Canada:
Withholding tax on refunds and allowances from non-residents
August 12, 2021
Red Meat & Samulovitch PC
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Introduction – Withholding Tax Provisions for Non-Residents
The Income Tax Act regulates whether income is taxable. In addition, the Tax Act contains many provisions designed to facilitate the administration and enforcement of tax debts. Section 153 (1) (g) of the Taxes Act is one such provision and reads:
- s 153 (1) Any person who pays at any point in a tax year …(G) Fees, commissions or other amounts for services … will be deducted or withheld from the payment the amount determined according to the prescribed rules.
As an administrative rule, Section 153 (1) (g) requires a payer to withhold tax to ensure that funds are available to meet a payee’s potential future tax liability. Whether a recipient actually has a positive tax liability is determined by filing an income tax return. You can compare this to an employer withholding income tax on the salary paid to an employee. Although amounts are withheld in advance, when filing an income tax return the employee may find that they are eligible for a tax refund.
In dealing with non-residents, Paragraph 153 (1) (g) is supplemented by the Income Tax Act Regulation 105, which states:
- s 105 (1) Any person who pays a fee, commission, or other amount to a non-resident for any service provided in Canada must deduct or withhold 15 percent of that payment.
Weyerhaeuser case clarifies Tax Ordinance 105
In Weyerhaeuser Company Limited v The Queen, the taxable entity appealed to the CRA Revenue Court of Canada against the withholding tax on its payments to non-resident contractors. Weyerhaeuser Company Limited (“Weyerhaeuser Co.”) was a Canadian forest company that employed non-residents for the services it provided in Canada. During the year under review, Weyerhaeuser Co. made payments to these non-residents totaling $ 14.3 million but withholding 15% tax on the portion of the payments it believed to be subject to taxation 105. Weyerhaeuser Co. has not withheld any taxes on the reimbursement of non-residents’ expenses such as travel, telephone and postage costs. The CRA took the position that these amounts were “in relation to” services provided in Canada under the terms of Tax Act 105. Therefore, Weyerhaeuser Co., because it failed to withhold the withholding, was liable for the taxes, interest and penalties on these amounts.
The tax court contradicted the CRA and granted Weyerhaeuser Co.’s appeal. The tax court found that the language used to describe when a tax deduction is required differs between section 153 (1) (g).
[“for services”] and Ordinance 105 [“in respect of
services”]. The credit rating agency argued that “in relation to services” should be given the widest possible scope in Regulation 105. However, as the Canadian tax lawyer who works for Weyerhaeuser Co. argued, this is wrong in terms of content. The tax court found that the Tax Ordinance 105 “could not go beyond the authorization contained in the statute itself”. On this basis, the CRA’s interpretation of Tax Law Ordinance 105 was in conflict with the purpose of Section 153 (1) (g) as it would place withholding tax obligations beyond what the Income Tax Law required. The purpose of 153 (1) (g) was to collect a tax reserve that could be applied to a future income tax liability. Therefore, the withholding has only been triggered for payments that are in the nature of income in the hands of a non-resident recipient. Income meant income here. When Weyerhaeuser Co. reimbursed foreigners out of pocket expenses such as travel expenses, it paid amounts that the foreigner “on [Weyerhaeuser Co.]’s called “not paid, not paying part of the service charge. This characterization of certain payment amounts as expenses was underpinned by invoices from foreigners to the Weyerhaeuser company. The tax court held that this was in the interests of the Canadian economy, foreigners only 85 % of their disbursements. As a result, Weyerhaeuser Co. was exempt from taxes, interest and penalties because it was right not to withhold.
CRA View – advance payments to non-resident contractors in accordance with Tax Ordinance 105
In 2019, the CRA recently responded to a taxpayer question regarding the application of Tax Ordinance 105 to a specific scenario involving a non-resident contractor and various non-resident sub-contractors. The taxpayer, a Canadian company, entered into a contract with a non-resident contractor to supply and install boilers in Canada (“Initial Contract”). The contractor turned around and outsourced the work to various subcontractors. Then the contractor ran into financial difficulties prior to the completion of the work, which resulted in subcontractors worried about whether they would get paid. To facilitate the completion of the work, the Canadian company has entered into a second set of contracts (“Payment Agreements”) with the Contractor. Under these agreements, the Canadian company prepaid the contractor for the amounts that the contractor promised to subcontract. When the subcontractors finished the work, they were paid from a special account after the disbursements were approved by the Canadian company and the contractor.
The Canadian company’s position in its inquiry to the CRA was that payments to the non-resident contractor under the payment arrangements were outside the scope of Tax Act 105 so no withholding tax was levied. They argued that the advance payments were the same as the payments made in the Weyerhaeuser Company Limited case and that they were of no income nature. The credit rating agency replied, referring to its position that Regulation 105 was applicable. According to the CRA, the prepayments made to the contractor under the payment arrangements only reduced the amount due by the Canadian company under the original contract, the entire income of which was in the hands of the contractor. It did not matter that the amounts paid under the payment arrangements were ultimately payable to the subcontractors.
Is the CRA correct? We can start by looking at previous CRA positions, even if they are not required by law. In a 2008 investigation into similar circumstances, the CRA said that “in relation to amounts received from [Canadians] to
[non-residents] as a reimbursement of [the non-resident’s]
However, in the 2019 investigation just described, the CRA denied the exclusion of subcontractor fees from withholding and found that its 2008 position “was only applicable to the extent that subcontractor fees were not compensation are. “
The CRA advises that a clear distinction must be made between reimbursements and allowances. The CRA rightly focuses on this distinction in light of Weyerhaeuser Company Limited. A comparison of the CRA inquiries from 2008 and 2019 reveals some interesting points. First, the distinction between reimbursement and reimbursement should be documented in writing – the 2008 foreigner’s bill to the Canadian listed the subcontractor’s fees as a reimbursable expense separate from his own reimbursement. Second, and arguably more important, is a timing issue – in the 2008 document, the subcontractor was already paid by the contractor and only then did the contractor bill the Canadian. In the case of 2019, it is difficult to argue that the payment agreement amounts were reimbursements. This is because it was prepayments for the original contract. In the hands of the receiving contractor, the amounts were initially income and only became expenses of the subcontractor at a later point in time, when the subcontractors had completed the work. This is the opposite of the 2008 situation. Given the nature of the payment arrangement, the amounts were revenue at the time of payment and Tax Law Ordinance 105 is associated with revenue that should have been withheld taxes. The contractor would need to file a tax return to claim the expenses and clear their true tax liability.
Pro tip for tax law – Have a tax attorney review your international contracts for withholding taxes for non-residents
Tax law is often described as an accessory. The nature of the transactions from a corporate or contractual point of view and even their sequence can have an impact on the application of the Income Tax Act. If you are a non-resident receiving payments from Canada, or a Canadian taxpayer making those payments, you should reach out to one of our leading Canadian tax attorneys who can review your proposed transactions and advise you on how to minimize them Your withholding tax burden in accordance with Tax Act 105.
The content of this article is intended to provide general guidance on the subject. Expert advice should be sought regarding your specific circumstances.
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