Introduction
The Canada Revenue Agency (CRA) recently released the final version of the following forms (the Forms), which are intended to assist Canadian resident payors who make certain payments to non-residents of Canada in determining the non-resident payee's eligibility for a reduced rate of withholding tax under a tax treaty between Canada and the non-resident's country of residence:
- NR301 Declaration of Eligibility for Benefits Under a Tax Treaty for a Non-Resident Taxpayer
- NR302 Declaration of Eligibility for Benefits Under a Tax Treaty for a Partnership with Non-Resident Partners
- NR303 Declaration of Eligibility for Benefits Under a Tax Treaty for a Hybrid Entity
The Forms can also be used by a non-resident in requesting a Certificate of Compliance under section 116 of the Income Tax Act (Canada) (the Tax Act) in respect of a disposition by the non-resident of "taxable Canadian property" that is "treaty-protected property." In certain circumstances, the Forms may also be used to support a request for a treaty-based waiver of withholding on payments of fees, commissions or other amounts paid for services performed in Canada.
Use of the Forms is not mandatory and will not protect the Canadian payor from liability should the amount of tax withheld by the Canadian resident payor be insufficient. Nonetheless, the Forms will likely be a factor considered by the minister of national revenue in exercising his discretion to waive or reduce interest and penalties in respect of under-withheld tax. Non-resident payees who do not provide a completed Form or otherwise demonstrate entitlement to treaty benefits may be subject to the full 25% withholding rate on taxable payments made to them.
Background
Pursuant to Part XIII of the Tax Act, every non-resident person is required to pay an income tax of 25% on certain payments that a person resident in Canada pays or credits, or is deemed to pay or credit, to the non-resident person, including payments of interest, dividends, management fees, rents, royalties and estate or trust income. The Canadian resident payor is responsible for withholding and remitting the correct amount of tax on behalf of the non-resident payee, and failure to do so may result in the payor being liable for any deficiency along with interest on such amounts and possibly a penalty ranging from 10% to 20% of the amount that ought to have been withheld.
Non-resident payees may be entitled to a reduced rate of withholding tax or, in some cases, no withholding tax, under one of Canada's bilateral tax treaties. Generally speaking, a non-resident payee will be eligible for a reduced "treaty rate" of withholding if the non-resident payee is (or is deemed to be) resident in a treaty country. Recent amendments to the Canada-US Treaty have imposed additional eligibility requirements that must be met before US resident payees are entitled to the treaty rate of withholding. Most notably, the Canada-US Treaty contains Canada's first (and to date its only) "limitation of benefits" (LOB) provision, which serves to deny treaty benefits to US resident payees who fail to satisfy certain US ownership or US activity requirements. Further, the Canada-US Treaty now contains rules regarding hybrid entities that are not yet found in Canada's other tax treaties, including rules that, in certain circumstances, serve to "look through" the hybrid entity to the first non-fiscally transparent level of ownership.
As the obligation to withhold the correct amount of tax rests with the payor, the payor must be satisfied that the non-resident payee meets all of the requirements under the relevant treaty to qualify for the reduced treaty rate. The CRA's historic position was that payors were generally entitled to rely on the payee's name and address in determining whether to apply treaty benefits. The CRA did not expect the payor to obtain written certification of treaty entitlement from the payee unless the payee was acting as nominee or agent of the beneficial owner of the payment, or there existed reasonable cause to suspect that the payee's name and address could not be relied upon. This policy is generally effective in respect of treaties whose only requirement for treaty benefits is residence, but does not assist the payor in determining other eligibility requirements such as the LOB provisions. The Forms represent an attempt to develop a more comprehensive and consistent method for non-resident payees to certify their entitlement to treaty benefits.
The Forms
Individuals, corporations and trusts
Form NR301 is to be completed by non-resident payees that are individuals, corporations or trusts. Generally speaking, the information to be provided by the non-resident in Form NR301 includes the non-resident's legal name, type of entity, mailing address, foreign tax identification number, Canadian tax number (if any), country of residence for treaty purposes and the type of income for which the declaration is being made. NR301 also includes a certification that (i) the information provided by the non-resident is correct and complete; (ii) the non-resident is the beneficial owner of the payment; and (iii) the non-resident is, to the best of the non-resident's knowledge and based on the factual circumstances, entitled to benefits under the relevant treaty with respect to the applicable type of income. In addition, the non-resident undertakes to immediately notify the payor (or partnership or hybrid entity through which the non-resident derives the income) of any changes to the information provided in the Form.
Partnerships
Non-resident payees that are partnerships should complete Form NR302, which generally requires similar information and declarations as Form NR301. A partnership taxed as a corporation in its country of residence can choose to complete either NR301 to claim benefits that the corporation itself is entitled to or Form NR302 to claim benefits that the partners are entitled to, whichever is more beneficial. Under the Tax Act, a partnership with one or more non-resident partners is deemed to be a non-resident of Canada for purposes of Part XIII. Until recently, the CRA's position was that withholding was required on payments to non-Canadian partnerships in respect of each partner, including Canadian resident partners. Form NR302 indicates that the CRA has changed its position as the NR302 worksheet contains an example indicating that withholding is no longer required in respect of the portion of the payment that is allocable to Canadian resident partners. In addition, the instructions state that for payments to partnerships with both resident and non-resident partners, payors are to apply the treaty exemption percentage (as calculated using the worksheets discussed below) to the full payment, as the calculation has already taken the allocation to Canadian resident partners into consideration.
