The Canada Revenue Agency (CRA) recently released final versions of new forms (the Forms) to be provided by recipients of payments from Canadian residents to certify eligibility for treaty-reduced rates of Canadian withholding tax. Separate Forms are provided for beneficial owners that are individuals or corporations and for partnerships and certain hybrid entities with one or more ultimate members that are entitled to a treaty reduced rate of Canadian withholding tax. The Forms would not be provided to the CRA, but rather to the Canadian resident payer of the withholdable amount or to certain intermediaries along a chain of payments subject to withholding. The release of the Forms marks a significant development for Canada and seems to signal that the CRA is requiring a greater level of diligence on the part of payers of withholdable amounts to ascertain that it is appropriate to apply a reduced treaty rate. Although the use of the Forms is not mandatory, and they will not guarantee avoidance of penalties, interest, or liabilities for underwithheld tax, many taxpayers will likely apply a 25% withholding rate on payments of withholdable amounts to recipients who do not complete the Forms.
Part XIII of the Income Tax Act (Canada) (ITA) imposes a 25% withholding tax on certain amounts paid or credited, or deemed to be paid or credited, by a resident of Canada to a non-resident (such as interest, dividends, pensions, annuities, royalties, estate and trust income, and management fees). The payer (or an agent of the payer or non-resident payee) must deduct or withhold applicable Part XIII tax from the payments and remit to the Canadian government. A payer who fails to collect or remit the full amount of Part XIII tax owing by a non-resident recipient is obliged to pay, on behalf of the non-resident, any deficiency thereof together with interest. In addition, the Canadian resident payer may be subject to a penalty ranging from 10% to 20% of the amount that should have been withheld.
The rate of withholding tax can be lowered or the tax can be eliminated by a tax treaty in force between Canada and the country of residence of the beneficial owner of the Canadian-source income. In addition to residency in a treaty country, some treaties may impose further requirements which have to be met to qualify for a treaty tax rate. For example, the Canada-U.S. tax treaty contains a reciprocal limitation on benefits (the LOB) provision which has generally been in effect since 2008. Under the LOB provision, in order to claim full treaty benefits, a U.S. (or Canadian) resident must meet certain requirements indicating a sufficient degree of connection to or presence in the U.S. (or Canada). In addition, a "look-through" rule allows amounts paid to certain "fiscally transparent" entities to be eligible for treaty benefits depending on the treaty residency of the entity's members.
In order to withhold at a reduced treaty rate, a Canadian resident payer should be satisfied that the non-resident recipient meets the requirements to qualify for the relevant treaty benefits. There are no provisions in the ITA specifying the level of due diligence that a Canadian payer must perform to determine whether a non-resident is treaty-eligible. Until recently, the CRA generally accepted reliance on the payee's address for determining whether to apply a treaty rate. According to the CRA, a written certification was only necessary if the direct recipient of income was an agent or a nominee of the beneficial owner or if there was a reasonable cause to suspect that the name and address provided by the alleged beneficial owner could not be relied upon.1 This rather rudimentary set of administrative requirements did not address establishing treaty entitlement under the LOB provisions.
New Withholding Forms
Prompted in part by recent changes to the Canada–U.S. tax treaty, the CRA developed a set of declaration forms which can be provided by non-resident payees to payers of withholdable amounts to certify entitlement to treaty benefits. In June 2009, draft Forms were released for public comments, and the final versions of the Forms were released on April 19, 2011. The primary use of the Forms for a payer of withholdable amounts is to gather information and representations from non-residents regarding entitlement to treaty-based reductions of Part XIII tax. The Forms can also be used to support a request for a Certificate of Compliance on the disposition of "taxable Canadian property" that is "treaty protected property." On the other hand, the Forms need not be provided to support statutory exemptions from Part XIII tax provided for in the ITA. Agents and nominees receiving payments on behalf of beneficial owners of income should still provide a certification in a form similar to that previously suggested by the CRA, but they can use the Forms in order to obtain the information required to complete the certification. A transition period until December 31, 2011 allows payers to gather any additional information needed to comply with the new administrative requirements.
Form NR301 (Declaration of Eligibility for Benefits under a Tax Treaty for a Non-Resident Taxpayer) is intended for use by individuals and corporations. By completing Form NR301, a non-resident certifies: that they are a resident of a treaty country; the beneficial owner of the applicable income; and are entitled to the benefits of the treaty between Canada and their country of residence in respect of that income.
Forms NR302 (Declaration of Eligibility for Benefits under a Tax Treaty for a Partnership with Non-Resident Partners) and NR303 (Declaration of Eligibility for Benefits under a Tax Treaty for a Hybrid Entity) address the complexities of "looking through" partnerships and hybrid entities for the purpose of determining the applicable tax treaty rate. Hybrid entities should use form NR303 if they are considered fiscally transparent by a country that has a tax treaty with Canada extending treaty benefits for income derived through those entities to the residents of that country who have an interest in that entity. If the hybrid entity is subject to tax as a corporation in the treaty country, complete Form NR301. Currently, the Canada-U.S. tax treaty is the only treaty signed by Canada with a specific clause applicable to hybrid entities, although the decision of the Tax Court of Canada in TD Securities LLC suggests that other hybrid entities may also be eligible for treaty benefits [see our Osler Update of May 11, 2010]. Forms NR302 and NR303 solicit information to: determine the tax rate applicable to each member of the partnership or hybrid; allocate to each such member a particular item of Canadian-source income or gain; and determine a blended tax rate applicable to the partnership or hybrid as a whole. Each of Forms NR302 and NR303 contains a worksheet for calculating an effective withholding tax rate, and another worksheet for calculating the total treaty exemption percentage related to business profits or disposition gains. Both schedules should be filled in on the basis of Forms NR301, NR302 and NR303, as applicable, collected from the members up the chain of ownership. This procedure allows looking through partnerships and qualifying hybrid entities to the ultimate beneficial owners entitled to treaty benefits.
All Forms, once signed, remain valid for three years unless prior to then the non-resident payee ceases to be eligible for the claimed treaty benefits, in which case a Form would expire at the earlier time. The Forms also include an undertaking by the non-resident payee to notify the Canadian payer or an intermediary to whom the Form is submitted of any change in circumstances.
In addition, Form NR302 includes information about Canadian resident partners which allows excluding the share of income payable to Canadians and thus, not subject to withholding tax. The instructions to this Form include an example indicating that no withholding is required in respect of the portion of a withholdable payment to a partnership that is allocable to a Canadian resident partner. This is a significant development in light of a provision in the ITA that deems any partnership that has at least one non-resident partner to be a non-resident person for Part XIII tax purposes. Until the release of the finalized Forms, the CRA had interpreted this provision to require withholding at the rate of 25% on the allocable share of a withholdable payment of each partner, including Canadian resident partners, who was not entitled to a treaty-based reduction of Canadian withholding tax.
One of the issues that the Forms do not expressly address is holding global securities through depository services such as CDS Clearing and Depository Services Inc. in Canada (CDS) or the Depository Trust Company in the United States (DTC). Some guidance in this respect is provided by the CRA in pending updates to IC76-12, "Applicable Rate of Part XIII Tax on Amounts Paid or Credited to Persons in Countries with Which Canada Has a Tax Convention" related to Forms NR302, NR302, and NR303. In particular, the CRA states that payments made to CDS on securities registered in the name of Cede & Co., which is the nominee name for DTC, are made without tax. Tax will be withheld by CDS based on information received from DTC and collected by DTC's participants. In other cases of securities held through depository and clearing systems, presumably the systems' participants (primarily investment dealers) will require payees to complete the Forms.
Are the Forms Compulsory and What is their Benefit?
The use of the Forms is voluntary, as there is no statutory authority requiring their use. The CRA has stated that Canadian payers can withhold at a treaty-reduced tax rate on the basis of equivalent information provided by other means. However, if no equivalent information is available or if the information available is incomplete or suspected to be incorrect, the CRA suggests that the payer should withhold at the full statutory rate of 25%. Moreover, even if Canadian payers obtain the required Forms from non-resident payees, they are urged not to rely blindly on the information provided. According to the CRA, the payer should question the information received if the payer knows or has reasonable cause to believe that the information on the Forms is incorrect or misleading, contradicts information in the payer's files or is given without knowledge or consideration of the facts. It seems likely that as part of auditing a Canadian resident taxpayer's withholding tax compliance the CRA will ask to be shown that prior to withholding at a treaty-reduced rate the taxpayer had obtained either the appropriate Form or equivalent information.
The CRA does note that in certain circumstances, it is not necessary to obtain one of the Forms to withhold at a treaty-reduced rate. These circumstances include certain payments made to non-resident individuals and U.S. trusts or estates, payments made to a Swiss address, and payments made without tax being withheld to CDS on securities registered in the name of Cede & Co.
The new Forms and their role are discussed by the CRA in pending updates to Information Circular 76-12R6 and in the CRA Press Release entitled "More Information on Forms NR301, NR302, and NR303", both of which were released on April 19, 2011. It appears from the CRA's comments that bona fide reliance on the Forms offers no legal protection to Canadian payers against joint and several liability with the non-resident payee for failure to remit the required amount of tax. In particular, the CRA confirms that where insufficient tax is withheld, an assessment can still be issued to the Canadian payer for the deficiency and interest; in which case a penalty will automatically be imposed.2 No reference is made in either the Circular or the Press Release of potential relief from the interest and penalties in cases when Canadian payers exercise due diligence by obtaining the Forms or equivalent information. The ITA provides a mechanism for the CRA to allow discretionary relief from penalties and interest. Presumably, the fact that a Canadian payer has obtained fully completed and up-to-date Forms from non-resident payees, and has no reason to believe the information provided is inaccurate, should be taken into consideration in determining whether the relief should be granted.
At a May 19, 2011 public appearance,3 the CRA was asked whether reliance on the Forms by a Canadian resident payor of a withholdable amount would provide any protection in the event that tax was mistakenly underwithheld and the payor had no reason to know that the information on the relevant Form was inaccurate. The CRA official said that the CRA reserves the right to assess the payor, recipient or their agents for underwithholding, and simply reminded taxpayers that they could apply for relief from interest and penalties, at which time the CRA would consider all relevant circumstances.
Even if the use of the Forms will not provide Canadian payers with protection from interest, penalties and liability for underwithheld tax, the Forms may be helpful as a tool to ensure that payers have current and sufficient information to establish the identity and residency of the beneficial owners of the income, as well as their eligibility for treaty benefits. However, completing the Forms may require internal mechanisms for collecting and timely renewing the Forms or equivalent information in order to conform to the new administrative requirements.
1. CRA Information Circular 76-12R6, "Applicable Rate of Part XIII Tax on Amounts Paid or Credited to Persons in Countries with Which Canada Has a Tax Convention", dated November 2, 2007. The Circular was revised in conjunction with the release of the new Forms.
2. CRA Press Release "More Information on Forms NR301, NR302, and NR303", dated April 19, 2011.
3. CRA Roundtable at the International Fiscal Association (Canada branch), 2011 International Tax Seminar (May 19-20, 2011).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.