U.S. President Donald Trump with U.S. House Speaker Mike Johnson on Capitol Hill in Washington, on May 20.Kevin Dietsch/Getty Images
Canadian investors may not be aware that when they earn income from a foreign investment, they may also be effectively paying a withholding tax to a foreign country.
As countries cannot collect taxes from non-residents directly, most will hold back part of the income a foreign investor receives from a company incorporated in that country.
“It’s just the simple way to make sure the government gets their tax,” says Karl Dennis, partner and national leader of the U.S. corporate tax team for KPMG in Canada.
Now, a provision in U.S. tax legislation passed by the House of Representatives threatens to raise taxes on investors in Canada and in other countries that impose taxes, such as a digital services tax, that the U.S. deems unfair to U.S. corporations.
Under section 899 of U.S. President Donald Trump’s One Big Beautiful Bill, Canadians who hold U.S. securities or invest in U.S. companies through Canadian investment funds could see the rate of U.S. foreign withholding tax on dividends they receive rise significantly.
At this point, cross-border tax experts have different interpretations of just how much the increase would be.
Some understand the bill as increasing the rate of U.S. foreign withholding tax by a maximum of 20 percentage points, either to 35 per cent from the 15 per cent rate available under the Canada-U.S. tax treaty, or to 50 per cent from the 30 per cent statutory foreign withholding tax rate when a taxpayer is ineligible for the treaty rate.
Others interpret the ceiling as 50 per cent, or a maximum of 20 percentage points above the statutory rate of 30 per cent, starting from the treaty rate of 15 per cent, where applicable.
Tax experts say they’re monitoring the progress of the bill and suggest the provision could be revised before its possible enactment.
John Natale, head of tax, retirement and estate planning services, wealth, at Manulife Investment Management, says investors should speak with their financial advisors or tax advisors rather than sell U.S. investments solely because of the proposed legislation.
“Sometimes, people are eager or panic,” Mr. Natale says.
Here’s a brief overview of how U.S. withholding tax currently affects Canadian investors based on the types of investments and where those investments are held.
(The tax implications for U.S. citizens who live in Canada aren’t addressed in this article, as those investors would be treated differently.)
U.S. foreign withholding tax
Under the Canada-U.S. tax treaty, the U.S. imposes a withholding tax of 15 per cent on dividends paid from U.S. companies to Canadian investors, which is half the default rate of 30 per cent under U.S. tax law.
To access the reduced treaty rate, a Canadian investor holding U.S. investments in a non-registered account needs to complete a U.S. W-8BEN form.
The withholding tax applies to dividends but, in general, not to interest from bonds or savings accounts, or to capital gains realized on the sale of U.S. investments. (One exception is real estate: Canadians pay U.S. taxes on interest earned from U.S. rental property and on capital gains from selling U.S. real estate.)
Taxable accounts
In a non-registered, taxable account, a Canadian investing directly in U.S. companies is subject to U.S. withholding tax on the dividends they receive.
When a Canadian invests in a Canadian mutual fund or exchange-traded fund that invests in U.S. equities, the fund itself is the taxable entity in terms of U.S. withholding tax. The fund then distributes the foreign dividend income to the unitholder and reports the amount of foreign withholding tax.
For example, a Canadian investor who is allocated $100 in U.S. dividends would receive $85, with the financial institution remitting $15 to the U.S. Internal Revenue Service.
The financial institution would then issue a tax slip – either a T3 or a T5 – reporting $100 in foreign dividends and $15 of foreign tax paid. The investor would then report the $100 dividend on their income tax return and claim a foreign tax credit for $15.
Under the proposed U.S. tax bill, the withholding rate would increase by five percentage points for every year the foreign country continues to charge an “unfair” tax. (Cross-border experts have different interpretations on whether the increases would max out at 35 per cent or 50 per cent, where a treaty rate of 15 per cent is available.)
Josée Baillargeon, director of taxation policy at the Securities and Investment Management Association, says it’s unclear whether any additional taxes imposed under section 899 above the treaty rate would be eligible for a foreign tax credit or a deduction from income in Canada.
“We’re currently seeking clarification on this matter from the Canada Revenue Agency,” Ms. Baillargeon said in a statement sent by e-mail.
The impact on TFSAs, RESPs, RDSPs and FHSAs
The U.S. doesn’t recognize the tax-deferred status of Canadian registered plans that aren’t retirement accounts, such as the tax-free savings account (TFSA), the registered education savings plan (RESP), the registered disability savings plan (RDSP) and the first-home savings account (FHSA).
That means Canadians who invest in U.S. companies or hold Canadian mutual funds and ETFs that invest in U.S. equities held in TFSAs and RESPs are subject to U.S. foreign withholding tax on dividends, just as they would be if they held those investments in a taxable account.
However, as these plans are tax-sheltered accounts in Canada, the Canadian investor doesn’t receive a tax slip reporting the foreign dividends and foreign withholding tax, nor can they claim the foreign tax credit in Canada to offset the withholding tax.
That means the 15 per cent U.S. withholding tax is a net cost to the investor that can’t be recovered.
RRSPs, RRIFs, LIRAs and LIFs
The U.S. does recognize RRSPs, RRIFs, life income retirement accounts (LIRAs) and life income funds (LIFs) as retirement accounts and tax-deferred accounts.
That means Canadians who invest in U.S. companies, or who hold ETFs listed on a U.S. exchange that invest in U.S. equities, are exempt from U.S. withholding tax on the dividends they receive.
Adam Seliski, partner, international tax and transaction services with EY Canada, says it’s unclear whether retirement accounts would continue to have access to their exempt status if section 899 were enacted.
“That’s something we’re monitoring very closely,” Mr. Seliski says.
Even under current rules, the retirement account exemption isn’t available for Canadian investors who hold Canadian mutual funds and ETFs that invest in U.S. equities.
Canadian U.S. equity funds held in retirement accounts are subject to U.S. withholding tax, and investors don’t have access to a foreign tax credit to offset, representing a drag on fund performance.
While there may be an advantage to holding a U.S. investment directly in a registered retirement account in terms of avoiding U.S. foreign withholding tax, Canadian investors who own U.S. assets must also consider U.S. estate tax implications and the cost of currency conversion.
Editor’s note: An earlier version of this article stated that Canadian investors who own U.S. assets in a registered retirement account must consider annual Canadian foreign reporting obligations. However, there are no reporting obligations for foreign assets in registered accounts.