounts be outstanding under an obligation that is connected to the agreement and that any security provided secures all of the obligations under the arrangements. This aggregation rule is relatively narrow. For example, it does not appear to extend to situations where there are multiple related lenders, nor does it appear to accommodate situations in which for valid non-Canadian-tax reasons, certain assets are not provided as security under all of the obligations. For example, in situations where there is a U.S. parent and there are secured loans to both the parent and the Canadian subsidiary, it is often the case that, because of U.S. tax considerations, the Canadian assets are provided as security for the Canadian obligation but not as security for the U.S. obligation.

Steve Suarez, "Canada Releases Revised Back-to-Back Loan Rules", Tax Notes International, October 27, 2014, p. 357.

Narrow 25% safe harbour (p. 363)

There are two basic scenarios in which the de minimis exception is intended to provide relief. The first is when the amount of any secondary obligations in respect of the Canco debt is relatively small so as to be less than 25 percent of the Canco debt….

The second situation is when the Canco debt is one of a number of debts owing by a group of related debtors to the same creditor, and the same secondary obligations that secure the Canco debt also secure the other debts owing by those group members….

[F]or other group debts to be included within item B [i.e., s. 18(6)(d)(i) and (ii), or 212(3.1)(e)(i) and (ii)], above:

  • the creditor must be Creditor itself, rather than any Creditor Party;
  • the security interests relating to the various debts and the Canco debt must correspond quite closely; and
  • the other group debts must arise under the agreement creating the Canco debt or an agreement that is ''connected'' to that agreement.

It is not obvious why such a high degree of interconnectivity between the Canco debt and other Canco Party debts is necessary to include the latter in the denominator for purposes of the de minimis exception….

Steve Suarez, "An Analysis of Canada's Latest International Tax Proposals", Tax Notes International, September 29, 2014, p. 1131.

De minimis rule in s. 212(3.1)(d)

While Finance is to be commended for trying to accommodate typical multinational group borrowing arrangements, unfortunately the de minimis test as proposed is at best only a partial solution. Fundamentally, the 25 percent de minimis threshold is too low, and the conditions required for another debt owing by a Canco Party to be included in the denominator of the 25 percent test…are too strict:

  • the creditor must be Creditor itself, as opposed to any Creditor Party;
  • the security interests relating to the different debts must correspond quite closely for a Canco Party debt to be included in the denominator; and
  • the different debts must arise under the agreement creating the Canco debt or an agreement that is connected to that agreement.

There is no obvious reason to require such a high degree of interconnectivity between the Canco debt and other Canco Party debts to include the latter in the denominator for purposes of the de minimis test, particularly given how much lower the degree of connectivity is between the Canco debt and the amount owing to Nonresident to create a Creditor Party debt and thereby trigger the rule….

Subsection 212(3.2)

Articles

Ian Bradley, Denny Kwan, Dian Wang, "Is The Back-to-Back Withholding Tax Regime an Effective Anti-Treaty-shopping Measure? ", Canadian Tax Journal, (2016) 64:4, 833-58

Derivative benefits concept under B2B rules can provide relief where ultimate funder has a Treaty-reduced rate that is higher than that of immediate funder (pp. 852-853)

The back-to-back regime incorporates the concept of derivative benefits, since the rules effectively preserve the treaty benefits of the immediate funder (or licensor) to the extent that the ultimate funder (or licensor) would be entitled to treaty benefits if it received the relevant payments directly….NR 1 is resident in a treaty country for which the withholding tax rate on interest is limited to 15 percent. NR 3 is resident in a treaty country for which this rate is limited to 10 percent. NR 2 is not resident in a treaty country. NR 1 loans $1,000 to NR 2, which in turn loans $1,000 to NR 3, which in turn loans $1,000 to Canco….

Canco will be deemed to have paid interest to NR 1 under proposed subsection 212(3.2). The deemed interest will be $20, because it is adjusted to reflect the difference in withholding tax rates between payments to NR 1 and NR 3, as a proportion of the rate on payments to NR 1 (that is, [15% — 10%]/15%). The deemed interest will be subject to $3 tax, for overall tax of $9 (or 15 percent of the actual interest payment). The total withholding tax reflects the treaty entitlement of the ultimate funder….Interestingly, the derivative benefit tests in the LOB rules might not provide relief in this case, since they generally require that the ultimate owner be entitled to treaty benefits that are at least as favourable (instead of providing relief to the extent of the ultimate owner's entitlement to benefits.)

No relief under B2B rules if immediate funder has higher rate than ultimate funder (pp. 853-854)

Although the back-to-back rules consider the treaty entitlements of the ultimate lenders (or licensors), the withholding tax payable under these rules cannot be less than the tax on the actual payments to the immediate funder (or licensor)….NR 1 is resident in a country for which the withholding tax rate on interest is limited to 10 percent, and NR 2 is not resident in a treaty country. NR 1 makes a loan to NR 2, on condition that NR 2 makes a loan to Canco. Although the connection test in proposed paragraph 212(3. l)(c) is satisfied, the back-to-back rules would not apply in this scenario because the tax on interest paid to the ultimate funder would not exceed the tax on interest paid to the immediate funder. Canadian withholding tax would apply at the full 25 percent rate.…

Sabrina Wong, "Bill C-29 Amendments to the Back-to-Back Rules", International Tax, Wolters Kluwer CCH, December 2016, No. 91, p. 5

Allocation under s. 212(3.2) formula of interest to ultimate funder in excess of actual interest to it (p. 7)

Essentially, the formula allocates to each ultimate funder an amount of deemed interest equal to a proportion of the actual interest paid by the taxpayer. The proportion is determined by reference to the pro-rata share of proportion of the taxpayer's debt that is ultimately funded by the particular ultimate funder (essentially the ratio of the net "funding" provided by the ultimate funder to the amount of the taxpayer's debt) and adjusted for the difference between the withholding tax rate on interest paid to the ultimate funder and the withholding tax rate on the actual interest paid by the taxpayer; it should be noted that the proportion is determined by reference to the average of principal amounts of debt or other obligations outstanding (and the fair market value of property in respect of which specified rights have been granted) under relevant funding arrangements in the period during which the interest accrued on the taxpayer's debt Thus, an ultimate funder could be allocated a pro-rata portion of the deemed interest even though it has provided a non-interest-bearing loan or it has not provided any loan at all but has granted "specified rights".

Subsection 212(3.21)

Subsection 212(3.3)

Articles

John Lorito, Trevor O'Brien, "International Finance – Cash Pooling Arrangements", 2014 Conference Report, (Canadian Tax Foundation), 20:1-33

Unavailability of s. 212(3.3) where Canco owes $50 to Netherlands intermediary, which owes $40 to Caymanco and $100 to USCo – because U.S. withholding rate is 0% (p. 7)

At first glance, it seems [in this example] that the rule in subsection 212(3.3) may apply as there would appear to be two intermediary debts and, therefore, two non-residents to which interest is deemed to be paid, namely, USCo and CaymanCo. …[H]owever, the back-to-back loan rules do not apply in respect of the intermediary debt owing to USCo because the fourth condition [that the withholding tax would be greater if the interest was paid directly to USCo] does not apply.

…[If] USCo is replaced with a corporation resident in Malaysia…the withholding rate would be 15% [rather than 0%]. As a result…subsection 212(3.2) would apply to allow the taxpayer to designate amounts such that interest on 80 per cent of the Canco debt is deemed to be paid to the Malaysia corporation. …[S]ubstituting the Malaysian corporation for USCo has reduced the withholding tax… .

It seems to be a somewhat incongruous result that subsection 212(3.3) can be applied to reduce the withholding tax payable in a situation in which the second intermediary lender is resident in a jurisdiction in respect of which the withholding tax rate is higher than that of the jurisdiction of the intermediary but not if the second intermediary lender is resident in a jurisdiction in respect of which the withholding tax rate is lower than that of the jurisdiction of the intermediary.

