REVENUE CANADA TAXATION BULLETIN D'INTERPRETATION NUMBER: IT-360R2 DATE: December 8, 1989 SUBJECT: INCOME TAX ACT Interest Payable in a Foreign Currency REFERENCE: Subparagraph 212(1)(b)(iii) (also section 21, subsections 18(2), 212(1) and (8), 214(7) and (14) and draft section 7900 of the Income Tax Regulations) Application This bulletin cancels and replaces IT-360R issued August 6, 1979. Current revisions are indicated by vertical lines. Summary Part XIII of the Act imposes a withholding tax on certain amounts, including interest, that a person resident in Canada pays or credits or is deemed by Part I of the Act to pay or credit to persons not resident in Canada. This bulletin deals with exemptions from Part XIII tax in respect of interest payable in a foreign currency. Two Information Circulars provide additional information on Part XIII tax: the current version of I.C. 77-16 gives a general description together with administrative comments and the current version of I.C. 76-12 gives applicable tax rates. Discussion and Interpretation 1. The provision in subsection 212(1) requiring a non-resident to pay tax is not dependent on the income being earned in Canada. If an amount is paid or credited to a non-resident person by a resident of Canada on account of interest, other than the enumerated exceptions in paragraph 212(1)(b), it is subject to tax. 2. Subparagraph 212(1)(b)(iii), one of the exceptions referred to in 1 above, exempts from tax interest payable in a currency other than Canadian currency, if it is payable pursuant to an arm's length transaction on an obligation enumerated in clauses 212(1)(b)(iii)(A) to (F). This exemption does not apply to: (a) interest on an obligation entered into after November 12, 1981 (otherwise than pursuant to a commitment in writing made on or before that date) and before February 26, 1986 (or after February 25, 1986 if pursuant to an agreement in writing made on or before that date) if all or any portion of the interest is contingent or dependent upon the use of or production from property in Canada, or (b) interest payable on an obligation, other than a prescribed obligation, issued or extended after February 25, 1986 (otherwise than pursuant to an agreement in writing made on or before that date) if all or any portion of the interest is contingent or dependent upon the use of or production from property in Canada or is computed by reference to revenue, profit, cash flow, commodity price or any other similar criterion or by reference to dividends paid or payable. Also, where the terms and conditions relating to the computation of interest payable on an obligation are changed pursuant to an agreement made after February 25, 1986, the obligation shall be deemed to have been issued after February 25, 1986 and not pursuant to a written agreement made on or before that date. As yet no obligation has been prescribed for purposes of paragraph 212(1)(b). 3. Interest payable in Canadian currency is deemed under subparagraph 212(1)(b)(iii) to include interest expressed to be computed by reference to Canadian currency. If interest is expressed to be computed by reference to Canadian currency and the non-resident has the option of taking a payment which is computed by converting the interest calculated in Canadian currency into a foreign currency based on a fixed rate or current rate of exchange, the interest is considered to be computed by reference to Canadian currency regardless of what option is chosen. On the other hand, if interest is expressed as being payable in Canadian currency or in a foreign currency, at the option of the creditor, the interest is considered payable in that foreign currency if the non-resident chooses that option. The foregoing comments relate to payments of interest actually made in money, and also to the value of payments made in kind (for example, in corporate shares or in goods) which are in lieu of or in satisfaction of interest payable in money. In the event that the contract providing for the payment of interest stipulates that in certain circumstances the non-resident creditor is entitled to payment only in kind, then where those circumstances exist and such payment in kind is made, it cannot be regarded as a payment in a non- Canadian currency and, therefore, it cannot be exempt from tax by reason of subparagraph 212(1)(b)(iii). 4. Where a payment may be regarded as a combined payment of income and capital, the income portion may constitute interest payable in a foreign currency. Where a non-resident person has guaranteed the repayment of any amount or amounts owing by a resident of Canada, the amounts paid or credited to the non-resident person as consideration for the guarantee shall be considered to be the payment of interest. Amounts paid to a non-resident person under an agreement as consideration for the non-resident person's agreement to lend money shall also be considered as interest if that person would have been liable to Part XIII tax on interest payable under the agreement. All the above amounts, and any similar transactions which result in interest being deemed to be paid or received, will be considered interest for the purpose of paragraph 212(1)(b). 