Canada Withholding Tax

The Canadian federal budget tabled on March 19, 2019 (“Budget 2019”) proposed modifications to the way in which Canadian withholding tax applies to dividend equivalent payments made under certain securities loans.

Under currently enacted rules, where a Canadian resident borrows shares of corporate stock in Canada, and the lender is a non-resident of Canada, withholding tax on dividend equivalent payments can apply depending on the type and value of collateral posted by the borrower under the arrangement. In particular, where the borrower posts cash or government debt having a fair market value not less than 95% of the fair market value of the borrowed securities, and is entitled to enjoy directly or indirectly the benefits of all or substantially all income derived from the posted collateral (the “95% collateralization test”), dividend equivalent payments will be deemed under the Income Tax Act (Canada) (the “ITA”) to be dividends paid on shares of Canadian corporate stock. This result obtains whether or not the borrowed securities are in fact Canadian, such that dividend equivalent payments in respect of shares of non-Canadian corporate stock can effectively be treated as dividends paid on shares of Canadian corporate stock for withholding tax purposes.

Budget 2019 proposes to remedy this unusual result by excepting from Canadian withholding tax dividend equivalent payments on certain securities loans involving shares of non-Canadian corporate stock. The proposed exemption would apply where the borrowed security is a share of a class of the capital stock of a non-Canadian corporation, and the 95% collateralization test is satisfied.

Budget 2019 would also deem all dividend equivalent payments made by Canadian borrowers under “securities lending arrangements” and “specified securities lending arrangements,” both as defined in the ITA, to be Canadian source dividends, regardless of whether the securities loan satisfies the 95% collateralization test.

Finally, Budget 2019 proposes to change the way in which dividend tax treaty articles apply to dividend equivalent payments made under certain securities loans. Where a non-resident of Canada transfers shares of Canadian corporate stock to a Canadian resident under such transactions, the non-resident would be deemed for the purpose of applying the dividend article of the relevant treaty to remain the beneficial owner of the securities, and the “SLA compensation payment” (as defined in the ITA) made by the Canadian borrower to the lender deemed for purposes of the dividend article to be paid by the issuer of the securities.