Canada: Joint Debt – A Matter of Form

This article was originally published in Blakes Bulletin on Tax And Corporate Finance, April 2004

Where there is a financing of a multinational group of affiliated corporations, it is becoming more common to have the indebtedness issued by several of the affiliated corporations as co-issuers, in which case there are various tax issues to address.

Although each co-issuer is jointly and severally liable under jointly issued debt, the funds themselves are advanced to the separate co-issuers in predetermined proportions. While the economic effect is somewhat similar to debt coupled with cross guarantees, the tax analysis can be surprisingly complex.

The simplest case is that of a parent and its wholly owned subsidiary. There, although the parent and the subsidiary are referred to as co-issuers of the indebtedness, the entire amount borrowed is often advanced to the subsidiary. The situation is not dissimilar to a borrowing by a wholly owned subsidiary which is guaranteed by its parent. Increasingly, however, the co-issuers are members of an international group of corporations, each of which is resident in a different country and each of which will be advanced a portion of the funds borrowed from an international group of lenders. Where one of the co-issuers is a Canadian resident corporation, a number of issues can arise under the Canadian Income Tax Act which can generally be dealt with through careful structuring while preserving the desired commercial relationship.

Withholding Tax

Where a Canadian borrower is one of the co-issuers and the lenders are resident in a number of countries, Canadian crossborder withholding tax issues will need to be addressed. If the indebtedness were medium term debt issued solely by a Canadian resident corporation, it could likely be structured to fit within the Canadian 5/25 exemption from withholding tax in respect of arm’s length debt issued by a Canadian corporation where the borrower cannot be obligated under any circumstances (other than in the case of an event of default or certain illegalities) to repay more than 25% of the amount advanced within the first five years of the date of issue. If the indebtedness were short term indebtedness issued only by a Canadian resident corporation, it could be issued entirely to Canadian resident lenders and Canadian branches or foreign banks thereby avoiding the Canadian withholding tax issue entirely. The fact that one or more non-residents guarantees the debt would not affect the Canadian withholding tax analysis unless and until the guarantee was called upon. Similarly, where a Canadian corporation guarantees debt of a non-resident, unless and until the guarantee is called upon, there should generally be no Canadian withholding tax on the interest payments by the non-resident.

Where there are multiple co-issuers, each of which is liable in respect of all of the debt, the analysis becomes more complicated. It is important to carefully structure the drawdown and the payment obligations so as to ensure that no amount paid by a non-resident co-issuer to a non-resident lender could be considered to be paid for, or on behalf of, the Canadian borrower and, accordingly, subject to Canadian withholding tax. In the case of short term borrowing which cannot be structured to be withholding tax exempt, it may be necessary to clearly identify the lenders from whom the Canadian co-issuer receives the funds and to stream the Canadian co-issuer’s payment obligations to ensure that the advances to the Canadian co-issuer are sourced from Canadian lenders and, at least prior to any event of default, the Canadian co-issuer’s payments are made solely to such Canadian lenders. In the case of medium term debt that can be structured to comply with the 5/25 withholding tax exemption, there is more flexibility, although the Canadian co-issuer’s payments need to be clearly identified as being made only in respect of amounts advanced to it.

To the extent that funds of the Canadian co-issuer are to be made available to satisfy obligations of the other co-issuers, it will be necessary to ensure that those funds are distributed to the co-issuers by way of loans, dividends or returns of capital rather than as payments being made directly by the Canadian co-issuer in satisfaction of a liability of a foreign co-issuer. Provided the structural integrity of the transactions is carefully observed, it would appear that these transactions can be structured to avoid Canadian withholding tax.

Capital Tax

The co-issue of indebtedness gives rise to capital tax issues for a Canadian co-issuer as well. Under the Act, the capital of a corporation includes all "indebtedness of the corporation" and the amount of indebtedness is determined by the amounts reflected on the balance sheet of the corporation, generally prepared in accordance with Canadian generally accepted accounting principles. A number of cases have made it clear that the financial statements will include the notes to the financial statements for these purposes. In the case of joint debt, it is understood that only the amount actually advanced to the particular co-issuer is recorded on its balance sheet, with a note to the financial statements indicating the full value of the joint debt in order to disclose the legal liability of the co-issuer for the part of the debt not advanced to the borrower.

In 1997, a request was made to the Canadian Department of Finance for an amendment to the Act to clarify that only the amount actually advanced to a co-issuer need be reflected in the co-issuer’s capital. The Department of Finance indicated that they would recommend an amendment to the Act in the event that it was considered necessary based on the interpretations being taken by the Canada Revenue Agency (CRA). It would appear that the CRA has accepted that only the amount advanced to a joint obligor needs to be included in the capital tax base. To do otherwise could result in significant double counting and double taxation. To date, there has been no amendment made to the Act to clarify the position of joint debt for capital tax purposes and it is necessary to rely on administrative practice to achieve an acceptable result.

Debt Forgiveness

Similar interpretative issues arise in the context of the Canadian debt forgiveness rules. However, it again appears that, with careful structuring, the amount which is actually advanced to a Canadian co-issuer can be clearly identified. Once that amount is identified and repayments are structured correctly, the Canadian rules appear to operate appropriately so that, provided the Canadian co-issuer repays the funds advanced to it, there should be no debt forgiveness for the Canadian co-issuer.

Foreign Property

Issues arise as to the manner in which debt issued by co-issuers in multiple jurisdictions should be categorized for purposes of the foreign property rules under the Act. Under these rules, there is a penalty tax on excess investments on foreign property by certain Canadian tax-exempts, such as trusts governed by pension plans, registered retirement savings plans and registered retirement income funds. Normally, if a Canadian tax-exempt holds debt of a Canadian corporation, the debt will not be foreign property even though it is guaranteed by the Canadian corporation’s foreign parent. Where debt is co-issued by a number of corporations, some of which are not resident in Canada, the analysis is different. Although the monies under the debt may originally have been advanced solely to the Canadian co-issuer, the debt is nevertheless issued by, and indebtedness of, non-resident corporations as well as the Canadian obligor. It therefore appears that the debt is in fact foreign property for purposes of the Act, although arguments could be made that this should not be the case if it could be demonstrated that the funds were advanced directly to the Canadian co-issuer, with foreign co-issuers acting in a capacity similar to that of a guarantor.


The use of debt issued by co-issuers appears to be regarded more favourably for commercial purposes than the use of multiple cross guarantees. However, such debt requires careful structuring and precise documentation to ensure that there are no unexpected Canadian tax issues. 

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.

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