A Notice of Ways and Means Motion tabled in Parliament on November 13, 2007 has moved forward the effective date for the elimination of Canadian withholding tax on interest payments to arm’s length non-resident lenders. The new effective date will be January 1, 2008 if the Motion is enacted in its current form.
This Motion accelerates the elimination of withholding tax on arm’s length interest previously announced in both the March 19, 2007 Federal Budget and draft legislation dated October 2, 2007. Under the prior announcements, the new rules were expected to take effect only upon ratification of the Fifth Protocol to the Canada-United States Income Tax Convention, 1980 (the “Treaty”). No specific time frame for ratification had been announced, but it was widely expected that it would not occur until well into the New Year.
The Federal Government has not announced whether it will seek to have the Motion enacted before the end of 2007. If enactment of the Motion is delayed until 2008, it is expected that the new rules will be given retroactive effect to January 1, 2008. In that case, the existing withholding tax rules would technically still apply during the period from January 1, 2008 to the date the new rules become law. This will require foreign lenders (and Canadian borrowers) to decide whether to withhold and remit withholding taxes in respect of interest payments during that period. Another issue will be whether to structure loans entered into after January 1, 2008 (but before enactment) to qualify for one of the existing exemptions from Canadian withholding tax.
If the new rules are enacted retroactive to January 1, 2008, foreign lenders should be entitled to claim a refund for any withholding taxes remitted on their behalf on or after January 1, 2008.
Canadian borrowers and foreign lenders who are considering relying on the Motion to not withhold tax from interest payments should consider the accounting impact of so doing. Canadian GAAP permits reliance on a proposed amendment for financial accounting purposes if the legislation is “substantively enacted”. According to the Canadian Institute of Chartered Accountants, legislation introduced by a minority government is “substantively enacted” when it passes Third Reading in the House of Commons.
The November 13, 2007 Motion does not affect the timing for the phase-out of withholding tax on interest payments to “related persons” under the Treaty. The Minister of Finance had previously announced that if both countries ratify the Fifth Protocol in 2008, the first reduction in the withholding tax rate to 7% in respect of interest paid or credited to “related persons” will apply retroactively to amounts paid or credited after December 31, 2007.