When a Canadian resident makes a payment to a non-resident, the Canadian payor is required to withhold 25% in certain circumstances. Generally, the requirement arises where the payment is of a passive nature – this includes interest, dividends, rents, and royalties, amongst others. Payments from non-resident to non-resident in relation to property in Canada are also often to subject withholding taxes in relation to passive sources of income.
What income is subject to Withholding Tax?
Section 212 of the Income Tax Act (Canada) (the “Tax Act”) specifically requires a withholding for the following:
- Management fees;
- Estate or trust income;
- Royalties (including those from trademarks, patents, secret formulas, and certain visual media);
- Timber Royalties;
- Payments by cooperatives to members;
- Pension Benefits (including Canada Pension Plan and Old Age Security);
- Non-competition amounts;
- Retirement Compensation Arrangement benefits;
- Retiring Allowances (including termination and severance payments);
- Registered Retirement Savings Plans;
- Deferred Profit Sharing Plans;
- Registered Retirement Income Fund Payments; and
- Several other types of payments
The specific application of the withholding tax to any of the above-mentioned sources of income must be considered alongside the jurisprudence, CRA technical interpretations, and any tax treaties which may affect whether withholding tax is actually exigible. For instance, in the case of management fees, an applicable treaty provision may deem such payments to be business profits and, therefore, not subject to Part XIII tax. As another example, royalty and rent payments are often reduced by treaty. Consultation with a tax professional is essential.
Subsection 212(13) of the Tax Act is a deeming provision. It broadens the application of the Part XIII withholding to capture payments made by non-residents to non-residents in respect of property situated in Canada. In the case where payments are made between non-residents, the rules contained in Part XIII should be carefully reviewed to determine whether withholding tax is exigible.
Who is liable for the tax?
The payor is liable for withholding the tax and remitting it to Canada Revenue Agency (“CRA”). Subsection 215(6) of the Tax Act provides that the payor becomes liable for all amounts that should have been deducted or withheld. This can expose, for example, a tenant or property manager to tax risk, where the landlord is a non-resident.
The payee is also liable, as they have failed to pay the 25% tax in accordance with subsection 212(1) of the Tax Act. CRA can seek to enforce payment against the recipient payee, but success in this endeavour is predicated, in part, upon the willingness of one country’s revenue authority to enforce another’s taxes (for example, see Article XXVI A of The Canada-US Income Tax Treaty).
In the Solomon decision (2007 TCC 654), the issue was whether the taxpayer (who became a resident of Switzerland) was properly assessed on Canada pension and social security income he received. Importantly, the judge explained that subsection 215(6) of the Tax Act does not shift that tax burden to the payor, because, in part, subsection 227(8.1) of the Tax Act creates joint liability for the payor and payee. The Solomon case is also of interest as an example of the possible benefits of a tax treaty: the tax treaty in question had the effect of reducing the withholding rate to 15%. Indeed, it is critical to determine (a) whether a tax treaty exists and (b) whether that treaty provides for a reduced withholding.
There are also filing obligations on the payor which are canvassed in NR4 - Non-Resident Tax Withholding, Remitting, and Reporting – 2013 (http://www.cra-arc.gc.ca/E/pub/tg/t4061/t4061-e.html or bit.ly/VEK7B0). The NR4 information return provides information to CRA on amounts paid to the non-resident. This tax does not generally, subject to the below commentary, require a filing on the part of the non-resident recipient.
Special Exception for Rental Income
Section 216 allows rental income to be taxed on a net rather than gross basis. Thus, a taxpayer is provided with the option of either paying withholding tax on gross rental income or electing to pay Part I tax on a net basis. If rental income is tax on a gross basis, it would ignore the fact that many non-resident landlords face mortgage interest payments, maintenance, and other expenditures. Without section 216 of the Tax Act, if the withholding exceeded the net income on a given property, the tax would be highly punitive.
Although not canvassed in this posting, section 216 also provides for payments on net for timber royalties.
The Canada-US Income Tax Treaty
Many countries have entered into tax treaties with Canada. The Canada-US Income Tax Treaty is used in this article for illustrative purposes. Importantly, applicable withhold rates vary between treaties.
Indeed, certain withholding obligations are reduced by operation of The Canada-US Income Tax Treaty. These withholding obligations have changed over time, and it is important to be cognizant of any Protocols to the Treaty, which may further alter withholding rates.
In the case of dividends, the withholding is limited by Article X to 5-15% of the gross amount of the dividend, depending upon the percentage of the company owned by the non-resident. In the case of interest, the withholding is limited to 0% by Article XI. In the case of royalties, the withholding is limited by Article XII to 10%, but may not be subject to any withholding, depending upon the nature of the royalty. In the case of pension income, the withholding is limited to 15% by article XVIII. In the case of estate or trust income, the withholding tax is limited by article XXII to 15%.
In transactions involving, for example, payments of dividends, interest, rents, and royalties to non-residents, careful consideration must be given to Part XIII tax. As the withholding obligation rests with the payor, payors should be vigilant in determining whether such payments are taxable and whether there is relief from the 25% pursuant to the applicable tax treaty, if any.