Publication
TITRE
Authorized Foreign Banks
DATE
18 décembre 2003
EXPERTISE
Barry N. Segal*
A 2001 technical bill introduced a regime of authorized foreign (schedule III) banks that may establish branches in Canada and carry on business here. The amendments were in part intended to relieve borrowers from part XIII withholding and remittance obligations related to interest on loans not originating in a foreign bank's Canadian branch. Draft regs of February 13, 2003 raise practical issues for authorized foreign banks.
Under the 2001 technical bill, effective June 28, 1999, an authorized foreign bank was deemed resident in Canada for part XIII purposes in respect of an amount paid or credited to or by it in respect of its Canadian banking business - that is, its business carried on through a Canadian branch, other than a business conducted through a representative office registered or required to be registered under section 509 of the Bank Act. (June 28, 1999 was the date on which foreign banks were first permitted to establish Canadian branches under the Bank Act.) The change did not amend the application of part XIII to interest paid on loans made directly by an authorized foreign bank and not through a Canadian branch.
Under current rules, the borrower must thus satisfy itself - generally by relying on the bank's representation - that the loan is in fact made through a Canadian branch. The draft amendments recognize the difficulty of requiring borrowers to determine that the loan is made through a Canadian branch, and they relieve Canadian-resident borrowers from the obligation to withhold and remit part XIII tax on interest paid or credited on loans made directly by the bank and not through a Canadian branch. The compliance obligations are thus shifted from the borrower to the authorized foreign bank, which must file an annual return in prescribed form disclosing its part XIII tax payable and pay that tax by the filing due date. The draft regs apply retroactively to taxation years of authorized foreign banks and Canadian-resident borrowers ending after June 27, 1999; a bank's prior years' returns are due six months after the draft regs come into force. Such banks are retroactively liable for any part XIII tax not withheld and remitted by a Canadian borrower in taxation years ending after the effective date, and they may be assessed for related interest and penalties; the borrower is relieved of such liability.
Many cross-border loans are not economic unless a part XIII tax exemption is available. However, the draft regs have practical implications for existing loan agreements where part XIII applies, and they may affect the drafting of future agreements in such cases. Many such loan agreements are drafted on the assumption that the borrower must withhold and remit part XIII tax: in order to indemnify the lender against any such tax, and to the extent that the borrower is obligated to withhold, the payment obligation is grossed up to eliminate the part XIII tax cost to the lender. Under the draft regs, the withholding obligation of the borrower ceases. Thus, the gross-up and indemnity clauses in existing loan agreements not made through a bank's Canadian branch may not be effective in protecting the bank against part XIII tax if the borrower's obligation to gross up the payment to the lender is predicated on its obligation to withhold and remit part XIII tax. When future agreements are drafted, the obligation to gross up and indemnify should, where necessary and possible, require the borrower to make additional payments so that the bank receives the same after-tax amount it would have received ex-part XIII tax, even though the borrower is not required to withhold and remit. The bank is thus left with adequate funds to pay its part XIII tax liability. It is understood from discussions with Finance that some banks have expressed concern over the retroactive nature of the draft amendments, which may be revised after the public consultation process.
* Barry N. Segal, Ogilvy Renault, (416) 340-6161, bsegal@ogilvyrenault.com.
