Withholding Tax on Capital Distributions to Non-Residents
It is generally understood that income distributions by trusts to
non-resident beneficiaries are subject to part XIII withholding tax
(paragraph 212(1)(c)), but many people are confused about whether to
withhold on capital distributions by trusts to non-residents. Such
distributions are common in, for example, family trusts where some
family members have moved to the United States. (We do not address
distributions from mutual fund trusts in this article.)
Although paragraph 212(1)(c) and subsection 212(11) create a withholding
tax obligation on certain capital payments, not all capital
distributions are caught. If the payment of capital does not fall within
the scope of paragraph 212(1)(c), no withholding tax will apply.
Two specialized rules may also apply:
Taxable capital gains distributed to non-resident beneficiaries
are subject to part XIII withholding tax because a taxable capital gain
is considered income under income tax law, but not under trust law.
Thus, in the absence of certain rules in section 212, withholding tax
would not apply. However, to protect the Canadian tax base, subsection
212(11) deems any distribution from a trust to a non-resident
beneficiary to be a payment of trust income, which causes the imposition
of tax under paragraph 212(1)(c). Although subparagraph 212(1)(c)(i)
carves out any amount deemed by subsection 104(21) to be a taxable
capital gain of a non-resident beneficiary, the carve-out does not apply
in this situation because a non-resident beneficiary will not meet the
residence requirement in subparagraph 104(21)(b)(ii).
Capital dividends distributed to non-resident beneficiaries are
subject to part XIII withholding tax. Further, any payment to a
non-resident beneficiary that is derived from a capital dividend
received by the trust is also subject to this withholding tax; thus,
trustees must track which trust properties trace their origins to
capital dividends. Any payment made by the trust to a beneficiary will
be considered income of the trust under subsection 212(11), and
therefore subparagraph 212(1)(c)(ii) will apply to subject the amount to
withholding tax where it "can reasonably be considered . . . to be a
distribution of, or derived from, . . . a dividend on a share of the
capital stock of a corporation resident in Canada, other than a taxable
Part XIII withholding tax does not apply to distributions of the
non-taxable portion of capital gains to non-resident beneficiaries.
Although the preceding discussion concerns withholding taxes to be paid
by trusts, it is also possible that a non-resident beneficiary may have
to pay part I withholding tax. Suppose that a non-resident beneficiary
disposes of a capital interest in the trust (for example, by a
distribution by the trust of property in satisfaction of that interest)
and the capital interest is taxable Canadian property (TCP). TCP is
defined to include an interest in a trust where more than 50 percent of
the FMV of the interest derives from real or immovable property in
Canada. In this situation, withholding tax obligations could arise under
section 116. However, the non-resident beneficiary can apply for a
certificate of compliance to apply withholding tax only on the net gain
rather than on the FMV of the capital interest, which could reduce or
eliminate withholding tax altogether.
Certain exemptions from part XIII tax may be available if the conditions in subsection 212(9) are met.
If the income is designated income as defined in section 210, withholding tax may apply under part XII.2 instead of part XIII.
Henry Shew and Matthew Cho
Cadesky Tax, Toronto