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Equipment Finance in Canada: Changes to the Income Tax Act May Have an Impact
Canada's conservative minority government recently passed its 2007 Financial Budget (the 'Budget'), which will likely impact the equipment finance industry and particularly cross-border (U.S./Canada) transactions. Central to the Budget was the proposal to eliminate withholding tax on interest payments on loan transactions. As will be discussed below, the likely impact will be that traditional cross-border transactions will be restructured to: 1) provide for quicker repayment of the principal portion of the loan, and 2) provide a means for a greater number of less internationally focused commercial banks and finance companies to undertake cross-border transactions which, prior to the enactment of the new legislation, would have be seen as too complex. This second impact may cause a more competitive environment and further add liquidity to any already liquid market. It is not clear, however, that the proposed legislation will have a significant impact on larger transactions or the activities of internationally focused lenders. While there will likely be enhanced competition for smaller straightforward transactions than currently exists, the market for complex large transactions, while restructured, will have the same level of competition as currently exists.
Background
Under the existing Income Tax Act Canada (the 'Act') and Canadian/ U.S. Tax Treaty (the 'Treaty') and subject to certain specific exceptions, any payment of interest by a Canadian company to a U.S. lender that is not an authorized foreign bank as defined by the Act, will be subject to the borrower withholding a portion (10%) (Reduced from 25% by the operation of the Canada/U.S. Tax Treaty so long as the lender is not a limited liability company; however, this may soon change) of the interest payment and delivering this withheld amount to the Canadian Government on behalf of taxes to be paid by the U.S. lender. In cases of equipment lease payments, the amount to be withheld is 10% of the entire lease payment (25% if the lessor is a limited liability company). This will not be changed by the proposed changes. Generally speaking, the U.S. lender would require the Canadian borrower to gross-up the amount of the repayment such that the actual dollar amount received by the U.S. lender would be the same absent the withholding tax. Clearly, these structures would make a U.S. lender less competitive than its Canadian counterpart. In order to avoid these non-competitive situations, international-oriented U.S. lenders set up cross-border subsidiaries in Canada or utilized some of the exemptions under the Act/Treaty.
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