Commitment fees are a common feature of many lending
arrangements whereby a lender is given additional compensation
above and beyond the stated interest rate for agreeing to provide
funding to the borrower. Similar to interest payments, Canadian
withholding tax may be applicable on such fees and must be
carefully considered in properly structuring cross-border lending
Commitment fees paid by a Canadian resident borrower to a
non-resident lender may be deemed to be interest and subject to
withholding tax under the Income Tax Act (Canada). The most
significant threshold issue in determining whether a commitment fee
will be deemed to be interest is first determining whether the
stated or "coupon" interest paid or credited to the
non-resident under the terms of the lending agreement is subject to
Canadian withholding tax under the Act on the date the agreement
was executed. In this respect, the treatment of the commitment fee
from a withholding tax perspective will follow the treatment of the
stated/coupon interest under the loan.
In general, Canadian withholding tax will apply at a rate of 25
percent on interest that is either (i) paid or credited by a
resident of Canada to a "non-arm's length"
non-resident lender; or (ii) considered "participating debt
interest" (for more detail, see
Canadian Tax Fundamentals: Withholding Tax on Cross-Border Interest
Payments). If neither of these conditions are met, and
consequently the stated/coupon interest under the loan is not
subject to Canadian withholding tax, the commitment fee will not be
deemed to be interest for purposes of the Act and will not be
subject to Canadian withholding tax. Accordingly, even if the
commitment fee is based on criteria that is contingent (e.g., based
on the borrower's revenue or cash-flow or is based on commodity
prices), no Canadian withholding tax should apply on the basis that
such fee is not "interest" for purposes of the Act. Care
should be taken to ensure that the commitment fee is reasonable in
the circumstances and is not effectively in lieu of interest that
the borrower would otherwise pay under the loan.
When structuring cross-border loans that have a commitment fee,
it will be critical to ensure that the general withholding tax
risks relating to the stated/coupon interest are properly managed
so as to simplify and mitigate the accompanying withholding tax
risks on any commitment fee.
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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