Canada: Back-To-Back Loans And The 5/25 Withholding Tax Exemption

The Canada Revenue Agency (CRA) has recently issued an administrative income tax ruling which expands the possible application of the 5/25 Canadian withholding tax exemption for interest paid by Canadian corporate borrowers, by blessing a back-to-back loan arrangement.

The ruling confirms that the general anti-avoidance rule (GAAR) would not be applied to deny the exemption in the circumstances presented.


The 5/25 withholding tax exemption generally applies when a Canadian resident corporation becomes indebted to a non-resident with which it deals at arm’s length, provided that the debtor cannot under any circumstances be obligated to repay more than 25% of the principal amount in the first five years after the date the debt is issued. An exception to the 25% limitation is made if there is an event of failure or default or illegality, in which case there can be an accelerated obligation to repay the debt in full.

The exemption has also been extended to debtors that are non-resident corporations with Canadian businesses or assets, provided that under Canadian tax law they are deemed to be resident for Canadian withholding tax purposes when they pay interest. Also, the exemption has been extended to partnerships, provided that each and every partner is a Canadian resident corporation or a non-resident corporation deemed to be Canadian resident for withholding tax purposes.


The exemption is not available if the Canadian debtor is a Canadian resident individual or trust or a partnership with one or more non-corporate partners. As a result, the exemption has not been available in a number of common situations in which Canadian entities may have wished to borrow from a non-resident of Canada. (Because individuals do not qualify, the exemption is not available for personal mortgage loans.)

The exemption is not available for a loan to a trust, such as a Canadian real estate investment trust (REIT), even if the trust has a corporate trustee.This is because a trust is deemed to be an individual for Canadian tax purposes. Many partnerships used for Canadian real estate investment and other activities have individuals as partners, so the withholding tax exemption is not available for partnership debt held by a non-resident.


In the past, CRA has frowned upon suggestions that the withholding tax exemption might be available where a Canadian corporation borrows from a non-resident on terms that would technically qualify for the exemption, and then on-lends to an entity that would not qualify to access the withholding tax exemption. If the Canadian corporation were properly characterised as an agent or nominee for the ultimate borrower, this would result in a failure to qualify for the exemption. Even if the Canadian corporation acted as principal to borrow and on-lend, the CRA’s position had been that GAAR may apply to deny the exemption. This depended on the facts and, in particular, whether the primary purpose for the loan to the Canadian corporation was to obtain the withholding tax exemption. If this were the primary purpose, there would be an "avoidance transaction". In addition, the position was that the loan to the Canadian corporation may be considered a misuse or abuse of the withholding tax exemption and, in that case, GAAR would apply to deny the exemption.


The recently released tax ruling appears to be the first publicly disclosed ruling granted by the CRA which confirms that GAAR would not be applied to deny the withholding tax exemption in the case of back-to-back loans.

In the ruling, the Canadian corporation that was the borrower from the non-resident investors was the general partner of a limited partnership operating a business in Canada. The limited partnership guaranteed the general partner’s obligations. The Canadian corporate general partner immediately on-lent the borrowed funds to the limited partnership on substantially the same terms, and earned a reasonable mark-up.

The ruling recited that the limited partnership was widely-held and publicly-traded, and had partners that were not corporations. Accordingly, the limited partnership could not have accessed the withholding tax exemption if it had borrowed directly from the non-resident lenders. In granting the ruling, the CRA must have concluded that the corporate general partner acted as principal when it borrowed from the non-residents, and not as agent or on behalf of the limited partnership.

A favourable withholding tax ruling was granted on the basis that there was no "avoidance transaction" when the corporate general partner borrowed and on-lent the funds to the limited partnership. For this purpose, an avoidance transaction is defined as a transaction that would result in a tax benefit, unless the transaction "may reasonably be considered to have been undertaken or arranged primarily for bona fide purposes other than to obtain the tax benefit." Key to the finding that there was no avoidance transaction were several factual representations made by the taxpayer in the ruling request, regarding the commercial reasons why structuring the loan in this manner was favourable to the parties, and the commercial reasons why the limited partnership was unable to obtain equivalent financing or financing at as favourable a cost from Canadian resident lenders or investors.

One of the key representations made was that the general partner corporation was able to borrow money in the U.S. at a lower rate of interest than the limited partnership would have been able to borrow directly.This was stated to be based on "management’s experience and recent market enquiries". It was further represented that, in any event, the general partner would be liable for all debts incurred by the limited partnership and that the limited partnership could not make commitments on its own, but rather the general partner had to make commitments for it.These further representations seem to be simple truths regarding the operation of all limited partnerships.


There may be other situations in which there is an existing structure whereby a Canadian corporation can borrow and access the 5/25 withholding tax exemption, and then on-lend to another entity that cannot directly access the same exemption. One example might be a REIT and a Canadian corporation that manages and administers the REIT. If the facts and circumstances would allow for factual representations to be made along the lines made in the recent tax ruling, it may be possible for the Canadian corporation to borrow from non-residents without withholding tax and on-lend to the REIT, and obtain an advance tax ruling confirming that GAAR will not be applied. Explanations would have to be made in support of the ruling request regarding why this structure is primarily for commercial purposes rather than tax purposes. Presumably the explanations would include details as to why the REIT needs to access non-Canadian markets for the type of financing being sought, and why those non-Canadian markets would look more favourably on a loan to the Canadian corporation (guaranteed by the REIT) rather than a direct loan to the REIT itself.

If a back-to-back loan is sought to be put in place where there is no existing Canadian corporation already part of the structure, so that a new Canadian corporation would have to be inserted as part of the series of transactions including the back-to-back loans, it would presumably be more difficult to identify commercial reasons for forming the corporation and structuring the loans in this manner. It could be argued that the formation of the Canadian corporation and its participation in the structure would be primarily for the commercial purpose of allowing the ultimate borrower to obtain funding at the lowest cost of funds, on the basis that, if the loan were subject to withholding tax, the borrower would have to provide a gross-up which could increase the effective cost of borrowing. This argument would require the Canadian tax authority to go beyond the rationale for the ruling recently granted.

The Canadian case law regarding the interpretation of GAAR, including the interpretation of the definition of "avoidance transaction" and what constitutes a "misuse" or "abuse" of the Canadian Income Tax Act is still developing. We are still awaiting the first case on GAAR to be heard by the Supreme Court of Canada. The approach of the courts in the future will presumably affect both the rulings practices of the CRA and the comfort level of Canadian borrowers in carrying out withholding tax planning of the type discussed above.

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.

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.

In association with
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:
  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.
  • Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.
    If you do not want us to provide your name and email address you may opt out by clicking here
    If you do not wish to receive any future announcements of products and services offered by Mondaq you may opt out by clicking here

    Terms & Conditions and Privacy Statement (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

    Use of

    You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). 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 & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


    Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd 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 or performance of information available from this server.

    The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


    Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

    • To allow you to personalize the Mondaq websites you are visiting.
    • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
    • To produce demographic feedback for our information providers who provide information free for your use.

    Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

    Information Collection and Use

    We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

    We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

    Mondaq News Alerts

    In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


    A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

    Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

    Log Files

    We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


    This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

    Surveys & Contests

    From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


    If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


    From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

    *** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .


    This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

    Correcting/Updating Personal Information

    If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

    Notification of Changes

    If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

    How to contact Mondaq

    You can contact us with comments or queries at

    If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.

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