US embassy cable - 05TORONTO2634

UNCLAS SECTION 01 OF 02 TORONTO 002634 
 
SIPDIS 
 
STATE FOR EB TONY WAYNE 
STATE FOR WHA/CAN, EB/IFD, INR 
STATE FOR WHA DAS WHITAKER 
USDOC FOR 3000/ITA U/S RHONDA KEENUM 
USDOC FOR 432/ITA/IAA/BASTIAN/RUDMAN/FOX 
TREASURY FOR U/S (INTERNATIONAL AFFAIRS) TIMOTHY ADAMS 
TREASURY FOR U/S (DOMESTIC FINANCE) RANDY QUARLES 
DEPT ALSO PASS USTR FOR J. MELLE AND S. CHANDLER 
DEPT PASS SEC - MARISA LAGO 
DEPT PASS FEDERAL RESERVE BOARD 
DEPT PASS TO IRS COMMISSIONER MARK EVERSON 
WHITE HOUSE/NSC - KIM BRIER AND SUE CRONIN 
 
SENSITIVE 
 
E.O. 12958: N/A 
TAGS: EINV, EFIN, KTIA, PREL, CA, US 
SUBJECT: Canadian Financial Services Sector:  U.S. 
Banks Say, "Ax the Withholding Tax on Interest" 
 
Refs: (A) 04 Toronto 0514  (B) 01 Toronto 1069 
 
Sensitive But Unclassified - Please Protect 
Accordingly. 
 
1.  (U) This message is one in a series reviewing the 
Canadian financial services sector from a cross-border, 
North American integration perspective.  In September 
2005 the Toronto Financial Services Alliance sponsored 
roundtables for ConGen Toronto with industry sector 
experts in venture capital (septel), banking (septel), 
securities (septel), and insurance (septel). 
 
2.  (SBU) SUMMARY: American banks that operate 
wholesale banking branches in Canada say that the 
Canadian and U.S. withholding taxes on income paid to 
non-residents impedes the development of a secondary 
loan market in Canada.  U.S. banking interests in 
Canada are the major victims but Canada and North 
America as a whole are losing out when Canada's 
secondary loan market remains relatively illiquid.  The 
Foreign Banks' Executive Committee (FBEC) at the 
Canadian Bankers Association (CBA) has mobilized the 
major domestic Canadian banks to lobby senior Finance 
Department officials in Ottawa to deal with this issue 
during upcoming bi-lateral Tax Treaty negotiations with 
the United States.  U.S. bank representatives located 
in Toronto ask that the USG encourage Canada to remove 
the withholding tax on income paid to non-residents. 
END SUMMARY. 
 
U.S. Bankers Complain about Withholding Tax 
------------------------------------------- 
 
3.  (SBU) In late September, two CEOs and one senior 
representative of Bank of America (Canada), Citibank 
(Canada), and JP Morgan Chase (Canada) approached the 
Consul General privately to complain bitterly about the 
Canada-U.S. withholding tax on income paid to non- 
residents.  At issue is paragraph 212 (1) (b) of the 
Canadian Income Tax Act (ITA), which deals with 
withholding tax on interest paid to non-residents.  The 
U.S. bankers said current bilateral withholding taxes 
on cross-border interest payments have a very 
detrimental effect on liquidity and, therefore, a 
correspondingly negative impact on the possibility of 
establishing a strong Canadian secondary loan market. 
They argued that they would be strong players in the 
Canadian secondary loan market, if it were permitted to 
become as dynamic as it is in the U.S.  In practice, 
the Canadian ITA keeps U.S. investors all but out of 
the secondary loan market, hitting U.S. banking 
interests, robbing the Canadian market of liquidity, 
and adversely affecting the strength and depth of North 
American integration in financial services. 
 
4.  (SBU) Elimination of withholding tax (or, at least, 
an expansion of the available exemptions) is a major 
priority for the Foreign Banks' Executive Committee 
(FBEC) at the Canadian Bankers Association (CBA).  The 
FBEC has been successful in gaining the support of the 
domestic banks on this issue and is now working to gain 
the support of senior Finance Department officials in 
an attempt to change the ITA.  Canadian Finance 
Department officials have been reluctant to address 
this issue because the projected cost of abolishing 
this withholding tax on interest and dividend earnings 
is worth C$2 billion per year in revenues.  The U.S. 
banking community in Canada would welcome strong U.S. 
support for removing the withholding tax as part of the 
current bilateral tax treaty negotiations. 
 
Withholding Tax Can Lead to Double Taxation 
------------------------------------------- 
 
5.  (SBU) Canada levies a 25 percent withholding tax on 
interest paid or credited to non-residents.  This rate 
has been reduced to 10 percent under many of Canada's 
tax treaties, including the present Canada-United 
States Income Tax Convention.  Canadian withholding tax 
is applied to interest payments made to all non- 
resident non-arm's-length lenders (i.e., related party) 
and to non-resident arm's-length (i.e., unrelated 
party) lenders.  Both countries allow their residents 
to credit foreign withholding taxes against their 
domestic income tax liability to avoid double taxation. 
However, the foreign withholding tax liability 
(applicable to earnings before expenses) can be larger 
than the domestic corporate tax liability (applicable 
to profits), making it a net "border tax" that 
effectively amounts to double taxation (reftel). 
 
Withholding Tax Impedes Secondary Loan Market 
--------------------------------------------- 
 
6.  (U) The withholding tax impedes the development of 
a dynamic secondary loan market in Canada by 
effectively shutting U.S. investors out.  For example, 
one of the deepest and most liquid markets in the U.S. 
is the Public and Conduit Asset Backed Securitization 
market.  In 2002 this market represented approximately 
US$730 billion of liquidity in the U.S.  By contrast, 
the Canadian Securitization market was some US$60 
billion in 2002.  According to the FBEC members of the 
CBA, the withholding tax is one of the main reasons why 
U.S. liquidity does not flow to Canada. 
 
7.  (U) Credit cards, auto loans, leases, and mortgage- 
backed securities are some of the most actively 
financed interest-bearing assets in this market. 
Currently, a Canadian financial institution desiring to 
boost its liquidity by selling a bundle of similarly 
priced and timed interest bearing assets in this market 
will find that U.S. banks, with deep pockets of 
liquidity, are not interested in buying because the 
interest earnings on Canadian assets will be too low to 
make the deal fly once the withholding tax on those 
interest earnings is factored in. 
 
Comment: Time to Ax this Tax 
---------------------------- 
 
8.  (SBU) Both U.S. and Canadian banks believe that the 
withholding tax on income paid to non-residents should 
be axed and measures taken to encourage and develop a 
secondary loan market in Canada.  Bankers argue that 
elimination of (or, at least, significant cuts to) the 
current withholding tax would have a widespread 
positive impact on both the banking and corporate 
marketplace with corresponding positive effects for 
investment and economic development in Canada and North 
America at large.  They argue that the most viable 
method of amending the withholding tax provisions in 
the Income Tax Act is through changes to the bilateral 
Tax Treaty between the United States and Canada. 
 
LECROY