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Canada: Canadian Budget proposes to extend “back-to-back” rules to rents and royalties


Andrew Spiro

Casey Richardson-Scott

Canada's Income Tax Act (the ITA) contains an anti-avoidance rule (commonly referred to as the back-to-back loan rule) that generally prevents the use of arm's length or treaty-resident intermediaries to reduce non-resident withholding tax applicable to related-party interest payments. As part of an expansion of these rules to various different circumstances, the 2016 federal Budget, released on March 22 2016, proposes to extend the back-to-back loan rules to cross-border rents and royalties.

Rents, royalties, and similar payments paid by a resident of Canada to a non-resident are generally subject to withholding tax under the ITA at a 25% rate, subject to reduction under an applicable tax treaty. Unlike many countries, most of Canada's treaties, reduce, but do not eliminate, the general withholding tax rate on royalties (generally to 10%). The extension of the back-to-back loan rules to royalties targets structures where a royalty is paid by a Canadian payor to a treaty-resident, which in turn pays a similar royalty to another non-resident which would not be entitled to treaty benefits.

The new rules, which are proposed to apply to payments made after 2016 (whether or not made pursuant to an agreement entered into before the Budget) will apply to a back-to-back royalty arrangement where there is sufficient connection between the royalty paid by a Canadian resident to an intermediary resident in a treaty country (the Canadian leg), and another royalty paid by the intermediary to a non-resident (the second leg), but only if the non-resident would have been subject to higher Canadian withholding tax than the intermediary if it had received the royalty directly from Canada. The Budget indicates that a sufficient connection will exist if either:

  • The amount payable under the second leg is determined by reference to the royalty under the Canadian leg or the fair market value of or revenues derived from the property being licensed under the Canadian leg, or any similar criterion; or

  • A factual connection can be reasonably established between the Canadian leg and the second leg.

Related rules proposed in the Budget extend the rules to include situations where the payment under the second leg is a payment of interest or certain kinds of dividends.

If the rules apply, the Canadian payor will be deemed to have paid a fictional royalty to the non-resident receiving the payment from the intermediary. The applicable withholding tax, which will be equal to the difference between the amount of withholding tax that would have applied to such fictional royalty less the amount withheld on the payment to the intermediary, will effectively serve as a penalty tax on the Canadian payor.

Importantly, unlike cross-border interest, there is no general exemption from withholding tax under the ITA for arm's length cross-border rents or royalties. Accordingly, Canadian residents paying arm's-length cross-border royalties could be subject to the new rules if a factual connection can be established between the Canadian resident's royalty obligations and any internal arrangement entered into by the non-resident licensor. Canadian payors should consider whether it is appropriate to ask for representations or otherwise perform diligence in this regard.

As draft legislation has not yet been released, the precise scope of the new rules is still uncertain.

Andrew Spiro ( and Casey Richardson-Scott (

Blake, Cassels & Graydon

Tel: +1 416 863 2400


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