The Canadian income tax regime differs for resident taxpayers and non-resident taxpayers in Canada. While a Canadian resident (for tax purposes) must pay Canadian tax on their worldwide sources of income, a non-resident Canadian is only liable to pay tax on Canadian sources of income. Canadian sources of income for non-residents include employment income earned in Canada and income earned from businesses operating in Canada. In addition, withholding tax under Part XIII of the Income Tax Act (the "Act") applies to income earned from Canadian properties.
This article will provide general commentary on withholding taxes and will discuss the specific rules in Part XIII of the Act that applies to interest payments made from a Canadian payer to a non-resident.
What is withholding tax and who is responsible to pay it?
A withholding tax is a tax paid to a government by the payer of the income as opposed to the recipient of the income. For example, an employee will often have taxes withheld from each pay cheque by their employer. The amounts withheld by an employer for income tax are indicated in Box 22 of the T4 slip issued to the Canadian employee and are remitted to the Canada Revenue Agency.
The withholding tax under Part XIII operates differently from the taxes withheld on most Canadian employee's earnings. First, Part XIII of the Act only applies to the Canadian sourced income of a non-resident person. Common types of payments on which taxes need to be withheld are interest payments, rents, royalties, pension benefits, and dividends. Second, the withholding tax is set at flat rate of 25% of the payment made to a non-resident. If all the income for a non-resident from Canadian sources is subject to withholding tax, the non-resident is not required to file a tax return. Canada has also entered into tax treaties with many countries which may reduce the rate of withholding tax on certain payments.
With respect to who is on the hook for the withholding and remittances, the Act creates an obligation on the payer to withhold the tax under subsection 215(6). However, even if a payer fails to withhold tax and remit those amounts to the CRA, a non-resident is also liable to pay these amounts to the CRA under subsection 212(1) of the Act. In other words, a non-resident is still liable for withholding tax even if the payer failed to withhold the amounts.
Interest under Part XIII – Tax on Income from Canada of Non-Resident Persons
The tax treatment of interest payments made from a Canadian payer to a non-resident is described under paragraph 212(1)(b) of the Act. The current tax treatment of interest payments to non-residents changed significantly about 10 years ago, with the changes being effective as of January 1, 2008.
Under the current regime, interest payments to non-resident are subject to withholding tax in two situations: if the debt is "participating debt interest" or if the debt is from a non's arm's length payer and is not "fully exempt interest" under the Act. In other words, an arm's length payer of interest to a non-resident is not subject to withholding tax except when the debt is "participating debt interest" as defined by 212(3) of the Act. Very generally, participating debt interest is interest that is dependant on the performance of the payer's business or investments.
The Act provides guidance, to some extent, as to whether parties are arm's length from each other. For starters, subsection 251(1) deems that "related persons" cannot deal with each other at arm's length. This means that any individuals connected by blood relationship, marriage or common-law partnership or adoption cannot be arm's length parties in any circumstances. In addition corporation and individuals can be "related persons" depending on the structure of control of the corporations.
Tax Tips – Withholding tax for Non-Residents
While a flat rate of withholding tax for non-residents on Canadian sourced income may seem like a simple concept, some of the provisions under Part XIII can be quite nuanced. Since a non-resident is liable for tax even if the payer of the Canadian income fails to withhold, a non-resident should take care to make sure withholdings are occurring when required. If not, the non-resident could be liable not only for the 25% tax, but for penalties on late remittances.
The withholding tax that applies to Canadian sourced income from property for non-residents is only one part of the non-resident taxation regime. For example, there are different rules that apply to non-residents with respect to the disposition of taxable Canadian property. If you are a non-resident with Canadian sourced income and are concerned about whether you are compliant with your obligations under the Act, contact our top Toronto Tax Lawyers.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.