Subsection 212(3.4)

Articles

PWC, "Bill C-29 significantly expands back-to-back rules", Tax Insights PWC International Tax Services, Issue 2016-53, 16 November 2016

Example illustrating key difference between the existing and amended rules in a situation Canco and 4 related non-residents (NR1, NR2, NR3 and NR4) (pp. 6-7)

Facts
Loans (it is assumed that each loan satisfies the connection test in the back-to-back rules):

  • Canco receives a $1,500 loan from NR1
  • NR1 receives a $2,000 loan from NR2 and a $1,000 loan from NR3
  • NR3 receives a $1,000 loan from NR4

Other facts:

  • Canco pays $150 interest to NR1, which is subject to 10% withholding tax or ($15) due to a tax treaty
  • Interest paid to NR4 is also eligible for a 10% treaty rule
  • Interest paid to NR2 and NR3 is not eligible for treaty benefits (and is therefore subject to a 25% withholding tax rule)

Existing Rules
Under the existing rules, Canco is deemed to pay interest to both NR2 and NR3, because they both provide funding to NR1, and interest paid to each funder would be subject to a higher withholding tax rate than interest paid to NR1 (notwithstanding that NR3 is itself funded by NR4, which is not subject to a higher tax rate). ...

Amended Rules
Under the amended rules, NR2 and NR4 are both ultimate funders. ...

Because NR1 receives $1,500 excess funding (see above), the amounts of funding received from NR2 and NR3 are reduced pro-rata ) to $1000 from NR2 and $500 from NR3) to eliminate the excess. Accordingly, the deemed interest paid to each ultimate funder is computed on the basis that Canco receives indirect funding of $1,000 from NR2 and $500 from NR4. ...

Canco is not deemed to pay any interest to NR4, because NR4 is eligible for the same 10% treaty rate as NR1.

Canco is deemed to pay $60 interest to NR2, which is subject to $15 tax.

Subsection 212(3.5)

Articles

Jason Boland, Christopher Montes, "A Detailed Review of the Back-to-Back Loan Rules", 2016 Conference Report (Canadian Tax Foundation), 26:1-32

Overview of s. 212(3.5) (pp. 26:13)

When a relevant funder receives funding (either by way of debt or specified right) which it uses (together with other funds) to fund several particular debts, additional rules are necessary to prevent the deemed interest payments under subsection 212(3.2) from exceeding the portion of the actual interest payments that relate to the back-to-back arrangement. ...

In these circumstances, subsection 212(3.5) provides that the amount owing by the relevant funder (or the FMV of the property in respect of which the relevant funder has been granted a specified right), in respect of each particular debt is reduced proportionately based on the total of all particular debts.

Subsection 212(3.6)

Paragraph 212(3.6)(a)

Articles

Nik Diksic, Sabrina Wong, "Cross-Border Lending Practices", 2017 CTF Annual Conference draft paper

Whether s. 212(3.6) applies prospectively (p. 6)

[I]f the particular debt or other obligation is issued in Year 1, but the dividend obligation only arises in Year 3, does subsection 212(3.7) apply for all periods of time before the dividend obligation arises? This concern is perhaps more acute in the context of the B2B loan arrangement rules, as the consequences of a B2B arrangement under subsection 212 (3.2) are more mechanical - if subsection 212(3.7) applies, the shares are deemed to be debt and are included in the formula in subsection 212(3.2)….

Despite the less than clear statutory language, a more reasonable interpretation is to apply the rule in subsection 212(3.6) on a prospective basis only. Although references to the "particular time" were removed in subsection 212(3.6), subsection 212(3.7) still refers to the concept of "the particular time" in the formula variables. — One possibility is that these are orphaned references from the prior version of these provisions, as there is no longer a reference to "particular time" in subsection 212(3.6). On the other hand, the references to "particular time" in subsection 212(3.7) could be interpreted as referring to the "particular time" in the formula in subsection 212(3.2), such that the relevant amounts determined under subsection 212(3.7) are to be determined separately for all particular times during the "relevant period" referred to in subsection 212(3.2). But that alone could still allow for the retroactive application of the rule. Another possibility is that the references to "particular time" in subsection 212(3.7) could also refer to the "time" at which a dividend obligation arises under subsection 212(3.6), although this is somewhat inconsistent with the normal drafting style used in the Act….

Whether dividend can be declared and paid simultaneously (p. 7)

[T]he Department of Finance expressly stated that dividends paid on common shares could be subject to the character substitution rules, provided the connection test is met….

[P]erhaps it is possible to structure a dividend without there being any time between declaration and payment. Furthermore, it seems surprising that the Department of Finance would craft a rule that is dependent on the vagaries of corporate law and the existence of an "obligation" for any brief moment in time if they truly intended to capture "plain vanilla” common shares.

Jason Boland, Christopher Montes, "A Detailed Review of the Back-to-Back Loan Rules", 2016 Conference Report (Canadian Tax Foundation), 26:1-32

Application of connectivity test to SPVs (p. 26:16)

...In practice, when an equity subscription is used to fund a special purpose vehicle (SPV) that uses the proceeds to fund a loan, the connectivity tests likely will be met. ...

...[I]f an SPV was funded initially with equity in order to invest in a non-Canadian asset, but the SPV later sells the asset and reinvests the funds in a loan to a Canadian taxpayer, the arrangement could be subject to these rules.

2nd leg might arise years later (p. 26:25-26)

...[T]he connectivity tests do not require that the two legs of a back-to-back arrangement be put in place at or around the same time. Therefore, each time a Canadian entity receives funding of any sort, it will have to trace the historical origin of that funding, even if one leg of the back-to-back arrangement was put in place a long time before, and the funds in the intermediary have been reinvested a number of times. For example, consider a situation in which a share investment is made in an intermediary jurisdiction for purposes of investing in a non-Canadian entity. A number of years later, the non-Canadian investment is sold and a new investment is made into Canada (which respects the applicable Canadian thin capitalization ratios). This arrangement could be subject to the back-to-back rules (including the character substitution rules), and therefore the arrangement must be reviewed and monitored for compliance on an ongoing basis. Is it feasible to require such historical tracing and ongoing monitoring? Will this significantly increase compliance costs for multinational groups who do business in Canada?

Second, foreign jurisdictions most likely will not provide foreign tax credits to compensate for the Canadian withholding tax paid under the back-to-back rules. This is because it is likely the intermediary jurisdiction will provide a credit only for the rate on payments actually made to its jurisdiction, not for any additional or notional amount. The ultimate funder's jurisdiction is unlikely to provide a foreign tax credit at all because it will not recognize a Canadian source of income.

Michael N. Kandev, "Canada Expands Back-to-Back Regime: Examining the Character Substitution Rules", Tax Notes International, June 19, 2017, p.1087

Potential application to dividend declared after particular debt has disappeared (p.1091)

[F]or the character substitution rules to apply, the dividend must be declared at or after the time the particular debt or other obligation referred to in paragraph (3.1)(a) is entered into. It remains uncertain whether a dividend declaration that occurs after the particular debt or other obligation has ceased to exist still triggers paragraph 212(3.6)(a). The text of the rule suggests that it might, but arguably this would not be an appropriate result.

Sabrina Wong, "Bill C-29 Amendments to the Back-to-Back Rules", International Tax, Wolters Kluwer CCH, December 2016, No. 91, p. 5

Potential application to common shares (p. 10)

[T]he Character Substitution Rules…generally apply where a "relevant funder" has an obligation to pay a dividend on its shares (other than "specified shares") or an amount under a rent or royalty arrangement, and either the amount of the payment is determined by reference to an amount of interest paid under a "relevant funding arrangement", or there is a causal connection (similar to that under the BTB Loan Rules) between the shares or rent or royalty arrangement and the "relevant funding arrangement". Where these conditions are satisfied, the rent or royalty arrangement or the holding of the shares, as the case may be, is deemed to be a "relevant funding arrangement" to which the BTB Loan Rules apply.

Since once a dividend on any type of shares is declared, the issuer would generally be considered under most corporate law to have an obligation to pay the dividend, it appears that most types of shares, not just shares with "debt-like" characteristics, may satisfy the first part of the conditions for the application of the Character Substitution Rules. The fact that "specified shares" are specifically carved out of the Character Substitution Rules and treated as debt seems to suggest that the Character Substitution Rules may not be targeting only "debt-like" preferred shares. Thus, the Character Substitution Rules may potentially apply to ordinary common shares on which dividends have been declared during the relevant period and where the requisite tests are met.

