10 Tax Tips & Traps for Non-Residents with a Presence in Canada
1. Thin Capitalization Rules Issue: A Canadian company capitalized by non-residents cannot exceed a 1.5:1 interest bearing debt to equity ratio in order to obtain an interest deduction and avoid punitive Canadian tax consequences.
Planning: Attention must be given to complying with the interest bearing debt to equity ratio. Consideration should be given to converting debt into equity or making the debt non-interest bearing.
2. Back to Back Loan Rules Issue: A Canadian subsidiary is financed with an interest bearing loan from a U.S. corporation, which obtained the funds by borrowing from a non-U.S. entity in the corporate group. Even though the Canada-U.S. Tax Treaty provides for an exemption from withholding tax on interest in respect of related party debt, the Canadian corporation may still be subject to a Canadian withholding tax in certain situations. For example, if the U.S. company borrowed the funds from a related entity in another tax jurisdiction, the government authorities may treat the loan as if the funds were borrowed from the latter lender and subject the interest payment to Canadian withholding tax.
Planning: Review all intercompany loans within the corporate group. Consider having non-interest bearing loans within the corporate group or avoid a U.S. entity as an intermediary if the end borrower is a Canadian company.
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