Canada, U.S. to scrap cross-border tax in treaty

OTTAWA, Sept 18 (Reuters) - Canada and the United States are expected to sign a new tax treaty this month that could increase Canadian companies' access to U.S. financing, experts said on Tuesday.

The two governments will eliminate the 10 percent withholding tax on interest payments made by borrowers in one country to lenders in the other.

The measure would mainly benefit Canadian companies that borrow from U.S. banks. Ottawa estimates it will cost the federal government an estimated C$250 million ($245 million) in the 2007-08 and 2008-09 fiscal years.

Finance Minister Jim Flaherty said in a speech on Sunday that the signing of a revised Canada-U.S. tax treaty would be "soon." Finance officials would not give details.

Tax lawyers who consulted with the Department of Finance said they had been told the revised treaty would be signed by the end of September.

Nancy Hughes Anthony, president of the Canadian Bankers Association, also believes an announcement is imminent.

"We understand that they are on the verge of being able to actually sign the tax treaty, which would be tremendous," she said.

The withholding tax is applied to the interest income of nonresident lenders. Canadian law obliges the Canadian borrower to withhold the tax from its interest payment to a U.S. lender and remit it directly to Ottawa.

In practice, the tax becomes a premium on capital because most sophisticated U.S. lenders require clients to "gross up" their payment so that they pay the full interest plus the tax.

"There's a very keen interest in this," said Michael Friedman, a tax lawyer with McMillan Binch Mendelsohn LLP. "The cost of obtaining capital will be reduced because borrowers won't face the demands to gross up and the ability to borrow capital will be increased."

He added: "It also reduces the legal complexity of borrowing transactions."

The 2007 federal budget said the withholding tax on arm's-length debt -- where borrower and lender are unrelated entities -- with the United States would be eliminated in the first year after the new treaty goes into effect. For non-arm's-length debt, the tax will be phased out over three years.

Ottawa also said it would then unilaterally extend the exemption to arm's-length debt with lenders in all countries.

The risk to Canadian banks is that they lose their competitive edge. But bankers have been pushing for the policy change for years and see more benefits than pitfalls.

"Anything that loosens up the free flow of capital between the two countries will be good for banks because it will be good for their customers," she said. "We hope it will result in increased foreign investment and other things that will be good for the bottom line."

Foreign currency tax tips

Both businesses and individual taxpayers may find themselves in situations where foreign currency transactions are required to be converted into Canadian dollars. This may be an almost daily occurrence for businesses involved in cross-border work. Individual taxpayers may have to take into account foreign currency rates on such diverse situations as the calculation of a gain or loss on an investment or the receipt of regular payments, such as pensions, from a foreign country.

You need not use the Bank of Canada rate in determining the conversion rates. There is both a current and historic converter from scores of other currencies to Canadian dollars at http://www.bankofcanada.ca/en/ rates/converter.html.

There is nothing in the Income Tax Act or the CRA's published material that requires you to use the Bank of Canada annual average exchange rate to convert your pension and investment income to Canadian dollars.


Page 14 of the 2006 General Income Tax and Benefit Guide indicates that you may use the exchange rate that was in effect on the day you received the foreign income. Interpretation Bulletin IT-270R3, Foreign Tax Credit, also indicates that investment income may be converted at the exchange rate that applied on the date it was received. Pension income may also be converted at that exchange rate.

However, if the amounts were paid at various times throughout the year, you may use the Bank of Canada annual average exchange rate as a convenience.

Of course, as we have pointed out in the past, there is nothing to stop one from trying each rate on for size and only after determining what produces the best result, making a choice. In the worst-case scenario, all that can happen is that you might be called upon to justify that decision.

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On a different aspect of foreign exchange, we have been finding more foreign hotels have been asking us, when we tender our credit card, whether we would like to pay in local currency or Canadian dollars. This generally is a huge trap for the unwary.

In August in London, our hotel would have converted the bill to Canadian dollars at a rate of $2.40 to the pound. We insisted in paying in pounds sterling and the subsequent VISA statement showed the conversion by our bank at $2.19!

An offer of the convenience of having your credit card debited based on Canadian dollars is just one more way hotels can rip off unwary travellers.

Copied from: Arthur Drache, Financial Post