Finance

26 April 2017 IFA Finance Roundtable, Q.12

[s. 212(3.6)(a) rule was intended to potentially apply re common share dividends]

Canco pays interest on an interest-bearing loan from its parent, Forco 2, which declares and pays dividends on its common shares held by Forco 1. Was there an intent that s. 212(3.6)(a) would not apply given that there is no obligation in the common share terms to declare any dividends?

Finance responded that the intention of this provision, and more generally of the character substitution rules, is to prevent abuse through using instruments and payments of different legal characters – and that this was especially possible where, in group structures, both preferred shares and common shares could be used. The intention was to capture not only dividends paid on preferred shares with a fixed dividend entitlement, but also dividends paid on common shares, on the basis that a dividend declaration respecting common shares also gives rise to an obligation to pay a dividend on the common shares.

Whether the rules applied would depend on whether the linkage test was met, which would require consideration of relevant factors such as the timing and quantum of the dividend payments.

Subparagraph 212(3.6)(a)(ii)

Articles

Peter Lee, "The Character Substitution Rules", International Tax (Wolters Kluwer CCH), June 2017, No. 94, p. 10

Potential embedded purpose test in s. 212(3.6)(a)(ii) (p. 12)

[A]t the 2017 IFA Conference…the Department of Finance…stated that the provision was intended to address situations where the back-to-back loan rules are "circumvented" using an instrument with a different legal character than debt. This is consistent with the 2017 BSI… . [T]he Department of Finance's 2017 IFA statement, together with the 2017 BSI, support a requirement that the character substitution rules (at least as they relate to shares) only apply where an avoidance motive has been established.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 212 - Subsection 212(3.7) 397

Paragraph 212(3.6)(b)

Articles

Michael N. Kandev, "Canada Expands Back-to-Back Regime: Examining the Character Substitution Rules", Tax Notes International, June 19, 2017, p.1087

Potential non-existence of the situation posited (p. 1092)

[I]t is utterly mysterious how a rent or royalty can be determined, in whole or in part, by reference to an amount of interest or how a relevant funding arrangement can be entered into because a specified royalty arrangement was entered into. While interest is compensation for the use or retention by one person of a sum of money owed to another rent is compensation for the use or occupation of property, or for the right to use or occupy property, and a royalty is compensation for the use of property, usually copyrighted material or natural resources, expressed as a percentage of receipts from using the property or as an account per unit produced. [fn: 23: The term "royalty" is also undefined for Part XIII ITA. … Mobil Oil Canada Ltd. v. R., 2001 FCA 333 adopted the following meaning…: …“Compensation for the use of property, usually copyrighted material or natural resources, expressed as a percentage of receipts from using the property or as an account per unit produced….] It is not clear how a logical or legal connection between interest, on the one hand, and rents or royalties, on the other, can exist as suggested by paragraph 212(3.6)(b).

Similarly, it is difficult to conceive of common situations in which rents or royalties are converted into interest or in which a particular relevant royalty arrangement was entered into because a debt or other obligation was entered into. Here, at least, some possibilities can be envisaged. Probably the only likely situation, which may fall under clause 212(3.92)(b)(i)(A), involves participating debt interest that tracks underlying rents or royalties or the value, production, or use of the underlying leased or licensed property. A more remote possibility involves money that has been lent to allow either the acquisition or development of tangible or intangible property that then has been leased or licensed. Arguably, however, the link between the two is too tenuous to meet the nexus requirements of clause 212(3.92)(b)(i)(B) in these situations.

Words and Phrases
royalty

Subsection 212(3.7)

Articles

Peter Lee, "The Character Substitution Rules", International Tax (Wolters Kluwer CCH), June 2017, No. 94, p. 10

Exclusion of shareholder funding where indirect debt is higher than direct debt (pp. 13-14)

Consider an arrangement in which "Taxpayer" (a Canadian resident) owes $30 to "Forco", a non-resident (the "direct debt"). Forco (which is the "particular relevant funder" in this example) is wholly owned by "Shareholder", which has invested $10 as share capital into Forco (the "Shareholder Share Capital"). Forco is indebted to "NR Funder" in the amount of $40 (the "indirect debt"). Both the indirect debt due by Forco to NR Funder and the Shareholder Share Capital are assumed to satisfy the applicable connectedness test (under the back-to-back loan rules or character substitution rules, respectively) vis-a-vis the direct debt). …

[T]he Shareholder is deemed to be owed a nil amount under the arrangement by taxpayer because, in the above formula:

  • A is the amount of direct debt (i.e., $30),
  • B is the amount of indirect debt (i.e., $40),
  • (A - B) is negative, and hence is deemed to be nil.

...NR Funder will be treated as the "ultimate funder" in respect of the entire amount of direct debt…

Full allocation of direct loan to shareholder equity if no indirect loan (pp. 14-15)

[Another] arrangement… is identical to the above except there is no indirect debt (for instance, the $30 direct debt may be funded entirely or at least as to $20 out of surplus funds derived from operations)….

In this example, the only funding for the direct debt which is recognized by the rules is the Shareholder Share Capital, if it should turn out that the connectedness test under the character substitution rules is satisfied, the Shareholder Share Capital will again be deemed to be a relevant funding arrangement, Shareholder will be deemed to be a relevant funder in respect of such arrangement, and the deemed relevant funding arrangement is deemed to satisfy the connectedness test under the back-to-back loan rules. However, the amount deemed to be owed to Shareholder by Taxpayer under a relevant funding arrangement is $30, because:

  • A is the amount of direct debt, being $30,
  • B is the amount of indirect debt, being nil,
  • C and D are both equal to the amount of Shareholder Share Capital, so their ratio C/D is 1.

This leads to an arguably anomalous result, in that the Taxpayer will be deemed to have paid the full amount of actual interest to Shareholder (even though Shareholder at most funded $10/$30 = 1/3 of the direct debt)….

Subsection 212(3.8)

Relevant Funder

Articles

Jason Boland, Christopher Montes, "A Detailed Review of the Back-to-Back Loan Rules", 2016 Conference Report (Canadian Tax Foundation), 26:1-32

Observations on scope of “relevant funder” (pp. 26:9-10)

...First, the use of the broadly-defined terms "relevant funder" and "relevant funding arrangement" allow the back-to-back rule to apply to multiple-intermediary structures. Second, the definitions of "relevant funder" and "relevant funding arrangement" are somewhat circular (note part 2 of both definitions). Finally, although the previous back-to-back rule that applied in the interest withholding tax context did not apply to a loan to the immediate funder that was made by a partnership, the revised rule applies in this situation. Widely held flowthrough entities typically used intermediary corporations to make loans into Canada in order to obtain withholding tax certainty without the need to track in detail the residence of their members. ...

Specified Share

Articles

Nik Diksic, Sabrina Wong, "Cross-Border Lending Practices", 2017 CTF Annual Conference draft paper

Whether a common share can be a specified share (p. 8)

[I]t seems reasonable to question whether a common share can, in certain circumstances, qualify as a “specified share”….

[T]he definition also uses of the words “or any…arrangement relating to the share”, which could import factual circumstances that go beyond traditional legal rights and obligations…. [A] controlling shareholder can, at any time, “require” the issuing subsidiary corporation to acquire its shares, without the need to resort to any legal rights beyond the control it has over the subsidiary…. [W]ould its control position with respect to the subsidiary be sufficient to constitute an "arrangement" that could result in common shares being "specified shares"? On the one hand, such an interpretation would seem well beyond the intended scope of the rules, as that would presumably capture all equity funding arrangements in a controlled group. On the other hand, some meaning must be attributed to the use of the term "arrangement”…

Jason Boland, Christopher Montes, "A Detailed Review of the Back-to-Back Loan Rules", 2016 Conference Report (Canadian Tax Foundation), 26:1-32

No requirement for specified share to pay dividends( p. 26:14-15)

...For a share to be a specified share, there is no requirement that a payment be made on the share. For example, if a Luxembourg entity issues redeemable preferred shares, those shares likely would be deemed to be a debt obligation for purposes of subsections 212(3.1) to (3.8). If the share issuance directly or indirectly funds an interest-bearing loan to a Canadian taxpayer, the connectivity tests likely would be met, resulting in a back-to-back arrangement. As a result, the holder of the preferred shares would be deemed to receive an interest payment, subject to Canadian withholding tax, even if the holder receives no payment at all on those shares in respect of the loan.

