Withholding Tax Issues

In Sentinel Hill No. 29 Limited Partnership v. Canada (Attorney General), 2008 ONCA 132, the Ontario Court of Appeal held that the Superior Court is not the place to resolve disputes involving assessments under the Income Tax Act (Canada) (the “Act”). That much is not surprising: in general, non-tax courts run as fast as they can from tax disputes, given the chance. The case illustrates, however, a nasty gotcha in international taxation that any practitioner who does cross border work should watch out for.

The appellant paid certain amounts to a non-resident that the appellant deducted in computing income on the basis of a ruling received from the CRA. Because the amount was deductible (or so the appellant thought), the appellant was required to withhold and remit amounts of withholding tax under Part XIII of the Act. Under its agreement with the non-resident, the appellant grossed up the amount payable to the non-resident and deducted and remitted Part XIII tax on the grossed-up amount.

The CRA later reversed its ruling and denied the appellant a deduction for the amounts paid to the non-resident. The appellant, understandably enough, claimed that it should receive a refund of the Part XIII tax that it had paid (in effect), but the CRA denied the claim on the basis that only the non-resident was entitled to claim back the withholding tax because Part XIII, legally, imposes tax on the non-resident payee. The appellant then launched a suit in the Superior Court on the grounds that the CRA had been unjustly enriched.

The Superior Court dismissed the action on a motion by the Crown, and the Court of Appeal upheld that decision. The Court of Appeal, unsurprisingly, held that the Act provides a complete code for resolving tax disputes. It was too bad for the appellant that it had borne the economic cost of the tax by entering into a gross-up agreement with the non-resident that removed any incentive it had to claim back the Part XIII. The Court wrote (at ¶13):

It would appear that if the person resident in Canada who is obliged to withhold and remit to CRA wants the ability to claim a refund from CRA in case of an incorrect or over payment, it must have an assignment or other legal arrangement with the non-resident that allows the resident to assert the non-resident’s rights. Without such an arrangement, no one other than the non-resident is owed a remedy; therefore there is no gap in Part XIII.

The moral of the story? If your agreement with a non-resident requires you to remit and withhold tax on amounts paid to the non-resident, and anything in your agreement reduces or eliminates the incentive the non-resident would otherwise have to claim that tax back in the appropriate circumstances, be sure that your agreement allows you to assert the claim on the non-resident’s behalf.