Canada: Budget 2016: New Rules Targeting "Back-To-Back" Arrangements

Last Updated: April 1 2016
Article by Carl Irvine

Budget 2016 proposes a series of new rules targeting the perceived use of "back-to-back" structures to (i) reduce Canadian withholding tax, or (ii) avoid the application of anti-avoidance rules currently contained in the Income Tax Act (the "Tax Act"). Although the new Budget proposals are presented as a conceptual extension of existing provisions in the Tax Act, in some cases, the proposals bear little resemblance to the existing rules.

"Back-To-Back" Royalty Rules

The first set of proposed new "back-to-back" rules targets the use of intermediaries resident in jurisdictions with which Canada has entered into a tax treaty in a manner that allows persons resident in non-treaty jurisdictions to access treaty-reduced rates of withholding tax in respect of the receipt of rents, royalties or similar payments (collectively, "royalties"). The proposed new rules will apply where:

  1. a Canadian-resident person (the "Canadian Payor") makes a royalty payment in respect of a lease, license or similar agreement to a person resident in a tax treaty jurisdiction (an "intermediary");
  2. the intermediary (or a person or partnership that does not deal at arm's length with the intermediary) has an obligation to pay an amount to another non-resident person (the "ultimate recipient") in respect of a lease, license or similar agreement, or of an assignment or an instalment sale; and
  3. one of the following conditions is met:

    1. the amount the intermediary is obligated to pay is established, in whole or in part, by reference to

      1. the royalty payment made by, or the royalty payment obligation of, the Canadian Payor, or
      2. the fair market value of property; any revenue, profits, income or cash flow from property; or any other similar criteria in respect of property, where a right to use the property is granted to the Canadian Payor; or
    2. it can reasonably be concluded, based on all the facts and circumstances, that the agreement with the Canadian Payor was entered into or permitted to remain in effect because of the arrangement between the intermediary and the ultimate recipient (i.e., the two "legs" of the transaction are connected).

The proposed rule will, however, only apply where the Canadian withholding tax payable in respect of payments to the intermediary is less than the withholding tax that would have been payable if the payment by the Canadian Payor were made directly to the ultimate recipient.

Where the new "back-to-back" rule applies, the Canadian Payor will be deemed to have made a royalty payment directly to the ultimate recipient, and the amount of withholding tax payable in respect of the deemed royalty payment will equal the amount of withholding tax avoided by use of the back-to-back arrangement.

The new "back-to-back" rule will apply to royalty payments made after 2016.

This proposal raises a number of concerns. First, unlike the existing "back-to-back" rules in the Tax Act, it is not clear that these rules are intended to be limited to transactions where there is a close relationship between the Canadian Payor and the ultimate recipient. Second, in the absence of draft legislation, it is not clear what factors would be used to assess whether there is a connection between the two "legs" of the back-to-back arrangement.

Character Substitution Rules

The second set of new "back-to-back" rules proposed in Budget 2016 are intended to prevent perceived tax avoidance through the use of structures intended to circumvent the existing "back-to-back" anti-avoidance rules in Part XIII of the Tax Act relating to interest (or the proposed rules relating to royalties) by establishing payments between the intermediary and the ultimate recipient that are economically similar to interest (or royalty) payments, but that do not formally constitute interest (or royalties).

These new rules would apply to deem a "back-to-back" arrangement to be captured by the existing (or proposed) anti-avoidance rules where:

  1. interest is paid by a Canadian Payor to an intermediary and there is an agreement that provides payments in respect of royalties between the intermediary and the ultimate recipient;
  2. royalties are paid by a Canadian Payor to an intermediary and there is a loan between the intermediary and the ultimate recipient; or
  3. interest or royalties are paid by a Canadian Payor to an intermediary and a non-resident person (e.g., the ultimate recipient) holds shares of the intermediary that include certain obligations to pay dividends or that satisfy certain other conditions (e.g., they are redeemable or cancellable).

The proposed character substitution rules will apply where a "sufficient connection" is established between (i) the arrangement under which an interest or royalty payment is made by a Canadian Payor, and (ii) the intermediary's obligation to the ultimate recipient in each of the three situations described above. Where such an arrangement is found to exist, the Canadian Payor will be deemed to have made an additional payment to the ultimate recipient having the same character as the payment made to the intermediary, which deemed payment will be subject to Canadian withholding tax. (It is not clear from the Budget documents whether the amount of withholding tax payable in respect of the deemed payment will be reduced by the amount of withholding tax payable in respect of the actual payment made to the intermediary).