Michael N. Kandev, "Canada Expands Back-to-Back Regime: Examining the Character Substitution Rules", Tax Notes International, June 19, 2017, p.1087

MRPS as example of specified share (p. 1090)

[I]f a Bermuda corporation funds a Luxembourg subsidiary by way of mandatorily redeemable preferred shares and the Luxembourg intermediary lends to a Canadian subsidiary at interest, that interest would be subject to full Canadian withholding tax of 25 percent, without any reduction under the Canada-Luxembourg tax treaty, because subsection 212(3.2) deems the Canadian borrower to pay the interest to the ultimate funder, the Bermuda corporation.

Ultimate Funder

Articles

Jason Boland, Christopher Montes, "A Detailed Review of the Back-to-Back Loan Rules", 2016 Conference Report (Canadian Tax Foundation), 26:1-32

General effect of definition (p. 26:10)

...An ultimate funder effectively is a relevant funder (other than the immediate funder) that has funded a relevant funding arrangement, but only to the extent it is the ultimate source of funding. [fn 50: That is, it has not used funding it received as a debtor or holder of a specified right. ...]

Subsection 212(3.9)

Paragraph 212(3.9)(b)

Articles

Ian Bradley, Denny Kwan, Dian Wang, "Is The Back-to-Back Withholding Tax Regime an Effective Anti-Treaty-shopping Measure? ", Canadian Tax Journal, (2016) 64:4, 833-58

Difficulties of a Canadian licensee in determining whether the B2B rule is applicable (p. 855)

[T]he joint committee on taxation has noted that a back-to-back royalty rule could increase the cost of doing business for some Canadians. [fn 60: …July 2016 joint committee submission, at 5-7.] Consider a Canadian resident that licenses software from an unrelated US resident. In order to rely on the exemption from withholding tax under the Canada-US treaty [fn 61: … at article XII(3)(b)] the Canadian requests a representation from the licensor that there is no licensing arrangement that may be caught by the connection test in the back-to-back rules. Although the non-resident is a licensor of software to many customers around the world, this is likely a very unusual request, and may be viewed as requiring the disclosure of confidential information. The licensor may be unwilling to divulge this information or may seek additional fees for doing so….

Subparagraph 212(3.9)(b)(ii)

Articles

Sabrina Wong, "Bill C-29 Amendments to the Back-to-Back Rules", International Tax, Wolters Kluwer CCH, December 2016, No. 91, p. 5

Likely insufficient information for Canadian taxpayer to evaluate arm’s length test (p.9)

[I]t appears that the "one of the main purposes" test requires the Canadian taxpayer to enquire as to the purpose of a "funding" lease or licence from an arm's length lessee or licensor. In many or most cases, the Canadian lessee or licensor will likely contract with and have contact only with the immediate licensor and therefore likely will not have sufficient information to determine whether or not the test is met.

PWC, "Bill C-29 significantly expands back-to-back rules", Tax Insights PWC International Tax Services, Issue 2016-53, 16 November 2016

Difficulty for the taxpayer in determining ultimate licensing structure (pp. 3-4)

The new back-to-back royalty rules...apply in certain circumstances when one or more "ultimate licensors" indirectly lease or license property to a Canadian taxpayer by way of a chain of "relevant royalty arrangements" involving one or more intermediaries. ...

When the licensor under an incoming royalty arrangement deals at arm's length with the taxpayer, the connection test will be satisfied only if one of the main purposes of this arrangement is to reduce or avoid withholding tax, or to avoid the back-to-back royalty rules.

This additional condition was added in the October proposals, and is intended to prevent the rules from applying to ordinary, arm's length commercial transactions that are structured without any main tax purposes. However, it may be difficult to rely on this condition in practice because a Canadian taxpayer is not likely to have sufficient information to determine an arm's length licensor's tax motivations.

Subsection 212(3.91)

Articles

Jason Boland, Christopher Montes, "A Detailed Review of the Back-to-Back Loan Rules", 2016 Conference Report (Canadian Tax Foundation), 26:1-32

Reasonably allocable requirement (pp. 26:20-21)

It is not clear what is required to prove to the satisfaction of the minister that a portion of the particular amount is reasonably allocable to an ultimate licensor, but the technical notes suggest looking at the relevant amounts actually paid to each ultimate licensor.

PWC, "Bill C-29 significantly expands back-to-back rules", Tax Insights PWC International Tax Services, Issue 2016-53, 16 November 2016

Potentially punitive effect of CRA not accepting allocation (p.4)

If the Minister does not accept that the taxpayer's allocation is reasonable, the amount paid to each ultimate licensor is equal to the actual amount paid by the taxpayer, adjusted to reflect:

  • an equal allocation of the actual payment between all ultimate licensors, and
  • the difference between the highest withholding tax rate imposed on a payment to any ultimate licensor and on the actual payment

The effect of the allocation formula, when the Minister does not accept the taxpayer's allocation as being reasonable, will be additional withholding taxes (due to the use of the highest withholding tax imposed on a payment to any ultimate licensor). This can be exacerbated by the fact that the formula does not recognize any spread between the royalties paid and received by an intermediary, which may reflect value added by the intermediary.

Subsection 212(3.92)

Paragraph 212(3.92)(b)

Subparagraph 212(3.92)(b)(ii)

Subsection 212(4)

Paragraph 212(4)(a)

Cases

Windsor Plastic Products Ltd. v. The Queen, 86 DTC 6171, [1986] 1 CTC 331 (FCTD)

shareholders acting in concert

The three shareholders of the taxpayer, each of whom was a minority shareholder and one of whom was related to a non-resident corporation ("Kenmar"), were the de facto directors of the taxpayer and from the beginning arrived at all their decisions through consensus, including decisions as to the level of management fees that should be paid to each of the three shareholders. Since the taxpayer was factually subordinate to a group which was acting in concert, the fees paid to Kenmar, being a member of that consortium, were found to have been paid to a person who was not dealing at arm's length with the taxpayer.

It was found that the test in s. 212(4)(a)(i) was met where one of the businesses of Kenmar was the providing of management services.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 251 - Subsection 251(1) - Paragraph 251(1)(c) shareholders acting in concert 106

Administrative Policy

30 March 2017 Internal T.I. 2016-0636721I7 - Consent fees and withholdings

consent fee was not for “advice or direction pertaining to the operation or administration of a company”

In order to obtain the agreement of arm’s length non-resident financial institutions to a sale of the shares of Canco to the non-resident purchaser, Canco paid “Consent Fees” to them, which were calculated as a percentage of the amount owing under each Credit Agreement. In finding that the Consent Fees were not management fees, the Directorate stated:

The Minister of Finance said at the time of the enactment of paragraph 212(1)(a) that… a management or administration fee or charge is to be regarded as an amount paid for advice or direction pertaining to the operation or administration of a company, not including an amount paid for services to an independent firm and, per subsection 212(4), not including specified amounts paid for identifiable services such as transportation, insurance, advertising, accounting and research. …

[T]he Consent Fees are not management or administrative fees or charges…[and] are simply paid to retain the outstanding Credit Agreements.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 214 - Subsection 214(15) - Paragraph 214(15)(b) whether consent fee was deemed to be interest under s. 212(15)(b) was moot 116
Tax Topics - Income Tax Regulations - Regulation 105 - Subsection 105(1) non-resident dealer who attended at Canadian board meetings was rendering services in Canada 168

2011 Ruling 2011-0416891R3 - Fees for Digital Content & Management Services

management of on-line store

A US LLC ("Corporation C"), whose sole member was a US corporation qualifying for benefits under the Canada-US Convention, ran a platform for the provision of "Digital Content" (movies, television shows, music videos, documentaries and similar audio-visual content) which it (and affiliated corporations) were permitted to distribute under content licence agreements with the third-party holders of the copyright. Canadian distributors (described as "Customers") created online storefronts for Canadian individual home users, running on Corporation C's platform, with customized design and branding for the Canadian Customers. Although the home users were licensed the right to receive Digital Content by virtue of agreements they entered into only with the Canadian Customers, it was Corporation C which collected the fees from them and operated the "online store," and it was stated in the description of facts to be the beneficial owner of those payments.

