Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.
Principal Issues: When a bond issued by a resident of Canada is sold by a non-resident to a resident of Canada on the secondary market, is there withholding on the accrued interest or the premium?
Position: Possibly
Reasons: It depends on whether or not the vendor and purchaser are dealing at arm's length, and on the terms of the obligation.
2008-026828
XXXXXXXXXX S.E. Thomson
(613) 957-2122
December 9, 2008
Dear XXXXXXXXXX :
Re: Bill C-28 - New withholding tax rules on interest paid to non-residents
This is in reply to your email dated February 14, 2008 in which you ask for some clarification of the new rules under Part XIII of the Income Tax Act (the "Act") enacted by Bill C-28, as they apply to interest paid to a non-resident. Your questions arose from an email exchange that you had with the Department of Finance on the subject.
You explain that you are fixed income portfolio managers, and you buy and sell bonds in the public debt capital market for your clients. In falling interest rate environments, most bonds move above par. You would like to know:
1. If a non-resident sells a position to a Canadian dealer above par, would that be subject to Part XIII withholding tax?
2. Does it make a difference if the bond is issued by a trust or limited partnership? Under the former so-called "5/25" rule, the bond had to be issued by a corporation.
Your question appears to involve actual taxpayers and a factual situation. As such, we are unable to definitively reply to your question until we have had the opportunity to review all the facts and related documentation. Such a review is conducted by the relevant tax services office where the query relates to a completed transaction, or by this directorate where the arrangement is the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5. We nevertheless offer the following general comments regarding the relevant provisions of the Act that may apply. Since these comments are general in nature, they may or may not apply in your situation and are not binding on the Canada Revenue Agency.
Bill C-28
Bill C-28 received Royal Assent on December 14, 2007, and enacted into law measures included in Budget 2007 and the 2007 Economic Statement. Bill C-28 eliminated withholding tax on most arm's length interest payments to non-residents, effective January 1, 2008. These changes are discussed more fully below.
Subsections 214(6) and 214(7)
In general terms, subsection 214(6) of the Act states that where an obligation (bond, debenture, etc.) issued by a person resident in Canada has been transferred by a non-resident person to a person resident in Canada, and an amount of interest would be included in the transferor's income by virtue of subsection 20(14) of the Act if Part I of the Act were applicable, that amount is deemed to be a payment of interest by the transferee to the non-resident. Therefore, Part XIII withholding tax may be required on the deemed payment, by virtue of paragraph 212(1)(b). However, if the obligation is described in paragraph 214(8)(a) or (b) (see below), subsection 214(6) will not apply.
In general terms, subsection 214(7) of the Act states that where an obligation (bond, debenture, etc.) issued by a person resident in Canada has been transferred by a non-resident person to a person resident in Canada at a price in excess of the face value of the obligation, the excess (i.e. the "premium") will be deemed to be a payment of interest by the transferee to the non-resident. 1 Therefore, Part XIII withholding tax may be required on the deemed payment, by virtue of paragraph 212(1)(b). However, if the obligation is an "excluded obligation", subsection 214(7) will not apply. Excluded obligations are described in subsection 214(8) (see below).
Subsections 214(6) and 214(7) were not amended by Bill C-28.
Subsection 214(8)
Subsection 214(8) describes "excluded obligations".
Paragraph 214(8)(a) was amended by Bill C-28, effective January 1, 2008. In general terms, new paragraph 214(8)(a) states that an excluded obligation includes:
- obligations described in paragraph (a) of the definition of "fully exempt interest" in new subsection 212(3) (see below), or
- obligations on which the interest would have been exempt under subparagraphs 212(1)(b)(iii) (i.e. arm's length foreign currency debt) or 212(1)(b)(vii) (i.e. the so-called "5/25 rule"), as those subparagraphs applied in 2007. Note that the 5/25 rule requires that the obligation must be issued by a corporation.
Paragraphs 214(8)(b) and 214(8)(c) were not amended by Bill C-28. Paragraph 214(8)(b) includes prescribed public issue securities. To date, there has been none prescribed. Paragraph 214(8)(c) includes what can be referred to a "shallow-discount" obligations. In general terms, paragraph 214(8)(c) describes obligations that are issued for at least 97% of their face value, on which the yield does not exceed 4/3 of the stated interest rate.
To summarize, obligations described in paragraphs 214(8)(a) and (b) are not subject to subsection 214(6), and obligations described in paragraphs 214(8)(a), (b) and (c) are not subject to subsection 214(7). Where the exceptions apply, subsections 214(6) and 214(7) will not apply to deem any portion of the purchase price of the relevant obligation to be a payment of interest.
New paragraph 212(1)(b)
If either subsection 214(6) or 214(7) applies when an obligation is transferred by a non-resident person to a person resident Canada, the deemed interest may or may not be subject to Part XIII withholding tax under paragraph 212(1)(b). Paragraph 212(1)(b) was significantly overhauled by Bill C-28, generally effective from January 1, 2008.
In general terms, new paragraph 212(1)(b) provides that Part XIII tax is required on payments of interest (including deemed payments of interest) by a person resident in Canada to a non-resident person, if the interest is:
- not "fully exempt interest" paid or payable to a non-arm's length person, or
- "participating debt interest".
"Fully exempt interest" is defined in new subsection 212(3) to include (we are using a very general description; please refer to the legislation for the precise wording):
(a) interest on government or quasi-government debt;
(b) interest on foreign real property mortgages (except where the interest is deductible in Canada);
(c) interest paid to prescribed international organizations; and
(d) amounts deemed to be interest under certain securities lending arrangements.
"Participating debt interest" is defined in new subsection 212(3) to include (generally) interest that is contingent on the use of or production from property in Canada, or is computed by reference to revenue, profit, etc., or to dividends. However, the interest will not be participating debt interest if it is included in paragraphs (b) to (d) of the definition of "fully exempt interest".
Your clients
To put this in context for your clients, if a bond issued by a resident of Canada is sold by a non-resident vendor on the secondary market to a purchaser who is a resident of Canada, there will be no Part XIII tax on the accrued interest or on the premium if,
- the vendor and purchaser are dealing at arm's length, unless the interest is participating debt interest;
- the vendor and purchaser are NOT dealing at arm's length, but the interest is fully exempt interest, other than participating debt interest; or
- paragraph 214(8)(a) applies.
Since the above comments are general guidelines only, and because Bill C-28 amended several other provisions in Part XIII that are not mentioned in this letter, we suggest that you refer to the actual legislation to see how it might apply to your clients.
We trust that we have been of some assistance.
Yours truly,
Olli Laurikainen, C.A.
For Director
International & Trusts Division
Income Tax Rulings Directorate
ENDNOTES
1 Subsection 214(7.1) will apply if the obligation was transferred from a person resident in Canada to a non-resident person, and back again.
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