PAYING NON-RESIDENTS — WATCH OUT FOR WITHHOLDING TAX!
Under our Income Tax Act, non-residents of Canada are subject to Canadian withholding tax on various kinds of income paid to them by Canadian residents. If you are a Canadian resident making such payments to a non-resident, you must withhold the required amount and remit it to the Canada Revenue Agency within a prescribed period. These rules cover, for example:
- Rent for the use of property in Canada
Example: you rent a house from a landlord who lives in Hong Kong and purchased the property as an investment, and who does not use a rental agent in Canada to collect the rents.
- Royalties (but not book royalties)
Example: your business licenses a film from a company in Italy.
Example: your corporation pays dividends to a US resident who invested in the business as a shareholder.
(Taxable shareholder benefits are deemed to be dividends for this purpose.)
- Estate or trust income
Example: you are executor of an estate, and income earned since the deceased’s death is payable to a beneficiary in Mexico.
- Pension income
- RRSP/RRIF withdrawals
- Commissions or fees for services rendered in Canada. (While the rest of the non-resident withholding tax rules are in section 212 of the Income Tax Act, this one is buried in section 105 of the Income Tax Regulations and is often overlooked, even by many accountants.)
Example: a motivational speaker who now lives in the Bahamas comes to Canada to lecture to your employees.
Interest payments were formerly subject to withholding tax in all cases. Since 2008, the tax no longer applies most of the time. However, it does apply to interest paid to a person with whom you don’t deal at arm’s length, such as a relative; or if the interest is “participating debt interest”, meaning (in very general terms) that the interest rate is calculated by reference to revenue, profit, cash flow, commodity price or dividends.
Alimony, spousal support and child support were formerly subject to withholding tax. This was eliminated in 1997, and so you do not have to worry about withholding tax on any such payments that you make to a spouse or ex-spouse who now lives outside Canada.
The non-resident withholding rules are very complex, and there are many exceptions and qualifications, both in the Income Tax Act and in Canada’s tax treaties with other countries.
Amount to be withheld
The amount to be withheld is, according to what is written in the Income Tax Act, 25% (15% for commissions or fees on services rendered in Canada). If the payee is resident in a country with which Canada has no tax treaty (e.g., Bahamas, Bolivia, Cayman Islands, Paraguay, Saudi Arabia), you must normally withhold the full 25%, and send those funds to the CRA.
However, for most countries you must find out whether the tax treaty between Canada and that country reduces the withholding tax. The rate that applies will depend on the type of payment as well as the country of residence of the payee. Canada has tax treaties with 94 countries or jurisdictions (including Hong Kong and Taiwan).
For example, here are some of the reduced rates of withholding tax provided by the Canada-United States tax treaty:
15% (reduced to 5% if the shareholder is a corporation that owns at least 10% of the Canadian company’s voting stock)
Estate or trust income
15% (for income arising in Canada)
15% on “participating debt” interest; 0% otherwise (i.e. on interest to a non-arm’s length person which would otherwise be subject to Canadian withholding tax)
15% (for a “periodic pension payment”, including a RRIF distribution up to certain limits each year)
Rent (real property)
25% (no reduction, as the treaty does not deal with such payments)
10% (0% for most payments for use of a patent, computer software or technology)
You can find the text of all of Canada’s tax treaties on the Department of Finance website, at www.tinyurl.com/can-treaties — scroll down to “Status of Tax Treaties”, click on that and then on “I. In Force”.
Can the non-resident get back the tax?
Generally, no. The non-resident withholding tax on passive income is normally the actual tax, not a prepayment on a tax to be calculated later (as is the case for employee payroll deductions that are withheld at source, or the withholding tax on RRSP and RRIF withdrawals by Canadian residents). The non-resident normally does not and cannot file a tax return in Canada to report the income.
There are some exceptions, however. The most significant is for rent on real property. The non-resident can elect to file a regular Canadian tax return to report the income, and to pay tax at normal graduated Canadian rates (that apply to Canadian residents) on the net income from the property, rather than having 25% withheld on the gross rental income. Where the expenses of the property are significant (e.g., mortgage interest, utilities, property taxes, property management fees and insurance), the non-resident will normally do this. In such cases, arrangements can be made in advance to reduce the amount that has to be withheld from each payment of rent.
For commissions or fees on services rendered in Canada, the non-resident does file a Canadian tax return, and pays regular Canadian tax, with a credit for the 15% tax withheld by the payer.
What happens if you don’t withhold or don’t remit?
If you fail to withhold the required percentage from each payment, you are liable for that percentage (or possibly more, if the amount you pay is considered to be a “net” amount after withholding tax). You are also liable for interest and penalties, which can be quite substantial. Interest compounds daily at a prescribed rate which changes quarterly (currently 5%). The penalty is normally a flat 10% of the amount you failed to withhold, but can be much higher for repeated violations or intentional failure to withhold. Criminal sanctions can also apply if you know about these rules and your failure to withhold is deliberate.
Similarly, if you withhold tax but fail to remit it to the CRA by the due date, you will be liable for the tax plus interest and penalties. The funds that you have withheld are considered to be held in trust for the federal government; you must not consider this as your own money.
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 withholding tax.