CRA ruled that monthly fees paid by the Customers to Corporation C for managing and maintaining components of the Customers' storefronts, for continuing access to the sales platform, and related support services, were (to the extent they otherwise could be considered to be management or administration fees or charges) not subject to Part XIII tax under s. 212(1)(a) by virtue of s. 212(4)(a) (as well as ruling that fees collected from Canadian home users were exempt from Part XIII tax under Art. XII(3)(a) of the Convention).

Paragraph 212(4)(b)

See Also

Agricultural and Industrial Corporation v. MNR, 91 DTC 1286 (TCC)

Beaubier J. affirmed the disallowance by the Minister of all but $100,000 per year of amounts paid by a Canadian subsidiary to its U.S. parent which allegedly were reimbursements of expenses incurred by the parent in connection with litigation involving the Canadian subsidiary, and for accounting, administrative and sales services, and for overheads, of the U.S. parent. It was noted that no time were records kept, no working papers respecting the expenses were submitted, no evidence was given as to how the alleged Canadian proportion of the work performed by the various employees of the parent was arrived at, there was no written agreement in evidence between the subsidiary and the parent concerning the payment of expenses, and the subsidiary had passively acquiesced to the charges made to it by the parent. Beaubier J. stated (p. 1290):

"... To be a 'specific expense incurred', it must be an explicit and identifiable expense that has been paid, or in respect to which an obligation to pay has been assumed... ."

Administrative Policy

IT-468R "Management or Administration Fees Paid to Non-residents" (Archived) 29 December 1989

8. The Department considers that the term "a specific expense"...applies to a particular expense item or a portion thereof, a sum of several expense items or a portion of a composite of various distinct expenses such as overhead expense including rent, power, heat, salaries, fringe benefits and other business expenses. A specific expense does not include depreciation, capital costs, reserves or unvouchered amounts. A specific expense is net, after all applicable credits or refunds have been deducted, and is without any mark-up or profit element to the non-resident.

9. ...a service performed by a non-resident would not be considered beneficial to the payer if it was a duplication of services already provided by the payer's own personnel.

10. ...Where an amount paid or credited to a non-resident is based on an allocation or distribution of certain charges or costs among various departments, branches or subsidiary corporations (including the Canadian payer), it is important not only that the expenses themselves are reasonable but that the method or basis of allocation or distribution is appropriate to the Canadian payer and reasonable in the circumstances.

Subsection 212(5) - Motion picture films

Cases

MNR v. Paris Canada Films Ltd., 62 DTC 1338, [1962] CTC 538 (Ex Ct)

The taxpayer, which was a distributor of motion picture films in Canada, made various payments to non-residents for film rights including a lump-sum payment to a Moroccan firm for the exclusive right to exploit certain films. Notwithstanding that the lump-sum payment was made for an outright purchase of film rights, it was subject to tax under s. 106(2) of the pre-1972 Act.

CBS/Fox Co. v. The Queen, 95 DTC 5631 (FCTD)

The plaintiff (a U.S. partnership) provided video tape reproduction masters to a wholly-owned Canadian subsidiary, which was entitled in consideration for royalties payable to the plaintiff to duplicate the masters for distribution within Canada through the sale of video cassettes. In finding that the royalties were subject to withholding tax under s. 212(5) on the basis that the words "motion picture film" include a video cassette of a motion picture film, Rouleau J. stated (at p. 5633):

"Although a video tape may be the method of presentation, the content, nevertheless remains a motion picture film within the ordinary and commonly understood meaning of those words."

MCA Television Ltd. v. The Queen, 94 DTC 6375 (FCTD)

The taxpayer's Netherlands affiliate ("B.V.") was the Canadian distributor of theatrical and television products produced by an American affiliate of the taxpayer. MacKay J. found in light of the terms of an agreement between the taxpayer and B.V. and the character of B.V.'s operations in Canada that B.V. operated on its own account rather than as agent for the taxpayer, with the exception of its role as collection agent for the taxpayer's share of "gross television receipts" received by B.V. as defined in the agreement. In going on to find that payments made by Canadian exhibitors to B.V. did not give rise to a liability of the taxpayer for Part XIII tax under s. 212(5), MacKay J. stated (p. 6385):

"The fact that B.V. had contractual obligations to the plaintiff under its licensing agreement, including the obligation to act as collection agent for the plaintiff in relation to the latter's share of television gross receipts as defined, did not, in my opinion, change the nature of the relationship between B.V. and Canadian exhibitors or create any legal relationship between those exhibitors and the plaintiff. The payments by Canadian exhibitors were to B.V., not to the plaintiff, and the description of B.V. as the plaintiff's collection agent does not change that."

MNR v. Paris Canada Films Ltd., 62 DTC 1338, [1962] CTC 538 (Ex Ct)

The taxpayer, which was a distributor of motion picture films in Canada, made various payments to non-residents for film rights including a lump-sum payment to a New York firm ("Sodak") for the exclusive right to exploit certain films. Notwithstanding that the lump-sum payment to Sodak was made for an outright purchase of film rights, such payment would have been subject to subsection 212(5) but for the application of the old Canada-U.S. Income Tax Convention.

See Also

Vauban Productions v. The Queen, 79 DTC 5186, [1979] CTC 262 (FCA)

The non-resident taxpayer, which had acquired from another film distributor the exclusive right for a limited period of time to show certain films on the CBC French-language network, agreed in consideration for a lump-sum payment to supply copies of those films to the CBC and to grant it for the same period of time the exclusive right to show them on its television network. Such a contract was a lease of a motion picture film rather than an outright sale for purposes of a withholding tax exemption appearing in the former Canada-France treaty because the rights acquired by CBC were not as extensive as those acquired by the taxpayer: CBC acquired only the right to show the films on its own network and not to assign or lease them; and the taxpayer had the right to a return of the films at the end of the term was upheld. The application of s. 106(2) of the pre-1972 Act was conceded.

Administrative Policy

27 March 2018 External T.I. 2017-0715561E5 - Withholding tax on royalties for streamed content

NR fee for streamed films and TV shows taxable under s. 212(5) only re Canadian use or reproduction

Canco streams motion picture films and TV shows (the “digital content”) to its Canadian and foreign subscribers (who pay monthly fees) through a live TV video stream, a delayed TV stream and a digital content library. In order to obtain the rights to the films and TV shows that it streams, Canco pays a royalty to an arm’s length U.K. content provider (“U.K. Content Provider”) that is based on the amount of viewing of the digital content by Canco’s subscribers. Canco either stores its digital content on a server that is located outside of Canada or it is streamed directly by the U.K. Content Provider to Canco’s subscribers, and does not change the content received by it.

Are the royalty payments made to the U.K. Content Provider subject to tax under s. 212(5) and, if so, are they exempt under Art. 12(3)(a) of the Canada-U.K. Tax Treaty?

After stating that “a motion picture film that is streamed remains a ‘motion picture film’ and that a streamed TV show is a “means of reproduction” of the TV work, CRA indicated that withholding under s. 212(5) would only be applicable “to the portion of the payments to the U.K. Content Provider which relates to the streaming of the digital content to Canco’s subscribers to the extent that the right in or to the use of the digital content is being used or reproduced in Canada” – except that:

Canadian withholding tax can still apply, should the right in or to the use of the digital content be partly used or reproduced in Canada prior to being streamed to these foreign subscribers for viewing outside of Canada (but only to the extent of the payment that is related to the use or reproduction in Canada) or if it was being streamed in Canada.

