2016-0636721I7 Consent fees and withholdings

Principal Issues: (1) Whether the consent fees paid to arm's length non-resident financial lenders are subject to withholding under Part XIII. (2) Whether fees in respect of certain financial services paid to a non-resident are subject to withholdings under section 105 of the Regulations.

Position: (1) No. (2) Yes, to the extent that the services are provided in Canada.

Reasons: (1) Amounts not interest. Also, paid to arm's length party and not participating debt interest. (2) Payments or portions thereof for services performed outside Canada are not subject to withholdings pursuant to paragraph 153(1)(g) and section 105 of the Regulations.

Author: Helmer, Shelley
Section: 212(1)(a), 212(1)(b), 214(15), 153(1)(g) and section 105 of the Regulations.

                                                                                                                                       March 30, 2017

Jaffer Majeed                                                                                                                 HEADQUARTERS
Compliance Programs Officer                                                                                        Income Tax Rulings
Speciality Audit Division                                                                                                 Directorate
Compliance Programs Branch
112 Kent, Place de Ville, TWR B,                                                                                   Shelley Helmer LL.B.
Ottawa, Ontario K1A 0L5                                                                                               613-670-9025

                                                                                                                                       2016-063672

Consent Fees and Financial Advisory Services

We are writing to you in response to your email of March 14, 2016, wherein you inquired whether payments of certain fees are subject to withholding tax pursuant to Part XIII of the Income Tax Act (the “Act”). This letter also reflects our conversations (Majeed/Helmer) and your additional inquiry regarding whether payments for certain financial advisory services would be subject to withholding pursuant to section 105 of the Income Tax Regulations (the “Regulations”).

In XXXXXXXXXX, XXXXXXXXXX (“Canco”), a Canadian resident corporation, and XXXXXXXXXX (“US GP”), a general partnership organized and subsisting under the laws of XXXXXXXXXX, paid fees to a number of arm’s-length non-resident financial institutions located in XXXXXXXXXX (the “Lenders”). These fees are called “Consent Fees” and are paid to maintain lien credit agreements between Canco, US GP and the Lenders (“Credit Agreements”) in the event of the sale of Canco to a non-resident corporation (the “Sale”). (endnote 1) We were asked if the Consent Fees should be subject to withholdings under Part XIII of the Income Tax Act (the “Act”).

On a phone call, on March 31, 2016, we were also asked to confirm whether section 105 of the Regulations applied to financial advisory services provided to Canco by XXXXXXXXXX (the “Advisor”), a financial institution resident and operating in XXXXXXXXXX.

Canco entered into a “Financial Services Agreement” wherein the non-resident Advisor will, to the extent requested and appropriate, assist Canco in:

(a)   analyzing and evaluating the business, operations and financial position of Canco;
(b)   preparing and implementing a marketing plan relating to the Sale, business combination or recapitalization of Canco;
(c)   coordinating the data room and due diligence investigations of the potential purchasers of the Canco;
(d)   evaluating proposals that are received from potential purchasers of Canco; and
(e)   structuring and negotiating the Sale, business combination or recapitalization of Canco.

At Canco’s request the Advisor will meet with Canco’s board of directors to discuss the proposed Sale.

XXXXXXXXXX of the Financial Services Agreement provides, in part, that one or more affiliates of the Advisor may perform a portion of the services and, to the extent requested by the Advisor, Canco will pay the fees directly to such affiliate.

Consent Fees

(1)   Are the Consent Fees subject to withholding under Part XIII of the Act?

The Consent Fees were amounts paid by Canco, pursuant to Consent and Amendment Agreements (the “Consent Agreement”) in order to avoid the default of Canco and US GP in respect of the Credit Agreements. Pursuant to the Consent Agreements, the Lenders would agree to the following change of the terms of the Credit Agreements:

•     to agree to a share purchase agreement in respect of Canco;
•     to agree to the sale the shares of Canco to the non-resident purchaser and one or more of its controlled subsidiaries, which would result in a change of control of Canco; and
•     to amend the definition of “Permitted Holders” in the Credit Agreement to replace the existing Permitted Holders with the purchasers and related persons and entities.

