2013-0499621E5 Paragraph 212(1)(d) and Credited

Principal Issues: Whether a royalty payable by a resident of Canada to a non-resident of Canada that was, in lieu of actual payment, applied to reduce the amount of a promissory note owing to the resident of Canada by the same non-resident of Canada is subject to the application of paragraph 212(1)(d)?

Position: Yes, the amount of the royalty payable to the non-resident that is applied against the promissory note in lieu of actual payment would be considered credited to the non-resident by the resident of Canada and, therefore, subject to a 25% withholding tax under paragraph 212(1)(d).

Reasons: The CRA's long standing position regarding the meaning of "credited" for purposes of Part XIII of the Act, as set out in paragraph 5 of Information Circular 77-16R4, includes circumstances where an amount due was applied by a resident of Canada against an amount owing by the non-resident to the resident of Canada. This is also consistent with the decision of the Tax Court of Canada in Richard Lewin Re: The J.J. Herbert Family Trust #1 v. The Queen which was subsequently upheld by the Federal Court of Appeal.

Author: Chang, Jack Yu-Fan
Section: 212(1)(d), 214(1), Article XII of the Canada-US Tax Treaty

XXXXXXXXXX

                                                      2013-049962
                                                      Jack Chang

July 14, 2015

Dear XXXXXXXXXX,

Re: Paragraph 212(1)(d) and Credited

We are writing in response to your email of July 30, 2013 in which you requested our views on the application of paragraph 212(1)(d) of the Income Tax Act (the “Act”). In your email, you described a hypothetical situation where a royalty charged by a resident of the United States and non-resident of Canada for purposes of the Act (the “Licensor”) to a corporation resident in Canada (the “Taxpayer”) was, in lieu of payment by the Taxpayer to the Licensor, used to reduce the amount of a promissory note (the “Note”) owing by the Licensor to the Taxpayer. In particular, you queried whether paragraph 212(1)(d) applied to the full amount of the royalty that was, in lieu of payment by the Taxpayer to the Licensor, used to reduce the amount of the Note.

For the purposes of our comments, we have assumed that the aforementioned royalty would be considered a royalty pursuant to subparagraph 212(1)(d)(i).

Our Comments

This technical interpretation provides general comments about the provisions Act and related legislation (where referenced). It does not confirm the income tax treatment of a particular situation, but is intended to assist you in making that determination. The income tax treatment of transactions will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R5, Advance Income Tax Rulings.

Generally, paragraph 212(1)(d) provides for an income tax of 25% on all amounts paid or credited to a non-resident person as, on account or in lieu of payment of, or in satisfaction of, rent, royalty or a similar payment. To the extent an amount has not been paid, the CRA's long standing position regarding the meaning of "credited" for purposes of Part XIII of the Act is set out in paragraph 5 of Information Circular 77-16R4 and was affirmed by the Tax Court of Canada’s decision of Richard Lewin Re: The J.J. Herbert Family Trust #1 v. The Queen which was subsequently upheld by the Federal Court of Appeal. Generally, the words "credits" and "credited" cover any situation where a resident of Canada or, in certain cases a non-resident, has set aside and made unconditionally available to the non-resident creditor an amount due to the non-resident. In particular, as described in subparagraph 5(d) of Information Circular 77-16R4, a resident of Canada would be considered to have credited an amount to a non-resident where the amount due was applied by the resident of Canada against an amount owing by the non-resident to the resident of Canada. Moreover, paragraph 5 of IC 77-16R4 concludes with the comment that:

“When an amount is subject to tax under section 212, subsection 214(1) provides that the tax is payable on the full amount paid or credited without any deduction from the amount.”

As a result, in circumstances where, in lieu of an actual payment of a royalty by the Taxpayer to the Licensor, the amount of the royalty payable is applied to reduce the Note owing by the Licensor to the Taxpayer, in our view, the entire amount of the royalty payable that is applied to reduce the Note would be credited to the non-resident and, therefore, subject to a 25% withholding tax under paragraph 212(1)(d). However, to the extent that the Licensor would be entitled to the benefits of Article XII of the Canada-US Treaty, the rate of withholding tax may be reduced.

We hope these comments have been of assistance.

Yours truly,

Lori M. Carruthers CPA, CA
Section Manager
for Director
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

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