All payments for services performed in Canada by a non-resident of Canada are subject to income tax withholding at a rate of 15%. It is the obligation of the Canadian payor to withhold and remit this amount pursuant to Regulation 105 under Canada’s Income Tax Act.
The rate of withholding is unaffected by any reduction or exemption available under a tax treaty. While it is possible to apply for a waiver, a new waiver must be obtained with respect to each new contract. Blanket waivers are generally not issued.
The amount withheld is applied against the non-resident’s Canadian income tax liability. If a treaty reduction or exemption is available then a rebate may be obtained by filing a Canadian income tax return after the end of the taxation year.
Proceeds from the sale of goods in Canada are not subject to withholding of Canadian income tax. A non-resident must nevertheless file a Canadian income tax return and pay Canadian income tax on such proceeds if the goods are sold in the course of carrying on business in Canada. Canada’s tax treaties generally provide an exemption from Canadian income tax if the business is not carried on through a Canadian permanent establishment.
Under Canadian law, an income tax return must be filed by a non-resident that carried on business in Canada in the taxation year regardless of whether an exemption is available under a tax treaty.
Management fees, dividends, interest, rent, royalties and other forms of passive income are subject to withholding at a rate of 25%, subject to reduction by tax treaty. This tax is referred to as Part XIII tax.
1. Management fees
Canada’s Income Tax Act exempts management fees from Part XIII tax if the non-resident service provider deals at arm’s length with the Canadian payor and provides the service in the ordinary course of its business.
Alternatively, an exemption is available if the fee is charged to reimburse the non-resident for specific expenses incurred for the purpose of performing services for the benefit of the Canadian-resident payor. Such expenses must be particularized (an inclusive fee is not acceptable), there cannot be a mark-up and receipts must be available to substantiate the expenses.
If neither exemption is available then, under Canada’s typical tax treaty, management fees are treated as business profits and are wholly exempt from Canadian income tax if they are not attributable to a Canadian permanent establishment maintained by the non-resident.
2. Dividends
The treaty-reduced rate under the typical treaty is 5% if the beneficial owner of the dividends is a corporation that owns at least 10% of the voting stock. This is the case, for example, with the Canada-Hong Kong Income Tax Agreement (2012). Under the Canada-China Income Tax Agreement (1986), however, this rate is 10%. In all other cases, the treaty-reduced rate for dividends is 15%.
3. Interest
Interest payments between arm’s-length parties are exempt from Part XIII tax if the interest is not ‘participating debt interest’. This concept refers to debt on which interest is contingent upon the use of, or production from, property in Canada or that is computed by reference to revenue, profit, cash flow, commodity price, etc. or by reference to dividends paid or payable on the shares of a corporation (not necessarily the debtor corporation). In other words, participating debt is debt the interest on which could be characterized as disguised dividends.
Given this exemption from non-resident tax on arm’s length interest payments, there is no tax disincentive to sourcing project financing abroad. When, however, debtor and creditor are not at arm’s length, we must rely upon a tax treaty for a reduction or exemption of the non-resident tax which would otherwise apply at a rate of 25%. Pursuant to recent amendments to the Canada-United States Tax Convention (1980), interest payments between the two countries are wholly exempt from taxation in the source country. Under Canada’s other tax treaties, including those with China and Hong Kong, the typical rate is 10%.
4. Rents
There is no treaty exemption or reduction for Part XIII tax upon rents from real property situated in Canada.
5. Royalties
Under Canada’s typical income tax treaty, Part XIII tax on royalties is reduced to 10% while a full exemption is available for:
- software licence fees;
- payments for the use of, or the right to use, any patent or information concerning industrial, commercial or scientific experience (other than such information provided in connection with a rental or franchise agreement); and
copyright and similar fees in respect of the production or reproduction of any literary, dramatic, musical or artistic work (other than payments in respect of motion pictures and works on film, videotape or other means of reproduction for use in connection with television).