As Dirty Harry famously said, "A man's got to know his limitations."
So when readers tossed me a bunch of exceedingly complex tax questions in response to last week's item about U.S. dividends, I knew better than to tackle them myself. Instead, I did what every self-respecting journalist who is way over his head does: I called an expert.
Jamie Golombek, managing director, tax & estate planning, with CIBC Private Wealth Management in Toronto, graciously accepted the challenge. Investor Clinic is grateful for his efforts, which included tracking down other experts at the bank to verify especially esoteric aspects of foreign dividend taxation.
Here are your questions, and his answers. You may want to pour yourself a stiff coffee before you begin.
I read with great interest your column concerning withholding taxes for dividends on U.S. stocks held in registered retirement savings plans and registered retirement income funds (no withholding taxes in these situations). Would you know if the same holds true with respect to other foreign stocks such as Germany, France, Sweden, etc.?
No, unfortunately not, as other countries have different rules.
The exemption from withholding for U.S. dividends paid to a Canadian registered retirement plan is provided for explicitly in the Canada-U.S. tax treaty. The tax treaties Canada has with other countries are not as generous.
Many European countries, for example, require tax withholding at the statutory rates. Canadians investing in foreign stocks should look at both the tax law of the foreign country and the tax treaty it has with Canada.
There is one tax question on U.S. dividend-paying equities that you did not touch on that I was hoping you could shed some light on: master limited partnerships (MLPs). I recently purchased an MLP and hold it inside my RRSP and was surprised to notice that when the dividend was paid there was U.S. tax withheld on the dividend. Can you please explain why this occurred and if there is any way for Canadian investors to avoid paying this tax?
A U.S. master limited partnership is a public partnership traded on an equities exchange. Most U.S. MLPs are generally in the natural resource or real estate business.
Distributions of income from MLPs are generally distributions of business income, which is treated differently than dividends paid on U.S. stocks. As a result, MLP income is subject to a 35 per cent withholding tax, which is not reduced by the Canada-U.S. tax treaty. Is there a way to avoid this tax? The answer is no, if it's in an RRSP. If it's held outside a registered account, you may be entitled to a foreign tax credit for some of the withholding tax against Canadian tax payable on that investment income.
How are U.S. limited partnership dividends or distributions treated fiscally inside and outside a RRIF?
A U.S. limited partnership that has income "effectively connected" with a U.S. trade or business must pay 35 per cent withholding tax on the effectively connected income that is allocated to its foreign (e.g. Canadian) partners.
This withholding tax is not reduced by the tax treaty and applies equally when such income is paid inside or outside a RRIF or RRSP.
What form do I fill out and whom do I send it to, to stop U.S. withholding tax on U.S. dividends? I hold these in both my RRSP and tax-free savings account and understand that only the RRSP qualifies for the relief.
With an RRSP, no form is necessary and your RRSP issuer should be taking care of that on your behalf to ensure that no withholding tax is being taken off U.S. dividends paid to your Canadian RRSP. If tax is being withheld, contact your RRSP issuer immediately to get the matter resolved.
TFSAs do not qualify for this complete exemption. However, they still qualify for a reduced 15 per cent treaty rate on U.S. dividends (which is less than the 30 per cent U.S. statutory non-treaty rate). A TFSA holder is required to complete a W-8BEN Form to be eligible for this reduced withholding.
I was under the impression that by completing form W-8, one can avoid the 15 per cent withholding U.S. tax on U.S. dividends in a non-registered account. This information comes from my son, a previous Merrill Lynch trader and founder of a hedge fund in New York. Is this correct?
A: No. The W-8BEN Form only gets you a reduction from the 30 per cent U.S. statutory withholding rate to 15 per cent withholding on U.S.-source dividends paid to a non-registered account.
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