Filing taxes while holding U.S. investments in Canada

Q: I have investment money that originated with a U.S. management company, but I moved it to a Canadian management company, keeping it in U.S. dollars.

Is this investment still considered U.S. dollars taxed by U.S. tax laws or are they considered under Canadian investments and must follow Canada’s tax laws?

—Peter

A: Canadian residents are taxable on their worldwide income, Peter. So it doesn’t matter where your investments are located. It doesn’t matter what currency you’re holding. All that matters is that you reside in Canada, so the Canada Revenue Agency (CRA) wants their fair share of income tax on any income earned anywhere in the world.

In fact, there is even a special form called a Form T1135 – Foreign Income Verification Statement that is meant for reporting foreign assets and income to the CRA. It is used to report “specified foreign property” if your cost for certain foreign assets exceeded $100,000 Canadian (based on the exchange rates at the time of purchase) at any time during the year.

Most “investment assets” like U.S. stocks would be considered specified foreign property, whereas personal-use real estate like a vacation property that is not rented out and only used personally would be excluded.

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Unless you are a U.S. “person”, Peter – generally a citizen or resident – your only tax obligations to the Internal Revenue Service (IRS) would be withholding tax. The IRS, the U.S. taxation authority, requires tax withholding on certain types of income based on the country of residence of a foreign person. Canada and the U.S. have a tax treaty called the Convention Between Canada and the United States of America originally signed in 1980 with various protocols (amendments) since then.

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.

The investment management company or financial institution where you own your U.S. investments should have had you fill out a Form W-8BEN, Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding and Reporting. Without this form, the default withholding tax rate for a foreign person earnings dividends or interest in the U.S. is 30%.

So if a Canadian like you, Peter, owns U.S. investments that have been subject to withholding tax of 15% (dividends) or 10% (interest), that income still needs to be declared on your Canadian tax return. However, you do get to claim the foreign tax already withheld. CRA allows you to claim a foreign tax credit for foreign tax paid in order to avoid double taxation of the income.

If you haven’t completed the Form W-8BEN for the reduced tax withholding, the excess tax withholding can only be refunded by filing a U.S. tax return, which can cost more than the potential tax refund in many cases.

Of note is that Canadian dividends qualify for a reduced tax rate due to something called the dividend tax credit. U.S. dividends are taxed at a higher rate (unless you own Canadian companies that are listed on a U.S. stock exchange – many companies are inter-listed).

For perspective, the tax rate for a Canadian dividend for someone earning $50,000 of income ranges from 8% to 19% depending on your province or territory of residence. This compares to 28% to 37% for U.S. dividends.

At $100,000 of income, the Canadian dividend tax rate range is 15% to 29%, versus 36% to 46% for U.S. dividends.

It is also important to note that registered accounts like RRSPs have an exemption from U.S. withholding tax if you own U.S. stocks, bonds or ETFs that own U.S. investments directly. But if you own a Canadian mutual fund or ETF that owns U.S. investments, the fund itself will have withholding tax that reduces the return on these investments in your registered account.

TFSAs have no such exemption from U.S. withholding tax. At least not yet.

In summary, Peter, it’s not the currency your investments are in or even the country they are in that matters for a Canadian resident. You’re taxed on that income regardless. There are some nuances related to withholding tax in registered accounts, but in a taxable, non-registered account, your all-in tax will generally be the same whether the investments are in Canada or the U.S. or either currency. Where and how you hold your investments is then more of a strategic and procedural decision as opposed to a tax one.

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Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.

About Jason Heath, CFP

Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto. He does not sell any financial products whatsoever.

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