The 2014 Canadian federal budget (Budget 2014) proposes to introduce to the Income Tax Act (Canada) (ITA) new anti-avoidance provisions regarding “back-to-back loans” that, where applicable, may affect the deductibility of interest and/or result in the imposition of Canadian withholding tax. These proposals do not have immediate effect – generally, they are proposed to apply after 2014.
The proposals are said to target financings provided to a Canadian by a related non-resident via an intermediary in order to avoid adverse consequences under the ITA that would otherwise arise if the financing were provided directly. However, as drafted, the proposals could also apply to a broader range of commercial arrangements. In particular, the proposals should be considered in the context of any cross-border financing transaction pursuant to which a Canadian is obligated to pay interest to an arm’s-length party, and a non-arm’s-length non-resident pledges or posts security or collateral that secures such obligation, some examples of which are noted below. It is by no means clear that the application of the proposals in these examples was intended, and the proposals may yet be amended prior to enactment to more narrowly target specific forms of indirect financing within corporate groups. Osler expects to engage with the Department of Finance regarding more appropriate targeting of these proposals.
Cross-border group credit facilities. A lender or lending syndicate will frequently negotiate a secured loan or credit facility with a corporate group that includes a Canadian and related non-residents. The Budget 2014 proposals may raise issues as to interest deductibility and imposition of Canadian withholding tax where a Canadian borrower pays interest on a debt and a related non-resident pledges collateral that secures the Canadian borrower’s obligations.
Secured non-resident guarantees. The Budget 2014 materials indicate that unsecured guarantees of Canadian liabilities by a non-resident are not subject to the proposals. However, arrangements involving secured guarantees would be caught.
Tri-party cross-border netting. These proposals may apply elsewhere where credit and collateral are contractually addressed on a group basis crossing the Canadian border, such as account pooling or group netting provisions or agreements.
Parties currently negotiating or implementing such arrangements will need to assess the materiality of the risk of uncertainty introduced by these Budget 2014 proposals and ensure that such risk is properly allocated under transactions concluded prior to any clarification from the Department of Finance and introduction (expected later this year) and passage of implementing legislation.
There is no grandfathering of existing transactions. Parties may wish to see if any clarification is forthcoming from Finance. A borrower considering any amendments in the near future may want to conduct the analysis of this issue concurrent with such amendment. In any event, given the effective date of the proposed changes, a review of existing transactions will be appropriate in light of implementing legislation, which is expected later in the year.