Corporations and trusts often make payments of investment income to investors, and those amounts are eventually included in the investors’ income tax returns. Assuming that all parties are in Canada, the burden is on the investor to calculate their liability for income taxes and remit that amount to the Canada Revenue Agency (CRA). But what if a Canadian corporation is paying a dividend to an investor outside of Canada?
If the investment income is being paid off-shore the CRA deems it to be a higher risk for collecting any income taxes that may be due. As such the law shifts the burden for remitting income taxes from the investor (recipient) to the corporation (payer). These payments are referred to as withholding taxes.
Non-residents of Canada are still liable in many circumstances to pay Canadian income taxes on any income that they earn in Canada. For example:
- Assume a person who lives in the United States owns a rental property in Canada. The tenant in Canada is responsible to remit withholding taxes to the CRA on the landlord’s behalf
- The executor of an estate, or the trustee of a family trust may be instructed to make payments to a non-resident beneficiary. These would be subject to withholding and the executor / trustee would be responsible for these payments
- Retired Canadian workers who have chosen to live abroad in their retirement would have their pension payments subject to withholding. The pension administrator would be responsible for remitting these payments
RRSP / RRIF withdrawals:
- Non-residents who have generated eligible RRSP contribution room are allowed to leave their investments in Canada on a tax sheltered basis. However withdrawals from the RRSP are again subjected to withholding taxes payable by the financial institution that keeps custody of the RRSP. The same logic would apply to regular payments from a RRIF
Commissions or Fees:
- If an otherwise non-resident person comes to Canada to perform services in exchange for a fee or commission, these revenues would be subject to withholding taxes. The payer that hired the individual would be responsible for remitting any withholding taxes to the CRA. This point is less widely known but never-the-less is a requirement under the Income Tax Act.
- All interest earned in Canada by non-residents used to be subject to withholding taxes. However, in 2008 those rules were relaxed considerably. Today, normally interest is exempt from withholding in most situations. Rare exceptions would include interest paid to related parties, such as Canadian resident father paying interest to non-resident child; or participating interest, where the rate of interest is tied to the profits, cash flow, revenue of a company or similar.
Spousal or Child Support:
- These amounts used to be subject to withholding, but similar to interest payments these rules changed in 1997. Today, payments made to an ex-spouse who lives abroad are no longer subject to any withholding taxes
These are a very general overview, the rules around withholding taxes are complex and there are exemptions to the rules outlined above which should be considered by anyone who may be liable to remit withholding taxes.
How much tax must be withheld?
The Income Tax Act does provide for different rates of withholding taxes depending on the country to which the payments are being made. The worst case scenario would be in the case where a person resides in a country that does not have a tax treaty with Canada (such as Bolivia, the Bahamas, Paraguay, Saudi Arabia). In these cases the withholding would be 25% of the amount to be paid to the non-resident.
Canada does however have tax treaties with many countries, and those treaties may reduce the rate of withholding required. As of writing, the withholding tax rates may be as low as 10% depending on the type of income and the country payment is directed to. There are 93 tax treaties currently in force between Canada and foreign countries.
Under treaty, withholding taxes may be reduced:
- Withholding reduced to 15%, or even 5% if the non-resident controls at least 10% of the company’s voting shares
- Withholding reduced to 10%
- Trust Income
- Withholding reduced to 15% (assuming all of the trust’s income is earned in Canada)
- 155 on participating interest
Again, exceptions to these rules exist and differ from country to country.
Can non-residents reclaim any of these taxes?
In most situations, no, the withholding taxes represent the final taxes due in Canada. Rather than the withholding representing a pre-payment of tax, similar to payroll deductions, the treaty tax rate is the actual tax bill that is assessed on passive income earned by non-residents.
Having said that, again, there are exceptions. The most common being the withholding taxes on rental income. As rental income is not eligible for a reduction of withholding taxes, it is subject to the full withholding rate of 25%. Further, that is 25% of the gross rents and not net rent after expenses are paid. This treatment may result in an unfair tax burden on a non-resident landlord paying tax on more income than they actually received. In this case, the non-resident can elect to file a tax return in Canada; if that return indicates that a refund is appropriate the CRA will reimburse the non-resident landlord.
What happens if withholding isn’t sent to the CRA?
As mentioned above, the burden under the Income Tax Act is placed on the payer and not the recipient for withholding taxes.
If withholding taxes aren’t remitted to the CRA, the Canadian payer becomes completely liable for any taxes due, and could further be subject to interest and penalties. The standard penalty for non-payment is 10% of the amount owing, but more could be charged if repeated amounts are missed. Similarly, interest is charged at a rate of 5% (as at time of writing) which accrues quarterly and compounds daily. In severe cases, criminal charges could even be laid if it is evident the payer was completely aware of their obligation to withhold but deliberately failed to do so.
If you are making any payments to non-residents it is important to obtain accurate advice as to your possible obligation to withhold and remit income tax.
This blog post was written by Derek Edelkoort, CPA, CGA