Copyright 2011, Blake, Cassels & Graydon LLP
Originally published in Blakes Bulletin on Tax, June 2011
CRA Changes Administrative Policy with respect to Determining Entitlement to Treaty-Reduced Rates of Canadian Non‑Resident Withholding Tax
Canada's Withholding Tax Regime
Part XIII of the Income Tax Act (Canada) (the Tax Act) imposes a withholding tax of 25% on certain amounts paid or credited to non-residents (and deemed non-residents) of Canada. Amounts subject to such withholding include interest, dividends, rents, royalties, management fees and estate or trust income. The obligation to withhold such amounts is imposed on a Canadian resident (or deemed resident) payer, and a payer that fails to withhold and timely remit such withholding tax may be liable to a penalty of 10% or 20% of the withholding tax, plus interest.
Under Canada's bilateral tax treaties, the applicable withholding rates under Part XIII are in most cases reduced, and in some cases the obligation to withhold is eliminated.
Historically, the published administrative policy of the Canada Revenue Agency (CRA) has been that, generally, a payer may accept the name and address of a payee as being that of the beneficial owner unless there is a reasonable cause to suspect otherwise, for the purpose of determining whether a payment to a payee is entitled to a treaty-reduced rate of non-resident withholding tax. Where there was doubt as to whether a payee was the beneficial owner of a payment, CRA expected the payer to obtain a basic form of certification from the payee attesting to its entitlement to treaty benefits. Where the payee acted as an agent or nominee of the beneficial owner, the payee was to certify as to the withholding rate applicable to the beneficial owner, having regard to such owner's jurisdiction of residence for treaty purposes.
The foregoing approach to determining entitlement to treaty-reduced rates of withholding tax does not address situations where further inquiry need be made beyond the residence of the beneficial owner of the payment.
The 5th Protocol to the Canada-U.S. Tax Treaty introduced, for the first time in a Canadian tax treaty, a comprehensive limitation on benefits (LOB) article (from Canada's perspective). The LOB rules deny the benefits of the treaty to a U.S. resident in circumstances where the resident does not have a sufficient connection to or presence in the U.S. (either by virtue of the resident's ownership or level of U.S. activity). In addition, the 5th Protocol introduced a look-through rule in the case of most "hybrid" entities (i.e., entities that are characterized for tax purposes as fiscally transparent in one jurisdiction and a taxpayer in the other).
The Part XIII rules do not provide a payer with a due diligence defence should it fail to withhold and remit at the appropriate rate. CRA's aforementioned administrative policy provided a practical approach for payers to be reasonably certain that they were withholding at the right rate. That practical approach, however, was unsuited for the more detailed analysis required to conclude that a U.S. resident was not subject to the LOB rules. Furthermore, other jurisdictions, such as the U.S., have had more detailed certification requirements applicable to non-residents claiming the benefits of an applicable tax treaty. Prompted in part by the above-mentioned changes to the Canada-U.S. Tax Treaty, CRA released a package of forms in draft in June 2009 for public consultation and subsequently released final versions of such forms on April 19, 2011.
New CRA Policy on Withholding
The new forms, NR301, NR302 and NR303, are to be provided by payees to payers in order to help payers establish appropriate treaty withholding rates. Although not discussed in this bulletin, the forms are also to be completed and included in a non-resident's application to CRA for a "section 116" clearance certificate in respect of the disposition by the non-resident of "taxable Canadian property" that is "treaty protected property". Form NR302 or NR303, as applicable, is also to be submitted to CRA, if a partnership or hybrid, as the case may be, is applying for a waiver of withholding under Regulation 105 of the Tax Act.
The forms are part of CRA's revised administrative policy with respect to determining applicable rates of Part XIII tax on amounts paid or credited to persons resident in a country with which Canada has a tax treaty. In addition to the release of the forms, CRA has also released two notes that provide additional information on the scope of CRA's new policy and how to use the forms: "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 NR301, NR302 and NR303" (click here to access) and "More information on forms NR301, NR302 and NR303" (click here to access). Both notes have been published on the CRA website.
Under CRA's new guidelines, a payer of amounts subject to Part XIII withholding must have recent and sufficient information to establish (i) the identity of the beneficial owner of the payment for the purpose of the application of treaty benefits, (ii) whether it is resident in a particular country with which Canada has a tax treaty and (iii) whether it is eligible for treaty benefits under the tax treaty on the income being paid (e.g., subject to the LOB). The new forms are not prescribed; therefore, they are not mandatory, and CRA has indicated that a payer may obtain equivalent information to that requested in the forms in lieu of obtaining the forms themselves.
