Tax Relief for Cross-Border Transactions

There have been a number of recent changes to the taxation of payments made to non-residents of Canada under both the Income Tax Act and Canada’s tax treaty with the United States.

January 2008 saw the elimination of withholding on interest paid to arm’s length non-residents of Canada. As of January 1, 2009 another change announced in the 2008 Budget is effective: there is a parallel regime under section 116 of the Income Tax Act for certain sales of “taxable Canadian property” by non-residents of Canada. Previously, non-residents who sold TCP (which includes, for example, shares of any private Canadian company) had an obligation to report the sale to CRA and the purchasers of that property had to withhold at least 25% of the purchase price until CRA confirmed that no Canadian tax was payable on the sale. (Many Canadian tax treaties, including the one with the United States, exempts residents of those countries from paying capital gains tax in Canada in most circumstances). It was a long and often frustrating process in which CRA might need up to 6-8 months to confirm what everyone suspected from the beginning: that a treaty applied and no Canadian tax was payable.

Now, in many cases, vendors and purchasers will have a more streamlined process available to them. Where the parties agree that the vendor is a resident of a country that has a tax treaty with Canada, that the tax treaty applies to the property being sold, and that the result is that no Canadian tax is payable on the sale, the vendor no longer has to go through the process of notifying CRA of the sale, and the purchaser no longer has to withhold 25% of the purchase price. Instead, the purchaser submits a short report of the sale to CRA within thirty days of the transaction with a brief description of the sale (who sold, what was sold, how much is payable, etc.). No more wait times, no more withholding.

Another significant recent change is the coming into force of the fifth protocol to the tax treaty between Canada and the United States. The protocol was signed in September 2007, and came into force effective December 15, 2008. The protocol makes many changes to the existing treaty, and those changes will be phased in over a number of dates. Some significant changes include the elimination of withholding on cross-border interest payments (including interest payments between related parties), changes to what constitutes a permanent establishment for service providers, and clarification of the treatment of “flow-through entities” under the tax treaty.

Changes to withholding rates, including the elimination of withholding on interest, will be effective from February 1, 2009, except that withholding on interest paid between related parties will be phased out more gradually: withholding at a rate of 7% is retroactively effective for 2008 interest payments and at 4% for 2009 payments, with no withholding from and after January 1, 2010. Service providers will have to be aware that, starting January 1, 2010, there are different rules governing whether the presence of employees or other workers in the United States constitutes a permanent establishment in that country. The rules extending treaty benefits to certain flow-through entity members are effective from December 15, 2008; the rules rationalizing Canadian and US income inclusions in certain cross-border flow-through structures will be effective from January 1, 2010.