Locations of other summaries Wordcount
Tax Topics - Statutory Interpretation - Interpretation Act - Section 35 - Subsection 35(1) - Broadcasting Interpretation Act definition of broadcasting not applicable to Treaty interpretation of those words 232
Tax Topics - Treaties - Income Tax Conventions - Article 12 television and broadcasting included digital streaming 330

5 November 2014 External T.I. 2013-0506191E5 - copyright photographs

payments for photos before incorporation into TV program were exempt

A Canadian company pays a non-resident for the use of the photographs in connection with television in Canada (for example in a backdrop to a film clip used in a television program that is to be used or reproduced in Canada). In finding that s. 212(5) would not apply, CRA stated:

[T]he Canadian company would not be paying an amount to the non-resident person for a right in, or to the use of, a motion picture film or Television Product. Instead, the company would be paying the non-resident person for the right to use the photographs which would be incorporated into Television Product.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 212 - Subsection 212(1) - Paragraph 212(1)(d) - Subparagraph 212(1)(d)(vi) payments for photos before incorporation into TV program were exempt 98

1 May 2014 External T.I. 2013-0514291E5 F - Redevances sur une oeœuvre musicale dans un film

s. 212(5) exclusion does not apply to copyright royalty for music used in film

Would copyright royalties paid by a resident of Canada to a resident of Belgium respecting the production or reproduction of a musical work to be utilized in a cinematic production be exempted under Part XIII? After confirming that the exemption described in s. 212(1)(d)(vi) generally would apply, CRA stated:

[I]f it were demonstrated that, in fact, a payment is specifically paid as or in payment in whole or in part for copyright respecting the production or reproduction of a musical work, it will be excluded from the field of operation of subsection 212(5) even if the musical work was produced or reproduced as part of a film.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 212 - Subsection 212(1) - Paragraph 212(1)(d) - Subparagraph 212(1)(d)(vi) copyright royalty for music used in film is exempt notwithstanding s. 212(5) exclusion 235

14 December 2011 Internal T.I. 2011-0424221I7 - copyright music

copyrighted music incorporated into film

A licence with a US-resident copyright holder of a musical work enabling the taxpayer to "fix, record, dub and edit the music in synchronized or timed relation to visual and audio elements" for a fixed fee with caps on usage (i.e. a maximum number of video promotions broadcast) is considered to be a royalty for a musical work under s. 212(1)(d)(vi) and is not a payment for a right to use a motion picture film or video product under s. 212(5), notwithstanding that the music is used in "promos" (i.e., promotions of program viewership) aired on Canadian telecasts:

Canco is not paying an amount to US for "a right in or to the use of a motion picture film or video product"; instead, Canco is paying US for the right to use/reproduce copyrighted music which will be incorporated into film or video produced in Canada.

Therefore, the licence fees are not subject to Part XIII tax.

19 April 2011 External T.I. 2011-0392761E5 - Motion picture films, ITA 212(5)

film reproduction in encrypted form

A Canadian-resident company (Canco) uses motion pictures distributed to it by a US and French company by reproducing them in Canada in digitized form and encrypting them, in order that it can provide them to Canadian customers using its specialized software. The fees paid to the US distributor (a qualifying US resident) are subject to Part XIII tax at a Treaty-reduced rate of 10%, and the fees paid to the French distributor are exempt from Part XIII tax if the conditions in Art. XII, para. 4(a) of the Canada-France Convention are satisfied.

19 February 1997 T.I. 961630 [health club videos]

health club videos

A Canadian corporation that obtains a licence to make videos available to patrons of a health club, who watch videos on installed television sets while they exercise, will pay royalties which are subject to withholding tax under s. 212(5). The phrase "for use in connection with television" is not limited to television broadcasting.

6 March 1995 Memorandum 942876 (C.T.O. "Video Reproduction Rights")

The phrase "in connection with television" would apply to video tapes destined for private home use.

Locations of other summaries Wordcount
Tax Topics - Treaties - Income Tax Conventions - Article 12 27

93 C.R. - Q. 30

RC is prepared to exempt the portion of a particular payment that is solely for the right to use a motion picture film or video tape outside Canada.

5 January 1993, T.I. (Tax Window, No. 28, p. 8, ¶2404)

The reproduction of video cassettes for non-commercial use does not generally fall within the purview of s. 212(5)(b) notwithstanding that a television set may be required to use the resulting product.

Subsection 212(11) - Payment to beneficiary as income of trust

Administrative Policy

22 December 2016 External T.I. 2015-0608201E5 F - Capital distribution from trust & NR4

capital distributions other than of capital dividends not subject to Part XIII tax

Although s. 212(11) deems all trust capital distributions to a non-resident beneficiary to be income distributions for Part XIII purposes, s. 212(1)(c) only imposes Part XIII tax on s. 104(13) income and capital dividend distributions. However, having regard to s. 212(11) and Reg. 202(1)(c), a Canadian-resident trust must report all capital distributions made to a non-resident beneficiary on Form NR4.

Locations of other summaries Wordcount
Tax Topics - Income Tax Regulations - Regulation 202 - Regulation 202(1) - Regulation 202(1)(c) all capital distributions made by Canadian-resident trusts to a non-resident beneficiaries must be reported on NR4s 134

18 November 2011 External T.I. 2011-0422441E5 - Capital dividend paid to a Non-Resident

redistribution of capital dividend subject to Part XIII tax

Shares of a Canadian-controlled private corporation held by the estate were redeemed for cash proceeds, with the resulting deemed dividend paid out of the corporation's capital dividend account. Would this amount when redistributed to a non-resident be subject to Part XIII tax? CRA responded:

Subsection 212(11)… characterizes any amount paid or credited by a trust or an estate to a beneficiary or other person beneficially interested therein as income of the trust or estate for the purposes of paragraph 212(1)(c)… .

Any capital distribution made by a trust or an estate is subject to Part XIII tax to the extent that it is an amount described in subparagraph 212(1)(c)(i) or (ii)… .

Subparagraph 212(1)(c)(ii)… provides that an amount that may reasonably be considered to be a distribution of, or derived from, a "dividend that is not a taxable dividend" (e.g. a capital dividend) received by the trust or estate on a share of the capital stock of a corporation resident in Canada is subject to Part XIII tax. Part XIII tax must be withheld by the payer and remitted on behalf of the non-resident… .

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 212 - Subsection 212(1) - Paragraph 212(1)(c) redistribution of capital dividend subject to Part XIII tax 149

9 October 2009 APFF Roundtable Q. 5, 2009-0327001C6 F - Succession canadienne - dividende en capital

allocation of capital dividend between estate duties and NR distribution

When a capital dividend (arising from insurance proceeds) received by an estate is used for the payment of estate taxes, would the distribution of the remainder of the estate to the heirs be excluded from the application of ss. 212(11) and 212(1)(c)? CRA responded:

[A]lthough an amount paid in favour of a Canadian estate as a capital dividend is used for the payment of estate taxes, the question of determining if a subsequent distribution in favour of non-resident beneficiaries can reasonably be considered to be a distribution of an amount received by the estate, or derived from such an amount, as a dividend is a question of fact. … Where applicable, the distribution would be subject to a withholding tax pursuant to subsection 212(11) and paragraph 212(1)(c)… .

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 212 - Subsection 212(1) - Paragraph 212(1)(c) allocation of capital dividend between estate duties and NR distribution 125

17 July 2003 External T.I. 2003-0020695 - Distribution from Trust

Year 2 distribution derived from Year 1 capital dividend subject to withholding

A trust receives a capital dividend in Year 1 (so that no part of the dividend is included in its income) and in Year 2 it makes a distribution in the same amount to its sole (non-resident) beneficiary. Would the distribution be subject to withholding under s. 212(1)(c)? CRA responded:

Withholding tax will apply…if either subparagraph 212(1)(c)(i) or (ii) applies. …(ii)…applies where it can reasonably be considered that the distribution is derived from an amount received by the trust as a capital dividend on a share of a corporation resident in Canada. Thus…withholding tax would be required.

20 October 1997 T.I. 971526

"In our view, subsection 212(11) of the Act merely characterizes any amount paid or credited by a trust or estate as income of the trust or estate for the purposes of paragraph 212(1)(c) of the Act. The wording in paragraph 212(1)(c) then makes it clear that such an amount is only subject to Part XIII tax to the extent it is an amount described in subparagraphs 212(1)(c)(i) or (ii) ... ."

12 April 1995 External T.I. 5-941713 -

Taxable capital gains of a mutual fund trust designated to a non-resident unitholder under s. 104(21) would not be taxable in Canada.

