International Trade Committee on Dec. 6th, 2007

[The Vice-Chair, Liberal, John Maloney]

I'd like to bring to order meeting seven of the Standing Committee on International Trade. Our first item of business is Bill S-2, an act to amend the Canada-United States Tax Convention Act, 1984.

We have as witnesses today, from the Department of Finance, Mr. Brian Ernewein and Lawrence Purdy. Thank you for coming.

You may recall that there was some concern expressed by Mr. Julian about the clause-by-clause consideration. We have some material that has been presented in both official languages.

Mr. Julian, are you content with what has been provided?

[Peter Julian, NDP, Burnaby—New Westminster, BC]

Thank you, Mr. Chair.

I am concerned. The clause-by-clause analysis is one page. It's limited to the enacting legislation that accompanies the actual treaty itself, which is basically annex A and annex B to schedule 1. I'm concerned about how this has been brought forward to the committee.

There's some concern about whether this was the appropriate committee to deal with financial legislation, or whether the finance committee should have dealt with this. That's certainly one question. But the information should have been much more fulsome and more quickly forthcoming. This isn't an adequate clause-by-clause analysis of the treaty implications, and it doesn't in any way describe the fiscal implications for at least two of the components within this protocol.

So I have some concerns and I have some questions, but I'm sure other members do too.

[The Vice-Chair, Liberal, John Maloney]

Is there anyone else who has any concerns or questions? If not, then we will deal with Mr. Julian's specifically. The Department of Finance officials, hopefully, will be able to respond to your concerns.

Mr. Cardin.

[Serge Cardin, Bloc, Sherbrooke, QC]

We've been given other information since Tuesday, and I've expressed my view on this subject. The people will be able to answer us, and if their answer is consistent with the information I've been given, we'll be able to continue, Mr. Chair.

[The Vice-Chair, Liberal, John Maloney]

Then I would ask you to pose your questions to our officials, and hopefully you'll receive satisfactory answers. Then we'll move on to Mr. Julian.

Mr. Cardin.

[Serge Cardin, Bloc, Sherbrooke, QC]

Good afternoon, gentlemen.

A number of aspects of the bill greatly favour the population that lives near the border and works in the United States. My main concern is this. Could the 10% withholding tax on interest have negative effects on the banking industry and the financial world as regards Canada-U.S. transactions? Was an analysis conducted of the potential effects, and, if so, what were they?

[Brian Ernewein, General Director, Tax Legislation Division, Tax Policy Branch, Department of Finance]

Well, thank you very much for the question.

I think that in this context, you might be touching upon one of two or three different aspects or features of the withholding tax changes. And if I may, I'll address all three, for the sake of comprehensiveness.

First of all, the withholding tax change, for the benefit of all committee members, eliminates withholding tax on arm's-length interest. That is interest paid by a Canadian--it works in both directions, of course, but I'll give you the example of interest paid by a Canadian--to a U.S. lender.

Currently, when interest is paid in those circumstances, the income tax treaty between Canada and the U.S. allows a maximum withholding tax of 10% to apply. There are many exceptions to this already in our domestic law in the case of arm's-length payments, but the treaty itself allows a maximum of 10%.

The same result currently is allowed under the income tax treaty for payments made by Canadian payors or borrowers to related party lenders. This might be the example of a Canadian subsidiary of a U.S. corporation borrowing money from the U.S. corporation. In that case, the interest payments the Canadian company makes to its parent would be subject, under the treaty, to a maximum of a 10% withholding tax.

The protocol proposes to eliminate withholding tax in both those cases. In the case of arm's-length interest to unrelated parties, the withholding tax is to be eliminated in the year in which the protocol takes effect. Some committee members may be aware of the fact that the 2007 budget legislation, recently introduced and recently considered by the finance committee, actually includes a parallel change to provide the same withholding tax exemption worldwide for payments made by Canadians to arm's-length lenders around the world, and furthermore, to make that change applicable as of January 1.

I raise that because one of the issues that has been raised is the uncertainty of when the withholding tax change would come into place. The budget legislation attempts to answer that question, not just for the U.S. but worldwide, by stipulating that it will apply as of January 1.

Finally, you ask about the implications of this, whether there'll be any reverberations or problems from or effects from eliminating this withholding tax. We think that the answer is yes, but we think they're positive effects. As I've mentioned, there are a number of exceptions already in our domestic legislation for withholding tax for arm's-length payments made to non-residents. What the treaty does, and what our complementary change to our domestic law does, is make that exemption universal. What that does, frankly speaking, is take a lot of tax advisers out of the equation who would often be working to get around the existing rules anyway. It also makes clearer or simpler the lending market so that Canadians have more competition and are able to benefit from more competition, both from lenders in Canada and in the U.S., and indeed, from third countries. So we do think that there are effects, but they are positive ones.

[Serge Cardin, Bloc, Sherbrooke, QC]

You mentioned a maximum of 10%. Without providing an exhaustive description, could you tell me what the variation in the rate depends on? On the amounts in question? Surely it's not simply the decision of the borrower or lender.

[Brian Ernewein]

There are at least a dozen current exemptions. The various things that generate an exemption are if it is long-term corporate debt--debt of more than a five-year term--or if it is paid by governments, sometimes two governments. There are those types of situations. Bank deposit interest sometimes qualifies for an exemption. As I say, there are about a dozen different headings under which exemptions already apply.

