Canada has repealed the federal capital tax. The elimination of this tax will make easier the crossborder securitization of various classes of Canadian leases and interest-bearing receivables on a tax-efficient basis. This results from the interplay between the Canadian withholding tax on the one hand, and provincial capital taxes on the other.

Canada's withholding tax regime creates a significant hurdle to securitizing leases or interest-bearing receivables in foreign capital markets. Subject to several exceptions, a 25 percent withholding tax applies to interest or rent paid to nonresidents. Although this rate is often reduced by treaty, it rarely falls below 10 percent, and generally renders an off-shore securitization less than desirable.

Notwithstanding the current withholding tax regime, it has been possible to structure cross-border securitizations of interest-bearing Canadian loans free of withholding tax if the loans satisfy the three criteria of a statutory withholding tax exemption:

• The borrower is a corporation resident in Canada (or a partnership having only such corporations as partners);
• with some exceptions (including acceptable events of default), mandatory repayments in the first five years do not exceed 25 percent of the amount of each loan;
• the parties are unrelated and deal at arms-length.

It has also been possible to adapt this long-term corporate debt exemption to structure off-shore securitizations for trusts and short-term loans without attracting withholding tax:

• In one transaction, a Canadian special purpose corporation (SPV) purchased a revolving pool of floor-plan loans, and issued five-year notes to U.S. investors.
• In another, a Canadian SPV borrowed five-year funds from a UK commercial paper conduit and on-lent the proceeds to a Canadian securitization trust.

These structures faced a number of complex issues, including the Canadian tax authority's policies with respect to back-to-back loans, tax minimization at the Canadian SPV level, and the desire to achieve off-balance sheet funding.

While these structures allow corporateloans to be securitized cross-border without withholding tax, they have not been used for leases or consumer assets. This stems from a "capital tax" imposed by certain provinces and, until recently, the federal government.

This capital tax applies to the liabilities and equity of most Canadian corporations, but is offset by an allowance for a corporation's holdings of loans made to other corporations. It is for this reason that capital tax applies when a Canadian SPV obtains off-shore funding to finance leases or consumer loans, but not where the securitized assets comprise solely corporate loans.

With the elimination of the federal capital tax, only provincial capital tax need be considered. Some provinces do not impose this tax; in others it ranges from .3 percent to .525 percent. However, a corporation will only be subject to a provincial capital tax if it has a "permanent establishment' in that province, which will generally depend on (1) the location of its head office and other places of business, (2) the residency of its employees and (3) the residency of certain types of agents that have "general authority to contract" on behalf of the corporation.

Except for Manitoba, an agent having general authority to contract will not constitute a "permanent establishment" if the agent is "independent" and acting in the ordinary course of its own business (such as, if the agent is not related to the corporation and performs services for a number of different entities).

Depending on the facts of a particular securitization, it should be possible to design an SPV so that its only permanent establishment is in a province that does not impose capital tax. By doing so, it would be possible to structure a cross-border securitization of pools of leases or noncorporate loans (such as auto loans, residential mortgages, credit card receivables and loans to REITS) on a basis that avoids both withholding tax and capital tax.

The securitization of more Canadian loans and leases off-shore will enable Canadian originators to obtain increased and lower-cost financing, while at the same time providing U.S. and other foreign investors with a diversified portfolio of well-underwritten Canadian receivables.