10 October 2000 Internal T.I. 2000-0047527 - SUBVENTION PAYMENTS

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues: Are subvention payments subject to Part XIII withholding tax?

Position: No

Reasons: Not considered to be a payment of, or in lieu of, interest as there was no borrowing by the payor.

		October 10, 2000

	KITCHENER-WATERLOO TSO		HEADQUARTERS
	International Tax Audit		Corporate Financing Section
				Financial Industries Division
	Attention: Lynda Barnaby		N.L. Storry
(613) 957-3499

				2000-004752

Application for Refund of Non-Resident Tax Withheld

This is in reply to your memorandum of September 12, 2000, wherein you requested our views regarding the definition of "interest" and whether payments made by a Canadian company to a non-related U.S. Company are included in this definition, and therefore, subject to Part XIII withholding tax.

Facts

Our understanding of the facts is as follows:

1. XXXXXXXXXX ("ACO") is incorporated and resident in Canada. ACO manufactures XXXXXXXXXX for sale to distributors throughout XXXXXXXXXX. A number of ACO's distributors are located in the United States. These distributors are resident in the United States and deal at arm's length with ACO.

2. XXXXXXXXXX ("BCO") is resident in the United States. Its XXXXXXXXXX does not carry on business in Canada and does not have a permanent establishment in Canada. BCO is in the business of providing inventory financing to customers of manufacturers who do not consider financing to be part of their business or lack the financial capacity to act as financier.

3. ACO and BCO entered into a contract to provide wholesale financing to some of ACO's U.S. distributors to finance the acquisition of distributor's inventory. As per the Program Agreement dated XXXXXXXXXX, BCO and ACO had the following rights and obligations:

a) ACO agreed to refer U.S. distributors to BCO for financing of inventory purchased from ACO;

b) BCO agreed to offer interest free financing for a limited period to the U.S. distributors (generally XXXXXXXXXX);

c) To induce BCO to offer reduced rates, ACO agreed to pay BCO a financing subsidy equal to the interest BCO would have otherwise charged the U.S. distributor during the interest free period;

d) BCO would invoice ACO monthly for financing subsidy and ACO agreed to pay BCO within XXXXXXXXXX of written demand;

e) BCO performs credit review, gathers supporting documentation and approves/disapproves U.S. distributors for financing;

f) BCO acquires title and risk of loss upon customer's execution of a certificate of acceptance; and

g) Interest Subsidy per XXXXXXXXXX, Amendment for the interest free period is a floating rate equal to the prime rate plus XXXXXXXXXX%.

4. U.S. distributors would apply to BCO for financing and upon approval BCO would finance the acquisition of the XXXXXXXXXX by U.S. distributors pursuant to leases, conditional sales contracts, security agreements, chattel mortgages and notes and other financing products.

Your Views

In your view, the financing subsidy paid by ACO to BCO results from a debt claim, and therefore, is included in the definition of "interest" pursuant to Article XI, paragraph 4 of the Canada-U.S. Tax Convention. In addition, you are of the opinion that the following characteristics of interest as set out in the Interest Act have been met:

a) the amount must be compensation for the use of a sum (principal) of money;

b) the amount must be referable to the sum (principal);

c) the amount must be calculated by reference to the time the sum (principal) is outstanding.

Accordingly, you consider the original position to withhold tax on the subsidy payment to be correct.

Our Comments

You have stated that the financing subsidy is included in the definition of "interest" pursuant to Article XI, paragraph 4 of the Canada-U.S. Tax Convention. However, only once a particular non-resident's tax liability has been established under the Act can we look to the terms of a particular tax treaty, if one exists, to determine what, if any, relief from such taxation may be available. In this regard, tax treaties are not taxing statutes and can neither be used to subject any taxpayer to taxation that is not otherwise provided for under the Act nor deny a taxpayer of any rights or benefits which the taxpayer may otherwise enjoy under the Act. As such, we must first establish a tax liability pursuant to paragraph 212(1)(b) of the Income Tax Act or some other provision of the Act before looking to the Canada-U.S. Tax Convention.

As we understand, the financing subsidy payments were made by ACO to BCO in order to induce BCO to extend credit on favorable terms to the U.S. distributors of ACO and are calculated by reference to interest foregone by BCO. However, there is no borrowing by ACO from BCO at any time. As stated in Interpretation Bulletin IT-396R, paragraph 12, "interest, while not defined in the Act, has been described in general terms in the courts as 'the return or consideration or compensation for the use or retention by one person of a sum of money, belonging to, in a colloquial sense, or owed to, another'. From this description, it follows that interest does not arise unless there is an amount due to, or belonging to, another person for the period for which the interest is calculated."

In addition, interest may be considered to arise where there is a debtor-creditor relationship. Interest could arise on the debt obligation, that is, the subvention payment. However, as we understand, BCO would invoice ACO monthly for financing subsidy and ACO agreed to pay BCO within XXXXXXXXXX of written demand. Although the subvention payment would not be considered interest, there is the possibility that interest would have accrued on any unpaid sum.

In General Motors Acceptance Corporation of Canada v. The Queen, [1997] T.C.C. 2864, Rip, J. stated:

General Motors Acceptance Corporation provides the mechanics to permit a retail customer without the necessary funds with the wherewithal to purchase a motor vehicle. GMAC, it is true, becomes the purchaser's creditor on assignment of the conditional sale contract, but no lender-borrower relationship is created between them... The Court of Appeal did not make any finding that GMAC is in a lender-borrower relationship with consumers... The Court of Appeal held that GMAC was operating a comprehensive wholesale and retail financing system...The Court of Appeal found that the legal form and nature of the contracts for financing inventory and consumer sale contracts are identical to a conditional sale or installment sale... For an amount to constitute interest, the amount must be paid by the borrower of the money to a person who loaned money to the borrower... In financing contracts with retail customers of General Motors of Canada Limited, GMAC has lost no interest because it did not lend money to the customer.

In general terms, it is our view that, notwithstanding that a fee may be calculated by reference to a notional amount of interest, the resultant amount does not assume the character of interest. In our view, in order to be considered interest, the financing subsidy payment must represent compensation for the use of borrowed money by ACO or compensation for a sum of money owed by ACO to BCO, be referable to a principal sum, and must accrue on a daily basis. Since BCO did not loan money to ACO thereby establishing a lender-borrower relationship, it cannot be said that the interest subsidy payments represented compensation for the use of borrowed money by ACO. Likewise, the interest subsidy payments are not paid by ACO to BCO as compensation for a sum of money owed by ACO to BCO. Therefore, the financing subsidy paid to BCO is not considered to be a payment of, or in lieu of, interest within the meaning of paragraph 212(1)(b) of the Income Tax Act.

We trust these comments will be of assistance.

for Director
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch