Participating debt interest and regular interest are treated differently by the Income Tax Act here in Canada. Whether interest is considered to be participating or regular depends on whether certain factors are present in the the repayment of such debt. For example, if money was loaned to someone so that they could go out and buy a rental property, participating debt interest would allow the creditor to make the amount of the interest payments dependent on something, say the profit from the rental property or the cash flow moving through it. It may also be tied to revenue, prices, or a variety of other factors.
Regular interest is when there is a set amount payable to a creditor based on how much was loaned.
Participating Debt Interest and International Taxation
In today’s fast-paced and competitive market economy, many people look past the Canadian border to produce and generate personal and corporate income. This is especially true for both Canadian and U.S residents alike. However, taxpayers often question what tax implications are imposed on income generated outside of the country. For example, many Canadian residents choose to conduct and run their business in the U.S. As such, cross-border business or investment activities could potentially have both U.S and Canadian tax implications.
Normally, when interest payments are made to a resident of another Country, taxes are withheld. Each tax treaty Canada has with other countries must be examined to determine whether withholding is necessary. The type of interest being paid matters for withholding purposes as well.
Participating Debt Interest and the Income Tax Act
Section 212(3) of the Income Tax Act defines Participating Debt Interest as interest (other than certain amounts which are “fully exempt interest”) that is “paid or payable on an obligation, other than a prescribed obligation, all or any portion of which interest is contingent or dependent on 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 to shareholder of any class of shares of the capital stock of a corporation. Over the course of the years, the Income Tax Act has undergone many amendments and as a result, withholding from most interest payments to non-residents has been eliminated. However, it is important to note that a taxpayer may subject to withholding tax on interest payments that fall under “participating debt-interest”.
Participating Debt Interest and Withholding Taxes
As of today, if you are earning participating debt interest from another country, that other country will very likely have to withhold taxes before sending you any funds. Under the current rules in Canada, certain payments including standby and guarantee fees are treated for purposes of the Canadian non-resident withholding tax provisions as interest on the related debt that would be, or is, issued. Further, pursuant to the new rules, these payments will also be exempt from Canadian non-resident withholding tax, provided that the recipient deals at arm’s length with the borrower and, where applicable, the amounts are not participating debt interest.
If you are a Canadian tax resident, and you are earning participating debt interest or are thinking about lending funds overseas, call us today!We can assist with putting together a plan to minimize taxation and/or withholding, and we ensure that you fully understand your tax withholding obligations.
**Disclaimer
This article provides information of a general nature only. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in this article. If you have specific legal questions you should consult a lawyer.
Daniel Ibrahim is a summer student at Rosen & Associates Tax Law.
Daniel completed his second year at the University of Windsor, Faculty of Law. He received his Bachelor of Arts in Sociology (Cum Laude) from York University and graduated at the top 20% of his class.
James Pendergast
James Pendergast is an Associate Lawyer at Rosen & Associates Tax Law. James is entering his third and final year at the University of Toronto Faculty of Law. Outside of academics, James is a chair of the Faculty of Law’s Health and Wellness Committee, volunteers with the Law in Action Within Schools (LAWS) program and was an Associate Editor with the University of Toronto Law Review. This year, James competed for the University of Toronto at the 2019 Donald G. H. Bowman National Tax Moot.
Participating Debt Interest
Participating debt interest and regular interest are treated differently by the Income Tax Act here in Canada. Whether interest is considered to be participating or regular depends on whether certain factors are present in the the repayment of such debt. For example, if money was loaned to someone so that they could go out and buy a rental property, participating debt interest would allow the creditor to make the amount of the interest payments dependent on something, say the profit from the rental property or the cash flow moving through it. It may also be tied to revenue, prices, or a variety of other factors.
Regular interest is when there is a set amount payable to a creditor based on how much was loaned.
Participating Debt Interest and International Taxation
In today’s fast-paced and competitive market economy, many people look past the Canadian border to produce and generate personal and corporate income. This is especially true for both Canadian and U.S residents alike. However, taxpayers often question what tax implications are imposed on income generated outside of the country. For example, many Canadian residents choose to conduct and run their business in the U.S. As such, cross-border business or investment activities could potentially have both U.S and Canadian tax implications.
Normally, when interest payments are made to a resident of another Country, taxes are withheld. Each tax treaty Canada has with other countries must be examined to determine whether withholding is necessary. The type of interest being paid matters for withholding purposes as well.
Participating Debt Interest and the Income Tax Act
Section 212(3) of the Income Tax Act defines Participating Debt Interest as interest (other than certain amounts which are “fully exempt interest”) that is “paid or payable on an obligation, other than a prescribed obligation, all or any portion of which interest is contingent or dependent on 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 to shareholder of any class of shares of the capital stock of a corporation. Over the course of the years, the Income Tax Act has undergone many amendments and as a result, withholding from most interest payments to non-residents has been eliminated. However, it is important to note that a taxpayer may subject to withholding tax on interest payments that fall under “participating debt-interest”.
Participating Debt Interest and Withholding Taxes
As of today, if you are earning participating debt interest from another country, that other country will very likely have to withhold taxes before sending you any funds. Under the current rules in Canada, certain payments including standby and guarantee fees are treated for purposes of the Canadian non-resident withholding tax provisions as interest on the related debt that would be, or is, issued. Further, pursuant to the new rules, these payments will also be exempt from Canadian non-resident withholding tax, provided that the recipient deals at arm’s length with the borrower and, where applicable, the amounts are not participating debt interest.
If you are a Canadian tax resident, and you are earning participating debt interest or are thinking about lending funds overseas, call us today! We can assist with putting together a plan to minimize taxation and/or withholding, and we ensure that you fully understand your tax withholding obligations.
**Disclaimer
This article provides information of a general nature only. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in this article. If you have specific legal questions you should consult a lawyer.
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