The new character substitution rules will apply to interest and royalty payments made after 2016.

This proposal raises many of the same concerns canvassed above with respect to the proposed "back-to-back" royalty rules. Furthermore, the proposal raises several practical tax policy questions. For example, why should the tax treatment of a royalty payment to a non-resident be affected because the non-resident chooses to finance its operations (for example, the purchase of the intellectual property to which the royalty relates) with a loan from another non-resident person (e.g., the ultimate recipient) or with shares having certain dividend obligations or which are redeemable? On their own, there is nothing about such financing arrangements (which, after all, are commonplace for Canadian companies) which are, per se, offensive. It may well be that the focus of this proposal will be narrowed when draft legislation is released, but, at present, it appears to be overly broad.

"Back-To-Back" Shareholder Loan Arrangements

The third set of new "back-to-back" rules will apply to "back-to-back" loan arrangements intended to avoid the application of Canada's shareholder loan rules, which (when applicable), can result in an income inclusion (in the case of a Canadian-resident shareholder) or a deemed dividend subject to withholding tax (in the case of a non-resident shareholder). The Budget documents suggest that taxpayers have been using intermediaries to avoid the application of these rules.

In simple terms, the new "back-to-back" shareholder loan rules will apply where a shareholder of a Canadian-resident corporation (or a person or partnership that is "connected" with the shareholder or that is a member of a partnership that is a shareholder) owes an amount (the "shareholder debt") to an intermediary who is not connected with the shareholder, and either:

  1. the intermediary owes an amount to the corporation (the "intermediary debt") and either recourse is limited in whole or in part to amounts recovered by the intermediary from the shareholder on the shareholder debt, or it can reasonably be concluded that the shareholder debt became owing or was allowed to remain owing because the intermediary debt was or was anticipated to be entered into; or
  2. the intermediary has a "specified right" in respect of a particular property that was granted by the corporation and either the existence of the specified right is required under the terms of the shareholder debt or it can reasonably be concluded that the shareholder debt became owing or was allowed to remain owing because the specified right was or was anticipated to be granted. (For these purposes, a "specified right" is proposed to be defined in the same way as the term is defined under the existing "back-to-back" loan rules.)

If such an arrangement is found to exist, the shareholder will be deemed to be indebted to the corporation in an amount equal to the lesser of (i) the amount of the shareholder debt, and (ii) the sum of the intermediary debt and the total fair market value of property over which the intermediary has a "specified right".

This proposal will apply to back-to-back shareholder loan arrangements as of March 22, 2016. For existing arrangements, the deemed indebtedness will be deemed to have become owing on March 22, 2016.

Multiple Intermediary Arrangements

Finally, Budget 2016 proposes rules to clarify that the existing back-to-back rules, as well as the new back-to-back rules proposed in the Budget, also apply to arrangements where there are multiple tiers of intermediaries. Under these new proposals, the back-to-back rules will apply to all arrangements that are "sufficiently connected" to the arrangement under which a Canadian-resident makes a cross-border payment of interest or royalties to an intermediary. Where such an arrangement exists, an additional payment (of the same character as that paid by the Canadian-resident to the first intermediary) will be deemed to have been paid directly by the Canadian-resident to the ultimate non-resident recipient in the chain of connected arrangements.

The proposed "back-to-back" shareholder loan rules will also be expanded to address multiple intermediary arrangements.

This proposal will apply to payments of interest or royalties made after 2016 and to shareholder loans as of January 1, 2017.

* * *

The Department of Finance has not yet released draft legislation containing details of the proposed new "back-to-back" rules, but given the proposed effective dates for the new rules, it is expected that such draft legislation should be released in the near future.

The foregoing provides only an overview and does not constitute legal advice. Readers are cautioned against making any decisions based on this material alone. Rather, specific legal advice should be obtained.

© McMillan LLP 2016

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.

Carl Irvine
In association with
Related Video
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
Check to state you have read and
agree to our Terms and Conditions

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.

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 by clicking here .

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.


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.