Most people have heard the phrase “withholding tax”. And most people know that withholding tax may be applicable to payments that are made to non-residents of Canada. A very common scenario is where a Canadian estate or trust has U.S. beneficiaries. I recently encountered this type of situation – a Canadian estate had one Canadian beneficiary (who was acting as executor of the estate), and the rest of the siblings were U.S. persons (and were non-residents of Canada for tax purposes). The estate distributed cash to the three U.S. resident beneficiaries. The estate was told that it had to remit 15% withholding tax on the distribution of cash (the regular withholding rate is 25%, but the Canada-U.S. tax treaty reduces the withholding amount to 15%), and it sent a substantial amount of additional tax to the government. I immediately informed the client that I thought this was an error, and that the Part XIII withholding tax was not applicable to this distribution.
At first glance, the advisors involved had thought that since this is a payment to a non-resident, withholding tax is applicable. However, it is important to understand that not all payments to non-residents are subject to withholding tax. In this context, the money distributed from the estate represented, essentially, tax-paid “capital” of the estate. This was cash that was already included in the income of the deceased taxpayer on the deceased taxpayer’s terminal return. It largely consisted of funds that were in the deceased taxpayer’s RRIF, which was fully included in income in the deceased taxpayer’s terminal return. Although income of an estate or trust is subject to withholding (per paragraph 212(1)(c) of the Income Tax Act), this distribution of already-taxed cash, did not rightfully fall under paragraph 212(1)(c) of the Income Tax Act. (On a technical note, although subsection 212(11) of the Income Tax Act deems such payments from an estate or trust to be income for the purposes of the withholding provisions, the CRA’s position is that this does not render this type of payment subject to the withholding – see CRA Doc 9409560.)
Fortunately, I noticed this mistake, and the estate will recover the tax that would likely have disappeared forever. Be careful when making payments to non-residents – not all such payments are subject to withholding tax.