This Article by Lori A. Mathison, Partner in the Tax Department with the Vancouver Office of Fraser Milner Casgrain LLPTAX, first appeared in CCH's Tax Topics^® newsletter No. 1953 dated August 2009.

Section 105 of the Income Tax Regulations note1 ("Reg 105") requires "every person paying to a non-resident person a fee, commission, or other amount in respect of services rendered in Canada, of any nature whatever …" to withhold and remit 15% of that amount. Reg 105 derives its legislative authority from subsection 153(1) of the Income Tax Act. note2 The policy behind Reg 105 is to ensure that the non-resident recipient of the payment for services pays any Canadian income tax duly owing. note3 Reg 105 does not impose a tax, it simply acts to secure payment of tax.

To date, judicial consideration of Reg 105 has been fairly limited. The recent Stora Enso Benteiligungen GmbH v. R. note4 ("Stora Enso") decision of the Tax Court of Canada reviewed how Reg 105 should be applied and extended the Reg 105 jurisprudence to include consideration of flat disbursement charges.

Facts

Stora Enso involved a German corporation ("Germanco") note5 that was assessed for failing to withhold 15% on amounts paid to a Swedish company ("Serviceco") in respect of services rendered in Canada for a Canadian company ("Canco") that was related to Germanco. Serviceco was retained by Germanco, on behalf of Canco, to perform services for Canco. Serviceco issued its invoices to Germanco, which in turn paid Serviceco for the services. Canco repaid Germanco through the internal accounting system of the companies.

Subsequently, and following an audit by the CRA, Canco paid to the Minister an amount equal to 15% of the amounts paid to Serviceco by Germanco. Canco was ultimately repaid by Germanco. Notwithstanding the payment received from Canco, the Minister assessed Germanco for failing to withhold 15% on amounts paid to Serviceco. note6

Multiple Withholdings

One of the main issues in Stora Enso was whether the Minister could raise an assessment against a non-resident payer when the withholding obligation had already been paid (in this case, by Canco). The Court found that it was inappropriate for the Minister to seek to impose multiple withholding obligations in respect of the same payment for the same services. As a result, it was found that there was a "lack of logic in the Crown's position that Germanco should also be withholding and remitting a further 15% to the CRA since Canco has already remitted 15% in respect of the very same services provided by Serviceco". This finding is consistent with the policy behind Reg 105, as described in Weyerhaeuser, to simply secure the payment of any resulting taxes.

The Court did acknowledge that it would be possible for there to be multiple withholdings in certain situations. For example, a subcontract, where one non-resident is contracted to perform services in Canada and in turns subcontracts the work to another non-resident, would give rise to multiple withholding obligations. note7 The difference, of course, is that in a subcontracting situation there are two sets of services being provided, which attract two layers of withholding obligations. This was not the situation in Stora Enso.

The Calculation

Another area of concern for the Court in Stora Enso was the actual calculation of the Reg 105 remittance. The Minister received 15% of the amount paid to Serviceco for its services, being 100% of the amount invoiced by Serviceco. This was lesser than what the withholding would have been had 15% been withheld from the amounts owing to Serviceco. Effectively, the CRA did not receive any withholding in respect of the additional 15% actually paid to Serviceco and the Court ordered the CRA to reassess Germanco in respect of this amount.

This mechanical issue in Stora Enso is an important reminder of the formula to be applied when a payer is contractually required to gross-up a payment made to a non-resident by an amount that is equivalent to the Reg 105 withholding. The following formula will determine the correct amount of withholding: note8

Flat Rate Disbursements

The final and most interesting issue in Stora Enso was how to handle disbursements. Serviceco added a surcharge equal to 10% of the fee for services each month to the invoices, describing such amounts as "out-of-pocket expenses". The issue was whether or not Reg 105 withholdings were required in respect of these amounts. The Court considered the Weyerhaeuser decision, where it was generally found that disbursements and "out-of-pocket expenses" are not subject to Reg 105. However, in Weyerhaeuser, the Court only considered actual out-of-pocket expenses and disbursements incurred. In Stora Enso, the flat rate calculation did not appear to be attributable to actual expenditures. The Court characterized such amounts as "more of a single price all-inclusive bundled contract done in the guise of a surcharge described as out-of-pocket expenses". The Court was "not satisfied that the Weyerhaeuser decision excluding actual reimbursements of disbursements and out-of-pocket expenses should extend to a situation such as this". Accordingly, the Court found that Reg 105 withholdings were correctly remitted on these "out-of-pocket expenses".

In considering whether Reg 105 applied to disbursements in Weyerhaueser, the Court looked at the wording of the enabling legislation, which imposes withholding on amounts "for services". note9 This was compared to the wording in Reg 105 which more broadly applies to "a fee, commission or other amount in respect of services" in connection with an argument that Reg 105 exceeds the power given to the Governor in Council by statute. In finding Reg 105 to be intra vires, the Court stated that "its operation does not extend beyond requiring the payor to deduct and withhold from payments of amounts that are in the nature of fees or commissions that, in the hands of the recipient, have the character of income earned in Canada." This is consistent with the purpose of Reg 105, to ensure ultimate payment of any amounts that might be subject to tax in Canada by virtue of subsection 2(3) of the ITA.

Although not express in the reasoning in Stora Enso, one might suppose, based on the underlying rationale in the Weyerhaeuser decision, that it was not clear on the evidence if the flat rate disbursement charge might be in the nature of income and thus potentially be subject to taxation under subsection 2(3) of the ITA. Any portion of the 10% in excess of disbursements actually incurred would be taxable income earned in Canada by Serviceco. note10 Indeed, the Court commented that it had no evidence that the amounts reflected actual out-of-pocket expenses or that a cap had been applied so as to lower the actual disbursements incurred to the 10% rate. If there had been evidence that the 10% disbursement rate represented all or a portion of actual disbursements incurred by Serviceco, then Reg 105 withholding should not have been required on these amounts. note11

Conclusion

The clear message in Stora Enso is that disbursements must be actually incurred and evidenced in order to protect any reimbursement from the application of Reg 105. In addition, we are reminded that multiple layers of withholding may be applicable in certain circumstances and to take care with the calculation of the Reg 105 withholding. Stora Enso is a carefully considered analysis of Reg 105 and the limits of the interpretive jurisprudence.

Lori A. Mathison, Partner in the Tax Department with the Vancouver Office of Fraser Milner Casgrain LLP

Notes:

1. Income Tax Regulations, Consolidated Regulations of Canada, c. 945, as amended.

2. R.S.C. 1985, c. 1 (5th Supp), as amended (the "ITA").

3. Weyerhaeuser Company Limited v. R., 2007 TCC 65 at para. 6 and 7 ("Weyerhaeuser").

4. Stora Enso Benteiligungen GmbH v. R., 2009 TCC 282.

5. Germanco was actually the successor to a different German corporation that failed to withhold, and which was subsequently reorganized. Germanco assumed all the liabilities in the reorganization and thus was the focus of the decision.

6. Reg 105 applies to "every person", and thus it was technically possible to raise an assessment against a non-resident.

7. See Information Circular 75-6R2 dated February 23, 2005 at para. 27.

8. See Information Circular 75-6R2 dated February 23, 2005 at para. 13.

9. Para. 153(1)(g) of the ITA.

10. See ss. 2(3), 115(1), 3 and 9 of the ITA.

11. It should be noted that the CRA provides administrative exceptions from withholding for certain travel expenses on a per diem basis, without requiring receipts. See Information Circular 75-6R2 dated February 23, 2005 at para. 24.