Budget Proposal To Affect Gross-Up Clauses In Canadian Loan Agreements

The 2012 Canadian budget has proposed measures to treat interest that is not deductible by a Canadian borrower because of the thin capitalization restriction as being in the nature of a dividend that is deemed to be paid to the relevant nonresident lenders. As a result, a portion of the interest paid to a non- Canadian borrower may instead become subject to the imposition of Canadian withholding tax on the amount of this deemed dividend. The budget legislation was introduced in the Canadian Parliament on October 18, 2012, as Bill C-45 and, in particular, is reflected in proposed subsection 214(16) of the Canadian Income Tax Act.

The proposals are changing the scope of the tax ''gross-up'' clause typically included in loan documentation. Accordingly, non-Canadian lenders should carefully consider its impact before committing to new loan arrangements with Canadian resident borrowers.