Alberta Chartered Accountants Round Table, 2 May 1994, Q. 8, 940956 (C.T.O. "Capital Amount Paid by Trust to Non-Resident (8192)")

S.212(11) does not make all capital distributions by a trust subject to Part XIII tax. Instead, it merely characterizes any amount paid or credited as income for the purposes of s. 212(1)(c). The wording of s. 212(1)(c) then makes it clear that such an amount is only subject to Part XIII tax to the extent it is described in s. 212(1)(c)(i) or (ii).

22 February 1994 External T.I. 5-932954 -

S.212(11) does not tax the non-taxable portion of capital gains distributed by an ordinary trust to a non-resident, or any portion of a capital gain distributed to a non-resident beneficiary of a mutual fund trust (given the exemption in s. 212(1)(c)(i)).

IT-465R "Non-Resident Beneficiaries of Trusts" 19 September 1985

  1. Subject to the exemptions in subsections 212(9), (10), (11.1) and (11.2)… subsection 212(11) provides that any amount paid or credited by a trust to a beneficiary (otherwise than on a distribution or payment of capital) shall be deemed for the purpose of paragraph 212(1)(c) to have been paid as income of the trust regardless of the source from which the trust derived it. Even if the amount so paid or credited was received by the trust in a form which, if it had been paid directly to the non-resident beneficiary, would have been exempt from Part XIII tax, subsection 212(11) applies to render that amount subject to tax under paragraph 212(1)(c) when it is paid or credited to the non-resident by the trust.

Subsection 212(13) - Rent and other payments

Paragraph 212(13)(a)

Administrative Policy

14 November 1997 Memorandum 971822

Annual payments made by a non-resident person carrying on business in Canada to a non-resident software supplier for updates, maintenance and servicing of computer software would not qualify as payments of "rent" and, accordingly, would not come within s. 212(13)(a). A review of judicial decisions indicated "that rent is generally a fixed payment (usually periodic) for the use of property for a given period of time, after which the right to use the property would extinguish (i.e., the right would be reverted back to the owner ... [O]nly in rare and unique situations would the word 'rent' be considered to mean 'royalty'".

Subsection 212(13.1) - Application of Part XIII tax where payer or payee is a partnership

Paragraph 212(13.1)(a)

See Also

The Queen v. Williams, 90 DTC 6399 (FCA), rev'd 92 DTC 6320 (SCC)

Stone J.A. found that unemployment insurance benefits earned by an Indian were not "property ... situated on a reserve" because the debtor (Her Majesty as represented by the Canada Employment and Immigration Commission) was not resident on the Reserve.

Twock v. Estate Duty Commissioners, [1988] 1 WLR 1035 (PC)

A simple contract debt (including a debt payable in futuro) is situate where the debtor resides. In the case of corporate debtors which carry on business in many jurisdictions, debts owing by them will be situate at the place where the company could be served with process at its registered office or place of business. Where there is more than one such place:

"The locality of the chose in action falls to be determined by reference to the place - assuming it to be also a place where the company is resident - where, under the contract creating the chose in action, the primary obligation is expressed to be performed." (p. 1041-1042)

Administrative Policy

13 July 2018 Internal T.I. 2017-0713301I7 - Assumption of accrued interest

withholding when debt of Canadian partnership assumed by sub

As part of the consideration for the drop-down of the assets of a Canadian partnership (whose partners were Canco and its wholly-owned Canadian subsidiary) to a wholly-owned U.S. subsidiary (“Debtor Affiliate”), Debtor Affiliate assumed the loan including accrued interest thereon that had been owing by Partnership to another Partnership subsidiary (“Creditor Affiliate”), and Creditor Affiliate released the Partnership from its obligations on the Loan.

The Rulings Directorate indicated that this transaction likely entailed a novation of the loan, and that Part XIII tax thereby applied under s. 212(1)(b) and s. 212(13.1)(a) at that time on the amount of the accrued interest on the basis that:

[A]t the time of this novation, the Partnership would be considered to have made a payment or credit in kind of the Accrued Interest to the Creditor Affiliate by delivering the Debtor Affiliate’s covenant to make the payments under the Loan agreement to the Creditor Affiliate.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 212 - Subsection 212(1) - Paragraph 212(1)(b) the covenant of the assuming debtor to pay accrued interest on a debt assumption was a payment in kind subject to Part XIII tax 323

25 May 2004 Miscellaneous 2003-0039231E5 - Paragraph 212(13.1)(a)

borrower partnership may be a look-through where s. 212(13.1)(a) inapplicable

An LP organized in the U.S. but having only Canadian-resident partners, and whose only source of income is dividends and other investment income on non-Canadian securities, borrows money from a U.S. financial institution for use in those investing activities. CRA stated:

[P]aragraph 212(13.1)(a) … would not apply … to deem LP to be a person resident in Canada because LP does not appear to have any income from sources in Canada. However, this does not mean that withholding taxes under Part XIII of the Act would not be exigible in respect of the interest paid by LP to the U.S. financial institution.

…[D]epending on the facts of a particular situation, one can look through the partnership to the partners as the persons who owe the debts of the partnership and who pay the interest on such debts. If this occurs, since at least one of the partners of LP is a Canadian resident and the interest is paid to a U.S. person, Part XIII tax is exigible, unless such payment is exempt from Canadian taxation under a provision of the Act (such as subparagraph 212(1)(b)(vii)) or the Convention. In this regard, Canadian jurisprudence generally supports the look-through approach where subsection 96(1) of the Act is not applicable.

7 May 2004 Miscellaneous 2004-0072131C6 - IFA Round Table 2004 Q.1 - 212(13.1)(a)

where s. 212(13.1)(a) does not apply, it may be possible to consider a Canadian partner to be an interest payer

In the context of a ruling request respecting a "tower" structure, a partnership of which two taxable Canadian corporations were the partners borrows money from a U.S. financial institution in order to acquire an interest in a U.S. limited liability company.

The CRA concluded that provided that the Partnership did not earn any income from sources in Canada, paragraph 212(13.1)(a) of the Act would not apply to deem the Partnership to be a person resident in Canada. However, this did not mean that withholding taxes under Part XIII of the Act would not be exigible in respect of the interest paid by the Partnership on the Loan to the U.S. financial institution.

…[T]aking into consideration the foreign law under which the Partnership was formed, the provisions of the partnership agreement and the terms and conditions of the loan agreement between the Partnership and the U.S. lender, the CRA came to the conclusion that the partners of the Partnership were considered to be the payers of the interest on the Loan. In other words, depending on the facts of a particular situation, one can look through a partnership to the partners as the persons who legally owe the debts of the partnership and pay the interest on such debts.

25 February 1991 External T.I. 903237

A partnership between two equal arm's length partners (a Canadian corporation and a non-resident corporation) carrys on an active business entirely outside Canada. Royalties paid by it to a non-resident corporation that is owned equally by the two non-resident parents of the two partners are deductible in computing the income from that business. The Directorate stated:

[A]ssuming the royalties are not deductible by the BD partnership in computing its income from a source in Canada, by virute of paragraph 212(13.1)(a), the BD Partnershp will not be considered to be a person resident in Canada for purpoes of Part XIII ... . Accordingly, tax wil not be exigible under paragraph 212(1)(d) ... .

6 February 1990 T.I. (July 1990 Access Letter, ¶1336)

For purposes of determining whether income is earned on a reserve, income from sources other than those enumerated in IT-62 generally will be considered to have their source at the payor's principal place of business, e.g., the head office of a payor bank.

12 November 1980 External T.I. RCT-0246

s. 212(1)(b) inappliable where s. 212(13.1)(a) does not apply to anadain partnership

A Canadian partnership formed in Canada earns income from U.S. sources. Interest on a borrowing from a non-resident lender is deductible in computing the partnership's income under Part I from the income earned in the U.S. The Department stated:

[S]ince the interest expense would be deductible in computing income from a source that is not in Canada, the partnership is not deemed to be a person resident in Canada pursuant to paragraph 212(13.1)(a) … . The partnership is therefore not required to withhold tax under paragraph 212(1)(b) … .

