Tax implications of foreign investments
(Special) — The recent slump in oil prices is causing many Canadian investors to move their money from energy-weighted markets at home to foreign markets for better yields. While this may be a profitable investment strategy, it also can create its own set of problems because many investors may not be aware of the tax implications that can come from owning foreign securities.
According to a recent Bank of Canada survey, the collapse in oil prices has put a damper on the sales forecasts and investment and hiring plans of many Canadian-based resource companies.
“With the decline in oil prices and a rebound in the U.S. economy and markets, investors in Canada are looking outside the country in pursuit of higher yields,” says Carol Bezaire, vice president of tax and estate planning with Mackenzie Investments. “This can be profitable but it also can be problematic because many investors may not understand the tax implications.”
Under the Income Tax Act Canadian residents are subject to income tax on all worldwide income. This encompasses all income and capital gains regardless of its source and would include all Canadian income plus all foreign sources of income such as employment income earned outside of Canada, rental income from property from outside of Canada and investment income from foreign accounts. This applies even if the money is reinvested outside of Canada or is never brought to Canada and even if the country where the income is earned has taxed it as well.
Canadian residents who hold shares traded on foreign exchanges typically are not required to file income tax returns in those countries. Instead, all income, dividends and capital gains from those foreign investments must be reported on a Canadian income tax return. This is the case if they are held in non- registered accounts.
If you hold a U.S. dividend paying stock in a non-registered Canadian account, for example, the dividends are subject to a 15 per cent withholding tax at the source by the foreign payer under the terms of a special tax treaty. Capital gains are not subject to the withholding tax.
Canada currently has in force 92 such tax treaties with foreign countries which are listed on the Canada Revenue Agency’s web site. The rules of the treaties can vary depending on the country.
“What a lot of people don’t know is that Canadian investors have to pay tax on the full amount of foreign dividends, not on the withheld amount,” Bezaire explains. “This creates a lot of confusion.”
To avoid double taxation, investors can apply for a foreign tax credit to reduce the amount of Canadian taxes they pay on the U.S. income received.
Many Canadian mutual funds and exchange traded funds have global holdings. In this case, the withholding taxes are incurred by the fund company and are recorded on the investor’s T3 tax form. The investor then can claim the tax credit. All taxes are in Canadian dollars.
Income earned from foreign investments in registered accounts such as RRSPs, RRIFs, LIRAs, LIFs and LRIFs held for pension or retirement purposes is exempt from the non-resident withholding tax. For Canadian tax purposes the income is taxed at the investor’s marginal tax rate when it is withdrawn from the account.
The Tax Free Savings Account and Registered Education Savings Plan are not considered registered accounts and therefore are subject to foreign withholding tax.
“Make sure when you look at investing in global markets that you are mindful of the complications with your tax return unless you are invested in a registered account and make sure that you have claimable income so you don’t lose out on the foreign tax credit,” Bezaire says. “The world of investments is getting smaller and investors today have a lot more choices, so it’s prudent to talk to an adviser and only invest in what you know.”
Talbot Boggs is a Toronto-based business communications professional who has worked with national news organizations, magazines and corporations in the finance, retail, manufacturing and other industrial sectors.