Confusion about foreign withholding taxes
11/21/2017 10:30:41 AM
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By Gordon Pape  | Monday, November 06, 2017


 

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While the Liberal government has its focus on tax changes, one thing Prime Minister Trudeau and his colleagues could do is to provide some clarity to the rules governing payments from foreign-based securities. Currently the whole area is a mess.

Mind you, this would involve negotiations with the U.S. and other countries. With the contentious NAFTA talks still in progress, the resumption of Trans Pacific Partnership discussions, plus the seemingly endless softwood lumber dispute, Canada may be getting a little thin on the ground when it comes to finding skilled representatives to present our case.

So I don’t expect the frustrations of investors to be addressed anytime soon. But that doesn’t mean we should forget about the problem. Someone in Ottawa should put it on their to-do list for future follow-up.

The issue is the application of withholding tax on dividends/distributions earned from foreign securities. Unless you’re a chartered accountant, it’s unlikely you have any clue about how much tax you’ll pay, if any.

Let’s start with a simple example – dividends from a U.S. corporation. They are subject to a 15% withholding tax if paid into a non-registered account. That amount can be reclaimed as a foreign tax credit.

But suppose the account is registered. Here’s where it gets tricky. Payments made to an RRSP or RRIF are tax-exempt under the Canada-U.S. Tax Treaty, as they are considered to be “retirement plans.” But payments made to a TFSA or RESP don’t have this protection. Although these plans are supposed to be tax-sheltered, the 15% dividend withholding tax applies. Moreover, there is no mechanism for recovering it. Since the money was paid into a registered plan, the foreign tax credit does not apply.

This is just the tip of the iceberg. Different rules apply if the security you own is not shares in a corporation. For example, many people are attracted by the high yields offered by U.S. master limited partnerships. These mainly invest in the resource sector, but they can be involved in other industries as well, such as amusement parks and financial services.

For example, NGL Energy Partners (NYSE: NGL) has a current yield of 14%. And Energy Transfer Partners (NYSE: ETP) yields 12%, while American Midstream Partners (NYSE: AMID) generates a yield of 9%.

Those are mouth-watering numbers to income-oriented investors. But there’s a good reason why I have never recommended them: The tax consequences are onerous. Canadian investors in these partnerships are subject to a withholding tax of almost 40%. Worse, Canadians who own shares in these securities are considered to be doing business in the U.S. and are supposed to file a tax return with the IRS as a result. That rule is rarely enforced, but it is not something you want to get involved with!

Those are just a couple of the problems related to U.S.-based cash flow. Money from other jurisdictions also creates difficulties.

For example, a reader asked recently if he should avoid putting units of Brookfield Energy Partners (TSX: BEP.UN) in a TFSA because he was worried about losing the 15% withholding tax. However, BEP is not a U.S. company (it is a limited partnership based in Bermuda), so different rules apply. Moreover, it’s impossible to tell from one year to the next what the tax consequences will be.

Jeff Finkelstein of RBC Dominion Securities has several clients who have positions in BEP. He says RBC withholds 15% of the amount of the distribution that is considered “foreign income.” However, no withholding tax has been levied on distributions from Brookfield Energy Partners, because they are regarded as “return of capital.” But there is no guarantee that will continue in the future. The composition of the distribution can change from year to year, so there could be withholding down the road.

A sister partnership to BEP does have some withholding applied, but not on the entire amount. Brookfield Infrastructure LP (TSX: BIP.UN) has a small foreign income component in its distribution mix. The amount of withholding is minuscule, however – in 2016 it was about $0.05 in tax on every $100 of distribution. Of course, that could change this year.

The bottom line is that you should not make any assumptions about the taxation of foreign payments in your accounts. Check with your broker on withholding before making a purchase and remember that past history does not necessarily mean the same situation will apply going forward.

It would be great if Ottawa could negotiate taxation uniformity for foreign payments to Canadians. But until that happens, it’s buyer beware.

Gordon Pape is one of Canada’s best-known personal finance commentators and investment experts. He is the publisher of The Internet Wealth Builder and The Income Investornewsletters, which are available through the Building Wealth website.

For more information on subscriptions to Gordon Pape’s newsletters, check the Building Wealth website.

Follow Gordon Pape on Twitter at https://twitter.com/GPUpdates and on Facebook at www.facebook.com/GordonPapeMoney.

Notes and Disclaimer

© 2017 by The Fund Library. All rights reserved.

The foregoing is for general information purposes only and is the opinion of the writer. Securities mentioned carry risk of loss, and no guarantee of performance is made or implied. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting, or tax advice. Always seek advice from your own financial advisor before making investment decisions.

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