Income Taxes
Under the Income Tax Act (Canada) (the "Tax Act"), a U.S. entity is generally liable to pay taxes on any income earned in Canada, if that U.S. entity is "carrying on business in Canada". Similar to the Bank Act, the Tax Act does not include a definition for the phrase "carrying on business in Canada", and accordingly, the meaning of this phrase is derived from case law, as well as guidance from the Canada Revenue Agency (the "CRA"), which is Canada's tax regulator.
Based on the relevant authorities, a cross-border purchase and sale of receivables or asset-backed securities between a Canadian entity and a U.S. entity would generally not, in and of itself, constitute carrying on business in Canada that would trigger Canadian income tax liability for a U.S. entity. However, if a U.S. entity's business activities in Canada extend beyond a mere purchase and sale of receivables or asset-backed securities (e.g., servicing and collection of receivables), then it may be subject to Canadian income tax.
In order to avoid the potential for Canadian income tax, a U.S. entity should be careful to conduct its business and affairs in a manner that minimizes touchpoints with Canada, consistent with the code of conduct described above.
Withholding Taxes
In 2008, the federal government of Canada eliminated withholding tax on most cross-border payments of interest from a Canadian entity to a U.S. entity. As a result, payments of interest on receivables sold by a Canadian originator to a U.S. SPV are generally not subject to withholding taxes. Similarly, payments of interest on asset-backed securities sold by a Canadian entity to a U.S. entity are generally not subject to withholding taxes.
The Tax Act includes certain exceptions to this rule that may result in withholding taxes being levied on interest payments, including where the payor and the payee are not dealing with each other at arm's length (i.e., the payor and the payee are affiliated with one another), or where the interest is "participating debt interest" (i.e., interest that is contingent or dependent on the use of or production from property in Canada, or that is computed by reference to, among other things, revenues, profits, cash flows or commodity prices).
In addition, it is important to note that withholding tax may apply to certain cross-border payments other than interest payments, including rent or lease payments, royalties and dividends.
Sales Taxes
Typically, an assignment of receivables by an originator to an SPV will not attract any sales taxes, as a sale of receivables is exempt from the goods and services tax ("GST") imposed by the federal government of Canada, as well as the provincial sales tax ("PST") imposed by the provincial governments of certain provinces (which in some provinces, has been harmonized with the GST to form a single harmonized sales tax ("HST")).
However, in securitization transactions that involve an assignment of tangible property (such as leased cars and equipment) together with the related receivables, the assignment of the tangible property may be subject to sales taxes.
Similarly, in securitization transactions that contemplate payment of servicing fees, these servicing fees may be subject to sales taxes. In order to avoid sales taxes on servicing fees, most transfers of receivables by an originator to an SPV are done on a "fully serviced basis" for a single consideration, which means that the originator, which is typically also the initial servicer, is not paid a separate servicing fee in exchange for servicing the receivables on behalf of the SPV.
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