The Consent Fees were levied at XXXXXXXXXX% of the outstanding amount of each Credit Agreement. The total of the Consent Fees paid was approximately $XXXXXXXXXX. XXXXXXXXXX of the Consent Agreement stipulates that “nothing in this Consent Agreement, nor in the Credit Agreement when read together, shall constitute novation, payment, readvance, or otherwise of any existing Accommodations Outstanding by the Borrower”.

The Income Tax Act

There is no provision in the Act that specifically refers to “consent fees”.  However, there are three provisions that could be relevant:

(i)   paragraph 212(1)(a), which deals with management or administration fees;
(ii)  paragraph 212(1)(b), which deals with interest payments; or
(iii) subsection 214(15), which deals with certain payments associated with lending agreements.

(i)   Paragraph 212(1)(a) – Are the Consent Fees management or administration fees?

A management or administration fee or charge is not defined in the Act (other than in subsection 212(4) which defines what a management or administration fee or charge is not).

Paragraph 5 of Archived IT-468, “Management or administration fees paid to non-residents” provides CRA’s view of this provision: 

“For the purposes of paragraph 212(1)(a) the Department considers that the term "management or administration" generally includes the functions of planning, direction, control, co-ordination, systems or other functions at a managerial level. These functions may involve services for various departments of a business such as accounting financial, legal, electronic data processing, employee relations, management consultation, labour negotiations, taxation, etc. relating to the management or administration. It is not possible to provide an all-inclusive definition of management fees in an interpretation bulletin, and it is suggested that the above comments be read together with the comments below in order to determine whether an amount paid or credited to a non-resident in a particular set of circumstances constitutes a management fee that is subject to a non-resident tax under paragraph 212(1)(a).”

The Minister of Finance said at the time of the enactment of paragraph 212(1)(a) that it is the Government's intention that a management or administration fee or charge is to be regarded as an amount paid for advice or direction pertaining to the operation or administration of a company, not including an amount paid for services to an independent firm and, per subsection 212(4), not including specified amounts paid for identifiable services such as transportation, insurance, advertising, accounting and research. (endnote 2)

XXXXXXXXXX we concluded that the aim of the income tax legislation has been important in the development of the Department's restrictive interpretation of paragraph 212(1)(a) and that the provision has not been interpreted as broadly as the words would otherwise clearly permit. This is also evident in the exclusions from the definition under subsection 212(4). (endnote 3)

Based on the foregoing, the Consent Fees are not management or administrative fees or charges. They are not amounts paid for advice or direction pertaining to the operation or administration of the business. They are not amounts paid in respect of managerial services in connection with the direction or supervision of business activities. They are not paid for "the functions of planning, direction, control, coordination, systems or other functions at a managerial level" nor for the decision-making process as it relates to the present and future direction and operation of the business. They are not fees paid to a person who has charge of or controls a business and who "is vested with a certain amount of discretion and independent judgment”. The Consent Fees are simply paid to retain the outstanding Credit Agreements.

(ii)  Paragraph 212(1)(b) – Are the Consent Fees interest payments?

In general, paragraph 212(1)(b) provides for Part XIII tax on interest, or an amount on account of, or in lieu of interest, where it is paid or payable to a person not dealing at arm's length with the payor of the interest.

The term interest is not defined in the Act. The CRA’s Folio S3-F6-C1 “Interest deductibility”, states that an amount is considered to be interest if, in general terms:

(a)   it represents compensation for the use of money;
(b)   it is referable to a principle sum; and
(c)   it accrues day-to-day.

While the Consent Fees are calculated as XXXXXXXXXX% of the principle sum owing and are paid in order that the taxpayer will continue to have the use of the money, the description of the Consent Fees indicates that they would not accrue on a day-to-day basis. Additionally, the conditions stipulated in subparagraphs 212(1)(b)(i) and 212(1)(b)(ii) would not otherwise have been met in order for paragraph 212(1)(b) to apply. Specifically, the Consent Fees are paid to the lender that is dealing at arm’s length with the taxpayer such that any interest would be exempt because subparagraph 212(1)(b)(i) has not been satisfied.  In addition, the Consent Fees are not “participating debt interest” as defined in subsection 212(3); therefore, subparagraph 212(1)(b)(ii) would not apply.

