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Some payments should not be subject to a withholding tax

A comfort letter is needed to clarify tax situation in that wake of Pangaea ruling.

Wouden puzzle illustrating withholding money

The Finance Department should amend the Income Tax Act clarifying the situation for Canadian issuers of debt securities (and issue a comfort letter of that intent in the interim) following the Federal Court of Appeal’s decision in Pangaea One Acquisition Holdings XII S.À.R.L. this past January, says the Joint Committee on Taxation of the Canadian Bar Association and Chartered Professional Accountants of Canada.

Pangaea was one of several shareholders of Public Mobile, which Telus was offering to buy. Another shareholder, Thomvest, paid Pangaea $3 million for it not to exercise its veto on the share purchase agreement. Thomvest withheld $750,000 in taxes on its payment and remitted it to the Receiver General. Pangaea argued that the money was not taxable and should be refunded. The Minister denied the refund.

“The issue in the case was whether the $3 million payment was taxable under Part XIII as an amount paid in respect of a ‘restrictive covenant’ as defined in subsection 56.4(1),” the Committee writes in a letter to the Tax Policy Branch of Finance Canada.

The text of the legislation is “extremely broad,” the Committee writes, and the court’s ruling would suggest no attempts to find a narrower legislative purpose within it.

“The court’s reasoning, coupled with the extremely broad language used in section 56.4, may cause Canadian issuers of debt obligations to withhold Part XIII tax on certain common types of payments to arm’s-length non-resident creditors,” the Committee says. “In our view, in some instances such withholding would tend to frustrate the tax policy objectives of Part XIII, including in particular the policy considerations underlying the Budget 2007 amendments to eliminate withholding tax on arm’s-length interest. Furthermore, the decision gives rise to added, and, we believe, inappropriate uncertainty as to the scope of paragraph 212(1)(i). We believe the situation should be clarified.”

To that end, the Committee recommends that the Act be amended to treat payments like those in Pangaea as deemed payments of interest (other than participating interest) under the related debt for Part XIII purposes.

This could be done, the Committee suggests, by modifying subsection 214(15) to delete the condition that the actual interest on the debt be taxable under Part XIII – effectively treating fees for making money available as interest for Part XIII purposes – and by adding a new paragraph to deem such fees to be interest for those purposes.

The Committee also suggests amending paragraph 212(1)(i) to specifically carve out amounts that are, or are deemed to be, interest for Part XIII purposes.

“In order to provide certainty to Canadian debt markets, we would recommend that a comfort letter be issued stating (with the usual caveats) that Finance intends to recommend such amendments to the Minister,” the Committee concludes.