Form NR301 is to be completed by non-resident payees who are individuals, corporations, trusts and, in certain cases, partnerships that are taxed as corporations on their worldwide income. It requires certification as to the payee's country of residence for treaty purposes, and the type of income for which the payee is making the declaration.
Form NR302 is to be completed by payees that are partnerships. The form states that where a payee partnership is subject to tax as a corporation on its worldwide income in a treaty country, the payee partnership may complete either NR302 or NR301, whichever is more beneficial in the circumstances. Form NR302 includes a worksheet for determining the appropriate blended withholding rate applicable to the partnership. The worksheet asks for identification of each partner including the type of entity it is, such partner's country of residence and its percentage interest in the income to which the form relates. The partnership is expected to obtain the appropriate form from each of its non-resident partners.
Part XIII contains a provision that deems a partnership to be a non-resident of Canada for purposes of withholding if any of the partnership's members is itself a non-resident. Historically, CRA's position was that a payer would have to withhold on payments to a partnership in respect of partnership interests held by Canadian residents (even though CRA would allow reduced withholding in respect of non-resident partners entitled to treaty benefits). It was understood that CRA had softened its position more recently, and this welcome change is confirmed by the release of these forms. The worksheet for form NR302 asks for information about Canadian resident members of a partnership and indicates that no withholding applies in respect of their interests. Also, the instructions for completing the form include an example that makes it clear that a payer need not withhold any amount in respect of payments to a partnership to the extent that interests in the partnership are held by Canadian residents.
Form NR303 is to be completed by hybrid entities. Currently, the Canada-U.S. Tax Treaty is the only of Canada's tax treaties under which a person resident in the U.S. can be considered to derive income that flows through a hybrid entity. Therefore, form NR303 is only currently relevant with respect to a hybrid entity, some or all of whose members are residents of the U.S. entitled to applicable benefits under the Canada-U.S. Tax Treaty. Like form NR302, the hybrid entity form includes a worksheet for determining the appropriate blended withholding rate, based on any treaty entitlements of the hybrid's members/shareholders.
The forms are generally valid until the earlier of three years from the end of the calendar year in which the form is executed, and when there is a change in the payee's eligibility for treaty benefits. Each form contains an undertaking by the payee that it will immediately notify the party to whom it is providing the form of any changes to the information in the form.
Where forms are used to support a payee's entitlement to reduced Part XIII withholding, the forms are not filed with CRA; rather, the payer is expected to keep them on file and to make such forms available for review by CRA if requested to do so. A payer is only required to obtain forms from the entity to which it makes a payment; where the recipient entity requires information from its members/shareholders in order to provide the payer with a form, such recipient is expected to obtain the appropriate forms from its members/shareholders.
CRA has provided for a transitional period for implementing its new policy until December 31, 2011, to allow additional information to be gathered by payers, which satisfies the requirements of the forms. If the information on file is sufficient to determine that tax treaty benefits do not apply or a particular tax treaty rate applies, the payer has to withhold tax accordingly. Where a payer has reason to believe that the LOB provisions will restrict the application of treaty benefits, the payer has to ask the recipient for certification or withhold at the full 25% rate.
Generally, a payer may accept the payee as the beneficial owner of the income unless there is reasonable cause to suspect that this is not correct. A payer should question whether the payee is the beneficial owner where the payee is known to act, even occasionally, as an agent or nominee, the payee is reported to be "in care of" another person or "in trust", or the mailing address for payment of the income is different from the registered address of the owner. In any case, where the payment is made to a partnership with non-resident partners or a hybrid entity with members resident in the U.S., CRA expects a declaration to be made by the payee and forwarded to the payer.
Exceptions to Use of Forms
In one of CRA's notes, it has identified a number of circumstances where the new forms are not needed or cannot be used.
If the payee is an individual, or an estate the trustee of which has a U.S. address, then no form is required provided certain criteria are met and the payer has procedures in place so that changes to the payee's information will result in a review of the withholding tax rate.
If the payee is an entity or organization entitled to an exemption under Article XXI of the Canada-U.S. Tax Treaty, the payee must obtain a letter of exemption from CRA and cannot use form NR301 to claim treaty benefits. A list of entities that have been issued such a letter is available in guide T4016, which is updated periodically by CRA.