3 November 1980 Internal T.I. RCT-0247

CRA does not look through partnership to Canadian partners where s. 212(13.1)(a) does not apply

S. 212(13.1)(a) would not apply to mortgage interest paid by a mooted Canadian partnership due to grandfathering. The Department stated:

With the exception of subsection 212(13.1) of the Act, there is no provision in the Act which deems a partnership to be a person, notwithstanding that section 96 provides that the income of a member of a partnership is computed as if the partnership were a separate person resident in Canada. We would not look through the partnership to apply Part XIII tax on the proportion of the payments that would apply to the Canadian partners.

Articles

Gregory Wylie, "Canada Revenue Agency Comments on Cross-Border Transactions", Tax Notes International, 7 June 2004, p. 991

Comment on CRA position that due to the joint and several liability of Canadian partners of a U.S. partnership, interest on a loan made to a U.S. partnership having Canadian partners might be viewed as interest payable by the Canadian partners.

J. S. Peterson, "Canadian Taxation of Non-Residents", 1974 Conference Report (Canadian Tax Foundation), p. 262

Effect of introduction of s. 212(13.1)(a) (pp. 264-265)

This amendment is expected to stop a fair amount of tax leakage. For example, it is presently possible for a partnership with all non-resident or some non-resident partners, to carry on business in Canada, and be entitled to all the standard deductions under Part I. If such deductions constitute, for example, management fees, royalties or interest paid to non-residents, there would be no Part XIII withholding tax unless the partnership were a resident of Canada. However, if such payments were made by a Canadian subsidiary, they would be subject to such tax. Accordingly, Budget Resolution 117(b) deems the partnership payor of such deductible items to be resident in Canada in respect of such payments. Thus, the Part XIII tax becomes exigible, and the Canadian business operations of such partnership become equivalent, from a tax point of view, to operating in Canada through a subsidiary corporation.

Paragraph 212(13.1)(b)

Cases

Canada v. Gillette Canada Inc., 2003 DTC 5078, 2003 FCA 22

Some of the shares held by the taxpayer in its French subsidiary were purchased for cancellation by the subsidiary in consideration for the assignment to the taxpayer of a note (denominated in French-francs) owing to the subsidiary by a French partnership whose principal partner was the U.S. parent of the taxpayer. A month later, the note was converted into indebtedness denominated in Canadian dollars.

The conversion of the note to Canadian dollars did not give rise to a payment, credit or loan given that the Canadian dollar note was issued and accepted as replacement for the original note in circumstances where the terms were remained the same except the currency of payment.

Words and Phrases
credit payment
Locations of other summaries Wordcount
Tax Topics - General Concepts - Payment & Receipt replacement with different currency note 58
Tax Topics - Income Tax Act - Section 15 - Subsection 15(2) 148

Administrative Policy

27 March 2013 External T.I. 2012-0450491E5 - Election under s. 216

full withholding on rents paid to non-Canadian partnership with some resident partners

Where a Canadian-resident tenant pays rent

to a partnership that has one or more partners who are not resident in Canada…the [Part XIII] withholding applies to the full amount of the payment even though some members of the partnership are residents of Canada.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 216 - Subsection 216(4) tenant not generally expected to withhold 139

30 October 1997 External T.I. 9716735 - : Taxation of Non-Resident Partners

withholding where non-resident partnership with Cdn partners

Respecting the application of s. 212(13.1)(b) to payments to a partnership of which there is a non-resident limited partner, CRA stated:

We confirm your understanding that where a person resident in Canada pays an amount to a partnership that has ceased to be a Canadian partnership (within the meaning of that term in section 102 of the Act), paragraph 212(13.1)(b) of the Act deems the partnership, in respect of the payment, to be a non- resident person. Paragraphs 5 to 8 of Interpretation Bulletin IT-81R addresses this matter further.

IT-81R "Partnerships - Income of Non-Resident Partners"

No withholding-reduction based on Cdn-resident members

7. ...Where tax is to be withheld under Part XIII because a partnership is deemed by paragraph 212(13.1)(b) to be a non-resident person, the withholding applies to the full amount of the payment even though some members of the partnership are residents of Canada. The portion of such tax withheld that is attributable to a resident member of the partnership may be claimed by him as a credit against the tax otherwise payable under Part I of the Act.

Articles

J. S. Peterson, "Canadian Taxation of Non-Residents", 1974 Conference Report (Canadian Tax Foundation), p. 262

Partnership not a person prior to enactment of s. 212(13.1)(b) (p. 263)

.. Part XIII tax applies only in respect of payments to non-resident “persons”. Under Canadian law, a partnership is not a “person” as such , even though it is treated as if it were a person for certain purposes in subdivision j of Part I. Where a payment is made to a non-resident partnership, there is thus an argument that the wording of s. 212(1) is inadequate to require that the tax be applied. Were this the case, the Part XIII tax could be avoided by the simple expedient of making all payments to non-resident partnerships.

Whether Part XIII applied on a look-through basis prior to enactment of s. 212(13.1)(b) (p. 263)

It is understood that this loophole was first tested in Ottawa when two non-resident banks formed a foreign partnership for purposes of lending to a Canadian resident. Exemption from the 15% withholding tax on interest was claimed on the basis of Canadian legal opinion that the partnership was not a “person” within the meaning of s. 212(1). While agreeing that the foreign partnership was not a “person”, the Minister held to the view that the interest payment was not to a “partnership”, but was rather a payment to the two non-resident partners. The Minister was apparently successful in this contention.

It is my view that where a partnership is constituted on a basis similar to Canadian law, there is a preponderance of authority for the view that a payment to it is really a payment to the partners [citing Dunbrik, 52 DTC 154 and Lindley on Partnership].

Subsection 212(13.2) - Application of Part XIII tax — non-resident operates in Canada

See Also

Eastern Success Co Ltd In It's Capacity as Trustee Of The Easter Law Trust v. The Queen, 2004 DTC 3521, 2004 TCC 689

The taxpayer, which was a non-resident trust, financed its construction of a condominium project in Canada through a loan from a non-resident lender. The interest was paid following the completion of construction.

Mogan J. found that as the interest accruing on the loan to the completion of construction was capitalized as part of the cost of the project under s. 18(3.1), that interest when paid should not be considered to be deductible in computing the taxpayer's taxable income earned in Canada for purposes of s. 212(13.2). Mogan J. noted that when an amount of interest is capitalized, "it loses its character as 'interest' and becomes merged in the overall cost of the building like the cost of the concrete foundation, brick siding, windows, roof and heating plant". Furthermore, it had been established in Oryx (74 DTC 6352) and Shofar (79 DTC 5347) that "when computing the income of a trader, any outlay or expense which becomes part of the cost of inventory is taken into account when computing 'gross profit' but is not deductible in computing income". Accordingly, Part XIII tax was not applicable to the payment of interest that had been capitalized as part of the real estate inventory of the taxpayer.

Administrative Policy

24 February 2000 Internal T.I. 1999-001425

Interest capitalized as inventory pursuant to s. 18(3.1) would be considered to be deductible for purposes of s. 212(13.2). The debtor will be required to withhold Part XIII tax on such interest in the taxation year in which the interest is paid or credited.

1996 Corporate Management Tax Conference Round Table, Q. 8

Where s. 250(5) deems a U.S.-incorporated subsidiary whose central management and control is in Canada, to be resident in the U.S., the subsidiary will be considered a "non-resident person" for purposes of applying s. 212(13.2). Therefore, if its operations are carried on solely in Canada, interest payments made by it to a non-resident of Canada will be subject to Part XIII tax (unless an exemption, such as under s. 212(1)(b)(vii)) is available.

Subsection 212(13.3) - Application of Part XIII to authorized foreign bank

Administrative Policy

13 July 2001 Comfort Letter No. 20010713

"The broad direction of our thinking" is that "it should be possible to provide that the payor's reasonable belief, or a presumption based on the payee's address, will suffice to relieve the payor from possible liability" where it makes a payment to a foreign bank that is believed to be in respect of that bank's Canadian banking business.

Subsection 212(14)

Administrative Policy

IC 77-16R4 "Non-Resident Income Tax" under "Certificate of Exemption - 212(14)"