Canada: Lending By Non-Canadians On The Security Of Real Estate

Non-Canadian investors who are considering real estate based lending in Canada should be aware of certain regulatory requirements or limitations in Canada.

If a lender has a "permanent establishment" in Canada and carries on business in Canada, it will be subject to Canadian income taxes. A non-resident lender with no Canadian presence who lends to a Canadian borrower will not be subject to Canadian income tax on its business profits, even though some of its profits may be generated in Canada. However, the Canadian government does impose a withholding tax of 25% on most payments of interest by Canadian residents to foreign lenders. Bilateral tax treaties between Canada and the investor’s country may help by setting a lower withholding tax rate. As well, there are limited exemptions from Canadian withholding tax on interest. For example, there is no withholding tax on interest payable by a resident Canadian corporation to an arm’s length foreign lender, provided that no more than 25% of the principal amount of the loan is due within five years, except in certain circumstances, such as default in the scheduled payment of interest or principal.

A non-resident intending to provide mortgage loans in Ontario will have to consider the Mortgage Brokers Act (Ontario), which imposes certain constraints. In order to carry on a business involving lending on the security of real estate, a person or entity must be registered under the Act as a mortgage broker. Certain lenders are exempt, mainly financial institutions governed by other legislation, such as banks and trust companies. To become registered, an individual, partnership, association or corporation must be a Canadian citizen or permanent resident of Canada. The Mortgage Brokers Act (Ontario) does not permit corporations to carry on business as mortgage brokers if the total percentage of shares held by non-residents exceeds 25%, the percentage of shares held by a single non-resident exceeds 10%, or if the corporation has not been incorporated in Ontario or federally.

The requirement for permanent residency (essentially, being required to have an office in Ontario) may be problematic for foreign lenders who wish to lend into Canada without establishing a new business in Canada.

The 1999 amendments to the Bank Act, enabling foreign banks to establish and operate full service or lending branches in Canada, provide investment opportunities by reducing both barriers to entry and costs of administration. Foreign banks no longer have to incorporate a Canadian subsidiary or open a representative office. The amendments will hopefully promote foreign bank presence in Canada and encourage competition in the financial services sector.

Foreign bank branches generally have the same abilities as domestic banks and foreign bank subsidiaries, with the exception of taking deposits. Generally, full-service foreign branches may not accept retail deposits, which are deposits of less than $150,000, and lending branches may not accept any deposits or borrow funds except from other financial institutions. For lending branches only a minimal capital deposit of $100,000 is required. For both branches, there is an increased ability to rely on the corporate governance processes of the parent and the branches are less regulated. For example, foreign bank branches cannot be members of Canada Deposit Insurance Corporation and thus can avoid the costly regulatory compliance process associated with being a member. The ability of a foreign bank branch to lever off the capital of its parent bank gives foreign banks a greater opportunity to focus on commercial banking and engage in various lending activities.

The Income Tax Act was also amended to ensure that foreign bank branches would be subject to tax treatment equivalent to that which applied to Canadian domestic banks. For example, Canadian borrowers can make interest payments to authorized foreign banks without withholding tax since those banks are deemed to be resident in Canada for the purposes of amounts paid or credited to the bank when the payments are in respect of that bank’s Canadian banking business.

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.