Canada: B2B Loans

Last Updated: January 14 2019

Introduction – Non-Resident Withholding Tax

For individuals or corporations that are not tax residents in Canada, certain payments that they receive from Canadian sources are subject to withholding taxes. A withholding tax applies in a somewhat different manner than normal income tax: a withholding tax is calculated at the time of the payment to the non-resident of Canada and usually applies to the gross payment; normal income taxes are calculated at the end of the tax year and are based on the taxpayer's net income (profits). Withholding taxes apply to various payments such as pensions, interest, dividends, rents, and royalties to non-residents unless otherwise specified by a tax treaty between Canada and the country in which the individual or corporation resides. The standard withholding rate is 25% of the gross payment for most types of payments; however, this amount is typically reduced to 10% or 15% for interest payments to a tax resident in a country that has a tax treaty with Canada, with the rates for other types of payments varying greatly depending on the particular tax treaty. For rental income, non-residents can elect under s.216 of the Income Tax Act and pay withholding tax on the net rental income rather than the gross rental income as discussed in more detail in our article on non-resident real estate taxation found here. While international tax planning can be complicated, our top Toronto tax firm is well equipped to advise you and meet your needs.

Tax planning by Treaty Shopping

Since the withholding tax rates vary from jurisdiction to jurisdiction, non-Canadian residents can carry out tax planning to operate in a jurisdiction with a favourable tax treaty with Canada so as to minimize the withholding tax rates. This in itself is not a problem, and, in fact, the reduced tax rates are an intentional benefit aimed at promoting international investment and business. However, what concerns the Canada Revenue Agency ("CRA") is the practice usually called treaty shopping.

Treaty shopping typically occurs where an individual wants to invest into Canada but resides in a jurisdiction that has either no tax treaty with Canada or a tax treaty with unfavourable terms. In order to minimize his tax burden, that individual may incorporate an entity in an intermediate jurisdiction—in particular, a jurisdiction whose tax treaty with Canada offers favorable terms. The individual can then invest into Canada through the entity and benefit from the intermediate jurisdiction's tax treaty. In effect, that individual would be able to access the beneficial treatment without residing in that intermediate jurisdiction and often with minimal actual presence in the intermediate jurisdiction.

Back-to-Back Loan Provisions: Canada's Response to Treaty Shopping

The treaty-shopping issue is an international problem, and countries have enacted various ways to discourage this behaviour. The back-to-back loan provisions in ss. 212(3.1) - (3.81) of the Income Tax Act for interest and ss. 212(3.9) - (3.94) for rents and royalties are in essence types of anti-conduit rules somewhat similar to what is utilized by the U.S. These provisions are aimed at preventing the use of a conduit in an intermediary jurisdiction where that conduit exists primarily to facilitate a loan to a Canadian borrower from the true lender, who is resident in a less favourable tax jurisdiction.

Technically speaking, pure conduit arrangements are already ignored—i.e., "looked through"—with the interest being treated as paid to the beneficial owner of the interest payment. Although the Canadian Courts imposed a fairly high standard to acknowledge that this type of pure conduit arrangement existed, taxpayers could often sidestep this problem with a properly set up structure. In response, the Department of Finance enacted the back-to-back loan provisions with regards to withholding tax on interest in 2014 and then amended them in 2016, further strengthening these provisions.

The result of these provisions is a horrendously complex set of definitions, rules and various applicability tests, which in some cases are unclear as to how broadly they apply.

The back-to-back loan provisions function by first identifying 'relevant funding arrangements' and then following the chain of 'relevant funders' until reaching an 'ultimate funder' of a particular loan arrangement.

The withholding tax on interest paid from Canada to the immediate foreign entity is then compared to what the withholding tax would have been had the interest been paid directly to the 'ultimate funder.' If paying the interest to the 'ultimate funder' would have incurred a higher withholding tax, then interest is deemed to have been paid to the 'ultimate funder' through a formula that results in the withholding rate on the interest essentially increasing to what it would have been if the entire interest payment had been paid to the 'ultimate funder'. Basically, the withholding tax on the interest paid to the immediate funder remains unchanged, but the 'ultimate funder' is deemed to have received a payment such that the withholding tax on that payment eliminates the tax advantage gained from the impugned funding arrangement.

For example, an individual is a non-resident of Canada and resides in Country A, which has no tax treaty with Canada but has a tax treaty with Country B with no withholding tax on interest. Country B has a tax treaty with Canada with a reduced interest rate of 10%. The individual creates a corporation in Country B and lends that corporation $1,000,000, and that corporation then lends $1,000,000 to a Canadian entity. If in a particular year the Canadian entity pays $10,000 in interest to the corporation in Country B, and that payment is subject to the 10% withholding rate. So, $1,000 is paid to the Canada Revenue Agency, and the corporation then pays the $9,000 to the individual in Country A.

If the back-to-back provisions apply, then the CRA would compare the $1,000 that it in fact received to the amount that it would have received if the entire $10,000 were paid to the individual in Country A. In this case, since Country A has no tax treaty with Canada, if the Canadian entity had paid the entire $10,000 to the individual residing in Country A, Canada's 25% withholding tax rate would apply and the amount owing to the CRA would equal $2,500. So, if the Canadian entity had paid the full interest directly to the individual in Country A, the CRA would have garnered an additional $1,500 in withholding tax.

