New Rules Update the Basics of Cross Border Taxation

Recent changes have been made to the US-Canada Tax Convention (See July 10 release from The Department of Finance).

In essence the release indicates that Canada agrees with the Technical Explanation of the Fifth Protocol that was issued by the IRS on July 10.

The Knowledge Bureau is pleased to announce that an newly updated version of The Cross Border Taxation Course by John Mill is available to keep Real Wealth Managers© abreast of the application of the changes. This interesting course will especially prepare you to better work with clients who have questions about residency relating to their travels in and out of the US. A short excerpt of this course follows:

The basic structure of the taxation of non-residents in both Canada and the U.S. involves two types of taxation. These types of taxation require either:

  1. the filing of a tax return; or

  2. withholding taxes on the gross amount of the payment. In general terms the dividing line between these types of taxation is whether the income is active or passive.

Tax Returns

Tax returns must be filed for:

  • employment;

  • business; and

  • taxable property dispositions.

Employment and business are dealt with in this chapter; the issues related to property dispositions are dealt with in the "Property" chapter. Both countries allow elective returns for rental income (see Property chapter); and Canada allows a return to be filed for pension income.

Withholding Taxes

The basic withholding tax rate in Canada is 25%. This basic 25% withholding rate is reduced by the Canada-U.S. tax treaty for all items of income except rent. Canada imposes a 15% withholding rate on payments to independent service providers.

The basic withholding rate in the United States is 30%. This basic 30% withholding rate is reduced by the Canada-U.S. tax treaty for all items of income except rent. The United States imposes a 10% withholding rate on the sale of real property owned by non-residents.

Exemptions

Certain items of income received by non-residents are exempt from taxation. Exemptions are found within the general taxation law and are further expanded by exemptions granted by the tax treaty.

In Canada these items include certain types of management fees, royalties and interest.

In the U.S. these amounts include interest paid by banks and insurance companies. In addition certain types of royalties and management fees are exempt from taxation.

The tax treaty adds exemptions for certain types of employment income, and business income. In addition the tax treaty exempts capital gains from the sale intangible property (shares) from taxation.

Treaty Rules

The tax treaty significantly modifies the source and withholding rules as follows:

Salaries, wages, compensation

-

must be more than $10,000 or 183 days

Sale of Inventory: business profit

-

permanent establishment

Interest

-

10% withholding

Dividends

-

5% or 15% withholding

Rents

-

no change

Patent, copyright, royalties, etc.

-

10% withholding or exempt

Sale of real property

-

shares of foreign corp. exempt

Sale of personal property

-

exempt

Pensions

-

15% withholding (periodic)

The tax treaty extends the number of situations in which income earned by non-residents is not taxable in the U.S. (and Canada). The most notable of these situations are:

  1. Personal services performed in the U.S. are not at taxable if they are:

    • Dependant personal services performed for a Canadian employer for less than 183 days in a year in the U.S.

    • Independent personal services performed in the U.S. for a U.S. employer for less than 183 days in a year in the U.S.

  2. Business income unless there is a permanent establishment

  3. Capital gains arising on the sale of personal property

In the absence of the treaty these items would all be U.S. source income. The treaty does not affect the source of these items of income -- it simply provides that these items of income are not taxable in the U.S. It is important to note that income sourced in the U.S. but exempt by treaty requires the filing of treaty based return.

Excerpted from Cross Border Taxation which has been updated for 2008. This course is a core course in the Investment Planning Services Specialist program and an optional course in the Tax Services Specialist program.