Payments made to CDS Clearing and Depositary Services Inc. (CDS) on securities registered in the name of Cede & Co. (the nominee of the U.S. equivalent of CDS, Depositary Trust Company (DTC)) are to be made without withholding tax. CRA states that CDS will withhold tax based on information received from DTC and collected by DTC's participants.
Interest and Dividends Payable to Non‑Resident Agents and Nominees/Financial Intermediaries
Payments subject to Part XIII withholding that are made to non-resident agents or nominees/financial intermediaries are subject to the 25% statutory withholding rate unless the nominee or agent has previously provided documentation to the payer that certifies that a lower treaty rate applies. CRA has prepared a form of certification for nominees and agents to provide to payers, and CRA recommends that nominees and agents obtain forms NR301, NR302 or NR303, as applicable, from the beneficial owners of such payments.
Do the Forms Protect a Payer?
Each form instructs the payer not to apply a reduced rate of withholding where it has reason to believe that the information provided in the form is incorrect or misleading, or where the form or equivalent information has not been provided or the form is substantively incomplete. Furthermore, CRA has made it clear that if CRA determines that insufficient Part XIII tax was withheld on a payment to a non-resident, CRA may assess the non-resident, the payer, or both for the tax and interest. If the payer is assessed, a penalty will also apply. At a recent tax conference, CRA confirmed this position, even in circumstances where the payer has received a completed form from the payee. CRA indicated that where a payer is so assessed, CRA will consider a request for waiver of penalties and interest on a case-by-case basis, and that reasonable care taken by the payer will be a relevant consideration.
While payers who apply a reduced level of withholding will continue to bear the risk of doing so, these new forms and compliance with CRA's revised administrative policy will at least provide payers with better information to mitigate the risk. It remains to be seen whether use of these forms will become market standard.
Tax Information Exchange Agreements Update
On June 2, 2011, the Canadian Department of Finance announced the entry into force of two tax information exchange agreements (TIEAs). The TIEA with the Cayman Islands entered into force on June 1, 2011, and the TIEA with Bermuda will enter into force on July 1, 2011. The Department of Finance also announced that Canada has entered into TIEA negotiations with Antigua and Barbuda on November 26, 2010, Grenada on November 27, 2010, Montserrat on December 3, 2010, and Uruguay on March 4, 2011.
The announcements continue the increased activity over the past year on the part of Canada to increase its TIEA network with jurisdictions that do not have a comprehensive double income tax treaty with Canada. With these announcements, Canada will have three TIEAs that will have entered into force by July 1, 2011; the TIEA with the Netherlands Antilles having entered into force on January 1, 2011. In addition, Canada has signed TIEAs with 11 jurisdictions and is in the process of negotiating TIEAs with 15 other jurisdictions. A list of TIEAs that have been signed and TIEAs that are being negotiated is posted on the Department of Finance website (click here to access) and is periodically updated by the Department of Finance.
By way of background, a TIEA is a bilateral agreement under which two countries agree to exchange information relevant to the administration and enforcement of their domestic tax laws. The existence of an in-force TIEA is significant from a tax-planning perspective because dividends paid by a foreign affiliate (FA) of a Canadian corporation that is resident in a jurisdiction with which Canada has an in-force TIEA from active business income earned in that jurisdiction are effectively exempt from Canadian tax. For this purpose, the residency of the FA is determined under the common law central management and control test.
This benefit is coupled with a penalizing provision intended to encourage jurisdictions with which Canada had no comprehensive double income tax treaty to enter into a TIEA with Canada. This provision deems otherwise active business income earned by a controlled FA at a particular time to be subject to tax in Canada on an accrual basis where the controlled FA is resident in a jurisdiction with which:
- Canada does not have a comprehensive double income tax treaty;
- Canada does not have a TIEA; and
- Canada has, more than 60 months before the particular time, either begun or sought to begin negotiations for a TIEA.
However, this provision will not apply before 2014 to jurisdictions with which Canada was, on March 19, 2007, in the course of negotiating a TIEA.
As Canada continues to expand its TIEA network, outbound tax-planning opportunities using FAs resident in TIEA jurisdictions to earn active business income or to earn investment income that is deemed to be active business income will continue to expand in breadth and scope.
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.