Published: August 10, 2021
Last Updated: November 19, 2021
Introduction – Non-Resident Withholding Tax Provisions
The Income Tax Act establishes if income is taxable. In addition, the Tax Act contains many provisions which are meant to facilitate the administration and enforcement of tax liabilities. Paragraph 153(1)(g) of the Tax Act is one such provision and reads:
- s 153(1) Every person paying at any time in a taxation year…(g) fees, commissions or other amounts for services…shall deduct or withhold from the payment the amount determined in accordance with prescribed rules…
As an administrative provision, paragraph 153(1)(g) requires a payor to withhold tax to ensure that funds will be available to satisfy the potential future tax liability of a payee. Whether a recipient actually ends up with a positive tax liability is determined by filing an income-tax return. You can analogize this to an employer withholding income tax on salary paid to an employee. Though amounts are withheld up front, on filing an income-tax return the employee may actually discover that they are entitled to a tax refund.
When dealing with non-residents, paragraph 153(1)(g) is supplemented by Income Tax Act Regulation 105 which states:
- s 105(1) Every person paying to a non-resident person a fee, commission, or other amount in respect of services rendered in Canada, of any nature whatever, shall deduct or withhold 15 per cent of such payment.
Weyerhaeuser Case Clarifies Tax Act Regulation 105
In Weyerhaeuser Company Limited v The Queen, the taxpayer corporation appealed to the Tax Court of Canada CRA’s assessment of withholding tax on its payments to non-resident contractors. Weyerhaeuser Company Limited (“Weyerhaeuser Co.”) was a Canadian forestry company that engaged non-residents for services rendered to it in Canada. In the year under assessment, Weyerhaeuser Co. had made payments to those non-residents totalling $14.3 million, but only withheld 15% tax on that portion of the payments which it believed were caught by Tax Act Regulation 105. For example, Weyerhaeuser Co. did not withhold tax on reimbursements for the non-resident’s disbursements such as travel costs, telephone, and postage charges. The CRA’s position was that these amounts were “in respect of” services rendered in Canada, pursuant to the language in Tax Act Regulation 105. Therefore, because Weyerhaeuser Co. failed to withhold, it was liable for the tax, interest, and penalties on those amounts.
The Tax Court disagreed with the CRA and allowed Weyerhaeuser Co.’s appeal. The Tax Court observed that the language used to describe when to withhold is different between paragraph 153(1)(g) [“for services”] and Regulation 105 [“in respect of services”]. The CRA argued that “in respect of services” in Regulation 105 should be given the widest possible scope. However, as the Canadian tax litigation lawyer acting for Weyerhaeuser Co. argued, this was contextually incorrect. The Tax Court noted that Tax Act Regulation 105 could not “go beyond the enabling authority contained in the Statute itself.” On this basis the CRA’s interpretation of Tax Act Regulation 105 was at odds with the purpose of paragraph 153(1)(g) because it would extend withholding obligations beyond what the Income Tax Act required. The purpose of 153(1)(g) was to collect a reserve of tax that could be applied towards a future income tax liability. Therefore, withholding was only triggered for payments that have the character of income in the hands of a non-resident recipient. Income here meant revenue. When Weyerhaeuser Co. reimbursed non-residents for out-of-pocket expenses like its travel costs, it was paying for amounts that the non-resident had incurred “on [Weyerhaeuser Co.]’s behalf,” not paying part of the fee for service. This characterization of certain payment amounts as disbursements was substantiated by invoices issued to Weyerhaeuser Co. by the non-residents. The Tax Court opined that it would be contrary to the interests of the Canadian economy to only reimburse non-residents for 85% of their disbursements. Accordingly, Weyerhaeuser Co. was relieved of tax, interest, and penalties because it was correct to not withhold.
CRA View – Prepayments to Non-Resident Contractor under Tax Act Regulation 105
In 2019 the CRA recently answered a taxpayer question about Tax Act Regulation 105’s application to a specific scenario involving a non-resident Contractor and various non-resident Subcontractors. The taxpayer, a Canadian corporation, entered into a contract with a non-resident Contractor who would supply and install boilers in Canada (“Initial Contract”). The Contractor turned around and subcontracted the work to various Subcontractors. Then, prior to work being completed, the Contractor experienced financial difficulties which caused the Subcontractors to worry about whether they would get paid. To facilitate completion of the work the Canadian corporation entered a second set of contracts with the Contractor (“Payment Agreements”). Under these agreements, the Canadian corporation paid the Contractor in advance the amounts that the Contractor had promised to pay its Subcontractors. As the Subcontractors completed work, they were paid from a dedicated account upon authorization of withdrawals by the Canadian corporation and the Contractor.
The Canadian corporation’s position in its inquiry to the CRA was that payments to the non-resident Contractor under the Payment Agreements were outside the scope of Tax Act Regulation 105 so that no withholding tax applied. They argued that the prepayments were akin to the disbursements in the Weyerhaeuser Company Limited case and did not have the character of income. The CRA responded, indicating its position that Regulation 105 was applicable. According to the CRA, the advance payments made to the Contractor under the Payment Agreements simply reduced the amount due by the Canadian corporation under the Initial Contract, the totality of which was income in the hands of the Contractor. It did not matter that the amounts being paid under the Payment Agreements were ultimately payable to the Subcontractors.
Is the CRA correct? We can begin by looking at previous CRA positions even though they are not law. In a 2008 inquiry regarding similar circumstances the CRA said “withholdings would not generally be required in respect of amounts paid by [Canadians] to [non-residents] as a reimbursement of [the non-resident’s] expenses, including the Subcontractor’s fee and travel costs.” However, in the 2019 inquiry just described the CRA denied the exclusion of Subcontractor fees from withholding and noted that its 2008 position was “true only to the extent that the subcontractor fees are not remuneration.”
The point the CRA makes is that there must be a clear distinction between reimbursements and remuneration. The CRA is correct to focus on this distinction in light of Weyerhaeuser Company Limited. A comparison of the 2008 and 2019 CRA inquiries reveals some points of interest. First, the reimbursement-remuneration distinction should be documented in writing – in the 2008 document the non-resident’s invoice to the Canadian itemized the subcontractor’s fees as a reimbursable expense separate from its own remuneration. Second, and arguably more importantly, is a timing issue – in the 2008 document the subcontractor had already been paid by the contractor and only then did the contractor invoice the Canadian. In the 2019 case it is difficult to argue that the Payment Agreement amounts were reimbursements. This is because they were in the nature of prepayments towards the Initial Contract. In the hands of the recipient Contractor, the amounts were first revenue and only became a subcontractor expense at some later point when the Subcontractors completed work. This is the reverse of the 2008 situation. Given the character of the Payment Agreement amounts at the time of payment was revenue, and Tax Act Regulation 105 attaches to revenue, tax should have been withheld. The Contractor would have to file a tax-return to claim expenses and clarify its true tax liability.
Pro Tax Tip – Have a Tax Lawyer Review Your International Contracts for Exposure to Non-Resident Withholding Tax
Tax law is often described as having an accessory character. The nature of transactions from a corporate or contract law perspective, and even their sequence, may have implications for how the Income Tax Act applies. If you are a non-resident who will be receiving payments from Canada, or a Canadian taxpayer who will be making those payments, you should consult with one of our top Canadian tax lawyers who can review your proposed transactions and provide advice on how you can minimize your exposure to withholding tax under Tax Act Regulation 105.
"This article provides information of a general nature only. It is only current at the posting date. It is not updated and it may no longer be current. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in the articles. If you have specific legal questions you should consult a lawyer."
Yes, non-residents also have to withhold tax when they are paying “a fee, commission, or other amount in respect of services rendered in Canada.” This means that a non-resident contractor must withhold tax from payments to a subcontractor if the payments are remuneration for a project being completed in Canada.
The Simplified Tax Act Regulation 105 process permits certain non-residents to have the withholding tax reduced or waived altogether. Approval under Simplified Tax Act Regulation 105 is based on an upfront assessment of the non-resident’s entitlement to relief under a tax treaty or expenses associated with the services provided in Canada. We discuss this in more detail here.