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Withholding Tax on Payments to Non-Residents

We incorporate a lot of Canadian corporations that have non-residents as directors or shareholders of the corporation. And, although it's easy for most non-residents to create or take part in Canadian companies, it's perhaps not so easy to be aware of the Canadian income tax rules that apply when the company wants to pay money to or for non-residents. One of those rules has to do with "withholding tax", which is sometimes called "Part XIII" tax for the section of the Income Tax Act (Canada) in which it arises.

Before we go further, let's clear up some terminology. In this article, "Canadian corporation" means a corporation or company formed either federally in Canada or in any one of the provinces or territories of Canada. (We tend to favour British Columbia companies, because they don't require non-residents to find a Canadian-resident director to be part of the board of directors and because the BC corporate laws are relatively more flexible than the laws in other parts of Canada.) A "non-resident" means someone who files their income tax returns outside of Canada.

The general rule is that whenever a Canadian corporation makes almost any kind of payment to a non-resident, the corporation must pay a tax, called a "withholding tax", to the Canadian government.

The kinds of payment that attract withholding tax include: interest, dividends, investment income, rental income, royalties, mutual fund distributions, pensions, annuities, and payments for acting services in films or videos.

The default rate for withholding rate is 25 percent. This rate can be reduced if a tax treaty exists between Canada and the country in which the non-resident lives. (This will be the case for most major countries, including the US, the UK and many Asian countries.) For example, under the Canada/US Tax Treaty, the rate for withholding tax on most payments of dividends is 15 percent and, in some cases, is as low as 5 percent.

In other words, if your Canadian corporation has to pay some dividends or interest to a non-resident, be sure it withholds the required Part XIII tax and pays only the net amount to the non-resident. If the non-resident is a member of a treaty country (such as the US), they will usually be able to claim a credit for the withholding tax, so that there's no double-taxation to the non-resident on these payments from the Canadian corporation.

You can learn more about withholding tax directly from the CRA website and their booklet, T4061 Non-resident Withholding Tax Guide or by calling the International Tax Services Office toll free at 1-800-267-3395 (in Canada and the United States), or from other countries at (613) 952-2344 [phone numbers current as at October 2006].

Let's review some highlights from the T4061 Guide:

  • To begin remitting, your Canadian corporation must apply for a non-resident tax account number, using Form NR75, Non-Resident Tax Remitter Registration Form.
  • Remittances can then be sent in using the voucher on the back of Form NR75 or by using Form NR76, Non-Resident Tax – Statement of Account.
  • Each remittance of withholding tax must be made by the 15th day of the month following the month in which the payment was made to the non-resident. Failure to pay the remittance on time can result in penalties and interest.
  • If the non-resident who received the payment thinks too much was withheld, he can apply to the Canadian tax department for a refund using Form NR7-R, Application for Refund of Non-Resident Tax Withheld. This has to be done no later than two years after the end of the year in which the original withholding happened.
  • By March 31 of each year, the corporation must file an NR4 Return, with the NR4 Summary Slip and NR4 Slips. The NR4 Summary Slip just summarizes the information on the NR4 Slips. You'll prepare one NR4 Slip for each non-resident who was paid out of the corporation, and send them a copy of that slip for filing with their personal income tax return. There are penalties for late filing of the NR4 Return or slips, and for sending out the slips late to a recipient.
  • Remember that, in Canada, directors of companies can be held personally liable for failing to make the company pay required income tax.
  • There are special rules, which can reduce the amount of tax withheld, for people receiving rental income from Canadian real estate or pension income, and for actors. If you fall into any of those categories, make sure you get proper professional advice.

In any event, the take-away message from today's article is that if you're a non-resident receiving payment from a Canadian corporation or a Canadian corporation having to pay non-residents, make sure you're up to speed on Canadian withholding tax. Remember that tax authorities do share information between countries, because of the tax treaties, so don't think you can ignore withholding tax requirements.

Complying with withholding tax requirements is definitely an area where you'll want to get professional advice, on both sides of the border, so you and your Canadian corporation are fully aware of the all the rules you need to follow to stay out of trouble with the tax authorities.

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