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Income tax — withholding tax on deemed dividend

A major law firm handled a sale of shares of a Canadian company by its US parent. The law firm made a mistake and overlooked the application of a particular rule in the Income Tax Act that created a deemed dividend (section 212.1). Through a combination of provisions of the Act, the vendor appeared to be liable for 15% withholding tax, some $320,000.

The law firm reported the matter to its insurer, which came to me for assistance.

I agreed that withholding tax applied, but I found a technical argument that reduced the withholding tax from 15% to 5%. The ultimate "beneficial owner" of the deemed dividend was a US company, based on an expansive interpretation of the Canada-US tax treaty that did not apply to the interpretation of the Income Tax Act. I backed up my analysis with extensive discussion of various authorities on tax treaty interpretation.

The CRA auditor agreed with my analysis, and the vendor's liability (and thus the law firm's insurer's liability) was reduced from $320,000 to just over $100,000.

Problem substantially reduced!

(2008)