5. Clause 212(1)(b)(iii)(D) was amended with respect to interest paid or credited after December 19, 1986 to exempt interest payable on an amount deposited at arm's length with a prescribed financial institution if the interest and the amount on deposit are payable or repayable, as the case may be, only in a foreign currency. Prior to its amendment, the provision only referred to such interest paid or credited by a bank to which the Bank Act applied. The previous provision continues to apply with respect to deposits made before 1988. A prescribed financial institution is defined in draft Regulation 7900 and means (a) a corporation that is a member of the Canadian Payments Association, or (b) a credit union that is a shareholder or member of a body corporate or organization that is a central for purposes of the Canadian Payments Association Act. Amounts deposited with financial institutions will generally be unsecured debts which would be reported to the applicable government authority (federal or provincial) as a deposit and which rank on a par with, rather than being subordinate to, all other unsecured deposits. These debts would include deposits (as that word is generally understood by persons doing business with banks, trust companies, credit unions, etc.), bearer deposit notes, certificates of deposit, guaranteed investment certificates, savings certificates and term deposit accounts. Such debts will not be considered to include debentures or banker's acceptances. 6. A Canadian dollar swap deposit consists of three steps: (a) the conversion of Canadian dollars into a foreign currency, (b) the placing of the foreign currency in a term deposit with a financial institution, (c) the purchase of a "forward exchange" contract at the time of entering into the term deposit where it is agreed by the depositor to convert principal and interest on the deposit back to Canadian dollars at maturity. It is the Department's view that the interest paid on such a swap deposit will qualify for the exemption under clause 212(1)(b)(iii)(D) provided the term deposit is a separate contract from the forward exchange contract. If, however, there is evidence to show that the non-resident's forward exchange contract with the bank forms part of the term deposit contract, or, that the forward exchange contract and the term deposit are one contract, clause 212(1)(b)(iii)(D) would not apply and interest payments thereon would be subject to non-resident tax. 7. Clause 212(1)(b)(iii)(E) exempts interest payable in a foreign currency to a person with whom the payer is dealing at arm's length from the taxing provisions of paragraph 212(1)(b) if (a) the obligation upon which the interest is paid is entered into in the course of carrying on a business in a country other than Canada, and (b) the interest payable on the obligation is deductible in computing the income of the payer under Part I of the Act from a business carried on by him in any such country, or that, but for subsection 18(2) or section 21, would have been so deductible. Whether any taxpayer, including a corporation, is carrying on a business and whether any such business is being carried on in Canada or in another country are questions of fact that must be determined in each case. 8. Where a non-resident person has presented a banker's acceptance for redemption to a person resident in Canada, the amount (discount) by which the price for which the obligation is redeemed exceeds the price for which the obligation was issued is deemed by reason of subsections 214(7) and 214(14) to be interest subject to tax under paragraph 212(1)(b). In some cases, clause 212(1)(b)(iii)(E) may apply to exempt the discount from tax, but only if the deemed interest and the obligation meet the requirements in 7 above. In this regard the mere issuing of a banker's acceptance by a Canadian drawer in a country other than Canada or the fact that a drawer has an agent or office in another country that carries out only purchasing activities for the drawer is not considered sufficient to constitute carrying on business in that other country. 9. For the purpose of clause 212(1)(b)(iii)(A) an obligation entered into on or before December 20, 1960, includes renewals of such obligations which were contemplated at the time. For example, a mortgage entered into in 1959 which becomes due in five-year intervals continues to be such an obligation if renewed at the end of each five year period. It ceases to be such an obligation if a further sum of money is advanced at the time of one of the renewals by the mortgagee. Subsection 212(8) provides that if a bond is issued after December 20, 1960, in exchange for another bond issued prior to that date, the new bond (issued after December 20, 1960) shall be deemed to have been issued prior to December 20, 1960, if the holders of the original bond had the right to make the exchange. 10. This bulletin is limited to the discussion of certain amounts of interest payable to non-residents in foreign currencies that are exempt from tax pursuant to subparagraph 212(1)(b)(iii). It should be noted that exemptions listed in subparagraphs 212(1)(b)(i) to (ix) could overlap in some circumstances and a transaction that does not fall within the exemptions discussed could fall within another of the listed exemptions.