As a result, the back-to-back loan provisions deem the Canadian entity to have paid the 'ultimate funder' in Country A an amount of interest that permits the CRA to collect the $1,500 difference from the Canadian entity (on top of the initial $1,000 of withholding tax that the Canada Revenue Agency already received). The back-to-back loan provisions therefore allow the Canada Revenue Agency to collect the full $2,500 of withholding tax that it would have received had the payment been made directly to the 'ultimate funder'.

Character Substitutions Rules

These provisions also include character substitution rules which were added to inhibit the use of equity to avoid being caught by the back-to-back loan rules. These rules require that a share issuer has an obligation to pay an amount or a dividend and that one of two connection tests are met.

The first connection test is met where the amount of the dividend or payment is determined in whole or in part by reference to an amount of interest to be paid under a relevant funding arrangement.

Alternatively, the second connection test is met where it can reasonably be concluded that the particular relevant funding arrangement was entered into or permitted to remain in effect because of the shares.

If either connection test applies, the shareholdings are deemed by subsection 212(3.7) to be part of the relevant funding arrangement and the shareholder to be a relevant funder. In other words, if the character substitution rule applies, the Income Tax Act treats the foreign shareholder as if it were a lender and imposes on the Canadian payor the withholding obligations for interest rather than those for dividends.

The broad language these rules contain causes significant uncertainty—even for relatively standard situations such as international cash-pooling arrangements often used by multi-national businesses where treaty shopping is not a motivator of the arrangement. For example, the character substitution rules only apply where there is an obligation to pay a dividend. The rules are presumably targeted at situations where the issued shares require regular dividend payments of amounts equal to the interest that a corporation receives, essentially creating shares that function like debt. But any payment of a dividend—even on common shares or where there is no obligation to pay dividends—arguably creates an obligation on the corporation 'to pay an amount' (the dividend that was issued) which could then engage the character substitution rules. This may still apply even if the dividend is paid immediately upon declaration as it is likely that the obligation to pay exists, if only for an instant. When asked for clarification, the Department of Justice indicated that these provisions could apply to common shares if the connection tests are met and to view the provisions as anti-avoidance rules. Specifically, they warned that the quantum and timing of dividend payments on the common shares would be relevant in determining whether the connection tests were met. The provisions are further criticized because the similar, US equivalents of these provisions include express exceptions for obligations that arise solely due to a dividend declaration and for "significant financing activities" which provide a degree of flexibility for financing arrangements within a corporate group.

Tax Tip – Multi-Jurisdictional Tax Planning Requires Professional Advice

Tax planning and corporate structures spanning multiple jurisdictions are definitely not examples of DIY endeavours. Beyond the fact that a mistake could effectively lead to much higher withholding tax rates on interest, rents, and royalties due to the back-to-back loan provisions, it is entirely possible that the 'ultimate funder's' resident tax authority will allow claims for foreign tax credits on the withholding tax on the deemed interest payments. This means that not only is the withholding rate increased, but you may be double taxed on that increased amount as well. With these kinds of stakes involved, it would be foolhardy to proceed without professional advice—our experienced Toronto tax lawyers can help you ensure your tax plan is done right.

The information is thought to be current to date of posting. Income tax law changes frequently and content may no longer reflect the current state of the law. This document is not intended to create an attorney-client relationship. You should not act or rely on any information in this document without first seeking legal advice. This material is intended for general information purposes only and does not constitute legal advice. If you have any specific questions on any legal matter, you should consult a professional legal services provider.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

Contact the Author?
Click here to email the Author
In Association with
In Partnership with
Other Canada Advice Centres
Competition and Antitrust
Labour and Employment
Intellectual Property
More Advice Centers
Useful Resources
Forms available to download for income tax filing in Canada.
Hear David J. Rotfleisch discuss timely and highly topical tax matters during appearances and interviews with specialist publications.
Useful explanatory videos of income tax matters.
The following questions and answers are based on the proposed measures that were announced on December 7, 2015.
The official Government website of the CRA.
This guide is for any person who deals with the Canada Revenue Agency (CRA). The guide gives you information on the 16 rights set out in the Taxpayer Bill of Rights and explains what you can do if you believe that the CRA has not respected your rights.
The Office of the Taxpayers' Ombudsman (OTO) works to enhance the Canada Revenue Agency's (CRA) accountability in its service to, and treatment of, taxpayers and benefit recipients through independent and impartial reviews of service-related complaints and systemic issues.
Ontario personal income tax is an annual tax collected from individuals who are Ontario residents on the last day of the tax year or have income earned in Ontario for the tax year.
The following documents provide instructions for filing your 2015 income tax return.
If you earned income in B.C. or operated a Corporation with a permanent establishment in B.C. last year you need to file an income tax return. Find out when you need to file your income tax return, and if any tax credits or rebates apply to you.
Generally, a corporation must file an Alberta corporate income tax return (AT1) for each taxation year during which it has a permanent establishment in Alberta.
Font Size:
Mondaq on Twitter
Mondaq Sign Up
Gain free access to lawyers expertise from more than 250 countries.
Email Address
Company Name
Confirm Password
Mondaq Newsalert
Select Topics
Select Regions
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of

To Use you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions