Canada: Withholding Tax On Cross-Border Commitment Fees
Commitment fees are a common feature of many lending arrangements whereby a lender is given additional compensation above and beyond the stated interest rate for agreeing to provide funding to the borrower. Similar to interest payments, Canadian withholding tax may be applicable on such fees and must be carefully considered in properly structuring cross-border lending arrangements.
This bulletin is the third part of a series on Canadian withholding tax in cross-border lending arrangements (see Canadian Tax Fundamentals: Withholding Tax on Cross-Border Interest Payments and Convertible Debt and the Canadian Withholding Tax Dilemma).
Commitment fees paid by a Canadian resident borrower to a non-resident lender may be deemed to be interest and subject to withholding tax under the Income Tax Act (Canada). The most significant threshold issue in determining whether a commitment fee will be deemed to be interest is first determining whether the stated or “coupon” interest paid or credited to the non-resident under the terms of the lending agreement is subject to Canadian withholding tax under the Act on the date the agreement was executed. In this respect, the treatment of the commitment fee from a withholding tax perspective will follow the treatment of the stated/coupon interest under the loan.
In general, Canadian withholding tax will apply at a rate of 25 percent on interest that is either (i) paid or credited by a resident of Canada to a “non-arm’s length” non-resident lender; or (ii) considered “participating debt interest” (for more detail, see Canadian Tax Fundamentals: Withholding Tax on Cross-Border Interest Payments). If neither of these conditions are met, and consequently the stated/coupon interest under the loan is not subject to Canadian withholding tax, the commitment fee will not be deemed to be interest for purposes of the Act and will not be subject to Canadian withholding tax. Accordingly, even if the commitment fee is based on criteria that is contingent (e.g., based on the borrower’s revenue or cash-flow or is based on commodity prices), no Canadian withholding tax should apply on the basis that such fee is not “interest” for purposes of the Act. Care should be taken to ensure that the commitment fee is reasonable in the circumstances and is not effectively in lieu of interest that the borrower would otherwise pay under the loan.
When structuring cross-border loans that have a commitment fee, it will be critical to ensure that the general withholding tax risks relating to the stated/coupon interest are properly managed so as to simplify and mitigate the accompanying withholding tax risks on any commitment fee.