Hybrid entities
Form NR303 is to be completed by hybrid entities considered "fiscally transparent" by the tax laws of a country that Canada has a tax treaty with (i.e., a foreign entity whose income is taxed at the beneficiary, member, or participant level such as US limited liability corporations, US "S" corporations that have "checked the box" to be taxed as partnerships and certain trusts) provided such treaty contemplates extending treaty benefits to income derived through the entity to the residents of that country who have an interest in the entity. A hybrid entity taxed as a corporation in its country of residence should complete Form NR301. The information to be provided and the non-resident's certification under Form NR303 are similar to the information and certification required under Forms NR301 and NR302 discussed above.
Worksheets
Forms NR302 and NR303 also contain worksheets to be used by the non-resident payee in computing the blended tax rate applicable to the partnership or hybrid entity as a whole. In computing this amount, the non-resident partnership or hybrid entity, as the case may be, is asked to provide (i) the name and type of entity in respect of each member of the partnership or hybrid entity; (ii) the tax rate applicable to each member of the partnership or hybrid entity; and (iii) the percentage of the particular type of income to be allocated to each such member. The worksheets are to be completed based on Forms collected from the members of the partnership or hybrid entity up the chain of ownership. As a result, the worksheets serve to effectively "look through" the partnership or hybrid entity to the ultimate beneficial owners entitled to treaty benefits.
The Forms expressly provide that, for withholding tax purposes, the Forms expire at the earlier of (i) a change in the effective rate of withholding; and (ii) three years from the end of the calendar year in which the Form is signed and dated. There will be a transition period until December 31, 2011, to allow payors to gather any additional information needed.
The Forms are not prescribed forms for purposes of the Tax Act and equivalent information can be accepted.
Exceptions to the Forms
In pending updates to Information Circular 76-12R, the CRA has outlined a number of circumstances where the Forms are not required or cannot be used:
- The payor may choose to apply reduced withholding tax without obtaining the Forms or equivalent information if the payee is an individual, or the payee is an estate and the trustee has a US address, provided certain other criteria are met and the payor has procedures in place so that changes in the payee's information (for example, a change of address or contact information that includes a change in country, or returned mail) will result in a review of the withholding tax rate.
- In certain circumstances, the CRA will issue a letter of exemption or reduced withholding rate which is to be relied upon by the payor instead of information from the payee. Circumstances in which such a letter should be sought include certain amounts paid to foreign governments, payments made to an entity or organization described in Article XXI of the Canada-US Treaty (i.e., certain religious, scientific, literary, educational and charitable organizations and certain tax-exempt pension plans) and certain treaty-exempt pension and annuity payments. It is generally the non-resident payee's responsibility to obtain a letter of exemption from the CRA and, absent such a letter, Canadian resident payors making payments in the circumstances described above should withhold at the full 25% rate.
- Payments made to an address in Switzerland can be made at the reduced rate prescribed by the Canada-Switzerland Treaty. Additional tax may be payable if the beneficial owner of such payment is resident in a country other than Switzerland, but these amounts are to be withheld and remitted by the Swiss nominee or agent and not by the Canadian payor.
- Payments made to CDS Clearing and Depository Services Inc. (CDS) on securities registered in the name of Cede & Co. are made without withholding tax. Tax will be withheld by CDS based on information received from the Depository Trust Company (DTC) and collected by DTC's participants.
- Agents and nominees are still required to provide written certification that they are receiving income on behalf of beneficial owners that are resident in a treaty country and eligible to claim benefits under that treaty. The Forms may be used by the non-resident agent or nominee in making this certification.
Practical implications
The Forms instruct Canadian resident payors to withhold at the full 25% rate where (i) the payee has not provided the appropriate Form (including applicable worksheets) or equivalent information; (ii) the Form (or equivalent information) is incomplete; or (iii) the payor has reason to believe that the information provided is incorrect or misleading. The CRA has also stated that the payor should question the information given and look at other information received from the non-resident, or known about the non-resident, if the payor knows or has reasonable cause to believe that the information on the Form is not correct or is misleading, contradicts information in the payor's files, or is given without knowledge or consideration of the facts of a situation. This may require Canadian payors to implement new review practices with respect to their non-resident payees.
Payor's liability
However, the CRA is clear that if the payor fails to withhold the appropriate amount of tax, an assessment (including interest) can be issued to the payor, the non-resident recipient, or both. If the payor is assessed, a penalty will also apply. The CRA has confirmed this position even when the payor has received a completed Form and has no reason to question the validity of the information supplied. Payors are entitled to apply for relief from such interest and penalties, and it is presumed that reasonable care taken by the payor in determining the correct amount of withholding tax will be a relevant consideration in considering such a request. The Forms may also prove beneficial in an audit, as it is expected that the CRA will request to see up-to-date Forms or equivalent information obtained by Canadian resident payors prior to making payments to non-resident payees.
Based on the foregoing, payors that rely on the Forms in applying a reduced rate of withholding will continue to bear the risk if the CRA subsequently determines that insufficient tax was withheld. Although the Forms will not protect a payor from being assessed for tax, interest and penalties, they may serve as a helpful tool in ensuring the payor's information regarding the payee is correct. Further, the absence of a completed Form or equivalent information may result in a request for relief from interest and penalties being denied. Nonetheless, until the CRA changes its position on a payor's ability to rely on the Forms or until the Forms become mandatory, the extent of their use remains to be seen.
It should also be noted that Part XIII tax is no longer applicable to interest paid to an arm's length party or interest paid in respect of an obligation to pay an amount to an arm's length party, provided the interest is not "participating debt interest." In general terms, participating debt interest is interest computed with reference to the success of the payor's business or investments. Accordingly, if a payment of interest is not subject to Part XIII tax, the relevant Form is not required in respect of that payment.
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