Does the 15% withholding tax apply to capital gains?

Q: In February MoneySense published an article that discusses taxation for dividend generated by U.S. stocks held by a Canadian resident. In that article states: “The treaty requires 15% tax withholding on dividends and 10% tax withholding on interest. So if you own a U.S. stock, as a Canadian resident, there will be 15% withholding tax on any dividends earned. If you own a U.S. bond, as a Canadian resident, there will be 10% withholding tax on any interest earned.”

In line with that, I have a few questions for you regarding holding U.S. stocks directly through a self-managed TFSA. Does the 15% withholding tax also apply to capital gains? That is, selling a U.S. stock at a higher price that what you paid for it initially? Secondly, for the withholding charges, is the investor the one reporting to the IRS or would that be done directly by the investment management company? And finally, when is the tax withheld: when the stock is sold or at the end of the fiscal year?

—Ezequiel

A: In regards to your first question Ezequiel, the 15% treaty rate only applies to dividends paid from U.S. corporations. Capital gains on the sale of investments other than real property are not taxed when the recipient is a non-resident, non-citizen of the U.S.—as long as that person has not been in the U.S. for 183 days or more during the tax year. Without a proper withholding document on file with the payer of the income, dividends and capital gains can be withheld at 30%. The fact that the dividend is paid inside of a tax-deferred account like a TFSA or RESP makes no difference to the 15% withholding on U.S. dividends.

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Generally, your investment manager withholds the 15% tax. In turn you receive a credit on your Canadian tax return, since the dividend is also taxable on your T1 General. If the tax is not withheld prior to you receiving the dividend, you need to file a tax return with the IRS to report the income, claim the treaty rate at 15% and pay the tax owed.

The fact that the dividend is paid inside of a tax-deferred account like a TFSA or RESP makes no difference to the 15% withholding on U.S. dividends. Generally, your investment manager withholds the 15% tax and you would receive a credit on your Canadian tax return since the dividend is also taxable on your T1 General. If the tax is not withheld prior to you receiving the dividend, you need to file a tax return with the IRS to report the income, claim the treaty rate at 15% and pay the tax owed.

In regards to your second question, generally, your investment manager withholds the 15% tax and you would receive a credit on your Canadian tax return since the dividend is also taxable on your T1 General. If the tax is not withheld prior to you receiving the dividend, you need to file a tax return with the IRS to report the income, and claim the treaty rate at 15% and pay the tax owed.

Cleo Hamel is a senior tax expert with American Expat Taxes in Calgary

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