[Lawrence Purdy, Senior Chief, Tax Legislation Division, Tax Policy Branch, Department of Finance]

I wonder if I might just add a word.

I think you asked about the maximum language in the treaty, that is, the maximum rate being 10%, and whether there might be other rates applying. Statutorily, the rate that's applied under our Income Tax Act is 25% in 12 payments of interest to non-residents. So the treaty applies a maximum rate of 10%. That takes the 25% rate down to 10%. For all those cases in which tax applies under our domestic law, the maximum rate under the treaty is at the 10% level.

[The Vice-Chair, Liberal, John Maloney]

Do you have any more questions, Mr. Cardin?

[Serge Cardin, Bloc, Sherbrooke, QC]

Yes.

That applies to both individuals and corporations?

[Lawrence Purdy]

It doesn't matter whether the recipient is an individual, an actual person, or a corporation, the fixed rate under our act is 25%, and then it's 10% under the treaty.

[Serge Cardin, Bloc, Sherbrooke, QC]

I'd like to know how things would work in practical terms. Let's suppose I've taken out a loan in the United States and I'm making interest payments. Would I be responsible for filing a return in which I would withhold an amount? For example, if the interest amounted to $1,000 a month, I would withhold part of that amount and remit it to the Department of Revenue?

[Lawrence Purdy]

Yes, assuming that none of the exemptions Mr. Ernewein described apply and the tax therefore does apply, you as the payer of the interest are required to withhold from the amount you pay the amount of tax owing.

[Serge Cardin, Bloc, Sherbrooke, QC]

The corporation receiving my interest payment, less the given percentage, would nevertheless be entitled to claim a foreign tax credit, I imagine.

[Lawrence Purdy]

In a legal sense the tax is being paid by the non-resident, so in the non-resident's home country the non-resident will typically get a tax credit for the Canadian withholding tax that has applied.

But your question points to an important aspect of this. In economic terms, although these taxes are imposed legally on the non-resident, with the collection being the responsibility of the Canadian payer, in the real world of many business transactions the non-resident will say, “I'm not interested in bearing that cost, so you the Canadian will have to pay me an amount that is increased to reflect the fact that the tax liability will exist.” So in practical terms you're right. Very often it is the Canadian payer who ends up on the hook for that tax.

[Serge Cardin, Bloc, Sherbrooke, QC]

As regards the proposed changes, I'd like to know whether things would balance out a little before the amounts are withheld in Canada and the individual or corporation in the United States claims a foreign tax credit. Did all corporations or individuals who received interest and were subject to a withholding tax—because this works both ways—receive the foreign tax credit?

[Brian Ernewein]

Presuming adoption of the treaty, it deals mostly with the past. In the future, if there is no tax obligation because the withholding tax is eliminated, the payments will be taxable only in the country in which the lender carries on business and is resident. But today the situation you've described is correct. The tax charged on the interest paid and withheld by the Canadian payer in the examples we've been talking about—again, it works both ways, but we're talking about payments going from Canada to the United States—the tax withheld by the Canadian and remitted to the Canadian government legally represents a tax on the non-resident, on the American lender who's receiving the interest payments.

The American lender, in calculating U.S. tax liability, will figure out how much its net income is, multiply that by a specific tax rate that applies in the United States, and subject to a number conditions, of course, will be able to deduct the tax paid to Canada from the U.S. tax liability. The situation will work in reverse for a lender from Canada lending to the United States and receiving interest from the United States.

[Serge Cardin, Bloc, Sherbrooke, QC]

That could have become a major irritant for lending companies in the case of loans made to Canadians. Now that this aspect has been eliminated, I'm going to go back to the question I asked earlier.

Could this have an impact on banking business? For example, if there are fewer irritants, could U.S. banks try increasingly to develop their markets in Canada and Quebec?

[Brian Ernewein]

Thank you again for the question.

I think the reality is that foreign financial institutions already have a presence in Canada. They form part of the market. But the elimination of withholding tax does take away one of the impediments to foreign financial institutions lending to Canada--supplying money for Canadian borrowers. We think that's a good thing, because it opens up the borrowing opportunities and reduces costs for Canadian borrowers. It will increase competition for Canadian financial institutions, but we don't think that's a bad thing. Indeed, the Canadian financial institutions support this change.

[Serge Cardin, Bloc, Sherbrooke, QC]

We don't really have any control over the rates here, and even less over those of the United States. The large differentials between these rates could encourage Canadians to do more and more business with U.S. financial institutions.

[Brian Ernewein]

I would suggest that opening up the markets and eliminating the withholding tax would actually lead, all other things being equal, to greater rate competition. The possibility of a withholding tax can create a differential in rates where one would not otherwise exist.

There are many other factors, of course, that can lead to differences in interest rates. In this case, the tax wedge that a withholding tax can create is not, in our view, a helpful one to have. While we all recognize the need to have taxes in certain circumstances, this does not seem to be one that is productive for the Canadian economy.

[The Vice-Chair, Liberal, John Maloney]

Thank you.

Mr. Julian.

[Peter Julian, NDP, Burnaby—New Westminster, BC]

Thank you, Mr. Chair.

Thank you very much for coming forward.

Given that we don't really have a very fulsome analysis of what the impacts of Bill S-2 are, my first question is this: There would have been impact studies done prior to the negotiation of the agreement; do you have copies of those studies with you?