Accordingly, it is our view that paragraph 212(1)(b) will not apply to the Consent Fees.

(iii) Subsection 214(15) – Are the Consent Fees payments described in subsection 214(15)?

We also considered subsection 214(15) of the Act which provides:

 “For the purposes of this Part,
(a)   where a non-resident person has entered into an agreement under the terms of which the non-resident person agrees to guarantee the repayment, in whole or in part, of the principal amount of a bond, debenture, bill, note, mortgage, hypothecary claim or similar obligation of a person resident in Canada, any amount paid or credited as consideration for the guarantee is deemed to be a payment of interest on that obligation; and
(b)   where a non-resident person has entered into an agreement under the terms of which the non-resident person agrees to lend money, or to make money available, to a person resident in Canada, any amount paid or credited as consideration for so agreeing to lend money or to make money available shall, if the non-resident person would be liable to tax under this Part in respect of interest payable on any obligation issued under the terms of the agreement on the date it was entered into, be deemed to be a payment of interest.”

In other words, paragraph 214(15)(b) deems certain payments related to lending arrangements to be treated as payments of interest if the non-resident lender would be liable to Part XIII tax on any interest payable on the obligation issued under the terms of the agreement.

Paragraph 214(15)(a) only applies to guarantee fees.

In any case, since Canco and the Lenders are at arm’s length, the Consent Fees would not be subject to Part XIII tax because of subparagraph 212(1)(b)(i) even if subsection 214(15) deemed them to be interest.

Financial Advisory Services

(2)   Are the fees for financial advisory services (the “Services”) provided to Canco by the Advisor subject to withholdings under section 105 of the Regulations?

The Income Tax Act

Paragraph 153(1)(g) of the Act provides, in part, as follows:

“Every person paying at any time in a taxation year
(g)   fees, commissions or other amounts for services, other than amounts described in subsection 115(2.3) or 212(5.1), shall deduct or withhold from the payment the amount determined in accordance with prescribed rules.”

The prescribed rules are found in subsection 105(1) of the Regulations, which provides:

“Every person paying to a non-resident person a fee, commission or other amount in respect of services rendered in Canada, of any nature whatever, shall deduct or withhold 15 per cent of such payment.”

It is important to note that section 105 of the Regulations only applies to payments for services rendered in Canada. Although the facts do not stipulate where the services are to be rendered, it would appear that at least some of the services, particularly meeting with the Board of Directors would be provided in Canada. As noted in paragraph 32 of Information Circular 75-6R2, “The portions allocated to the services to be performed inside and outside Canada must be clearly expressed either within the contract or through the related information and documents. It is the responsibility of the non-resident and the payer to determine the proper value of these amounts.”

Unless exempted, a copy of this letter will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency’s electronic library. After a 90-day waiting period, a severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. You may request a modification to this 90-day waiting period. The severing process removes all content that is not subject to disclosure, including information that could reveal the identity of the Taxpayer. The Taxpayer may ask for a version that has been severed using the Privacy Act criteria, which does not remove taxpayer identity. You can request this by e-mailing us at: ITRACCESSG@cra-arc.gc.ca, in which case a copy will be sent to you for delivery to the Taxpayer.

We trust that these comments will be of assistance, and thank you for your enquiry.

Yours Truly,

Terry Young, CPA, CA
Manager, International Section I
For Director
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

ENDNOTES

1  Note, this information is taken from the agreements and differs from that in the incoming email from Audit.
2  Hansard, July 22, 1963 p. 2489. XXXXXXXXXX.
3  See also Peter Cundill & Associates Ltd. v. The Queen, [1991] 1 CTC 197), aff'd [1991] 2 CTC 221 wherein the Federal Court Trial Division examined the application of paragraph 212(1)(a) in the context of a portfolio management company and the court explained, “(g)enerally speaking, a management or administration fee is an amount paid in respect of managerial services in connection with the direction or supervision of business activities...”.

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