Withholding Tax on Canadian Subsidiary of a Foreign Parent Corporation

Doing what is legally best for your business and its advancement into Canada, given Canada's strict tax-related rules.

Contact Neufeld Legal PC at 403-400-4092 / 905-616-8864 or Chris@NeufeldLegal.com

In Canada, when a Canadian subsidiary corporation pays certain types of income to its foreign parent corporation, that payment is subject to a non-resident withholding tax. This is governed by Canadian tax law, but the specific tax rate is often modified by international tax treaties.

A. The General Rule: 25% Withholding Tax

Under Part XIII of the Income Tax Act (Canada), a Canadian resident (like a subsidiary) must withhold tax on specific payments made to non-residents (like a foreign parent). The standard statutory rate for this withholding tax is 25%. This applies to several types of payments, including:

• Dividends: The most common form of repatriation of profits from a subsidiary to its parent.

• Interest: Specifically, interest paid to non-arm's length parties.

• Royalties: Payments for the use of patents, trademarks, or other intellectual property.

• Certain management or administration fees.

• Rentals.

B. The Impact of Tax Treaties

Canada has a broad network of bilateral tax treaties with countries around the world. These treaties are designed to prevent double taxation and can significantly reduce the statutory 25% withholding tax rate.

• Reduced Rates on Dividends: Tax treaties often reduce the withholding tax on dividends. For example, the Canada-U.S. tax treaty generally reduces the rate to 15%. This rate can be further reduced to as low as 5% if the U.S. parent corporation owns a significant percentage (e.g., at least 10%) of the Canadian subsidiary's voting stock.

• Reduced Rates on Other Payments: Treaties also provide for reduced withholding tax rates on other payments, such as royalties and interest. For instance, the Canada-U.S. tax treaty can reduce the withholding tax on royalties to 10% and, in some cases, on interest to 0%.

C. Key Considerations for Canadian Subsidiaries and Foreign Parents

• Subsidiary as a Canadian Resident: A Canadian subsidiary, even if wholly owned by a foreign company, is considered a resident of Canada for tax purposes. This means it is subject to Canadian corporate income tax on its worldwide income.

• Branch vs. Subsidiary: The tax treatment of profits can differ if the foreign corporation operates through a Canadian branch instead of a subsidiary. A branch is subject to a "branch profits tax" which is designed to approximate the withholding tax that would have been paid on a dividend from a subsidiary.

• Thin Capitalization Rules: Canadian tax rules include "thin capitalization" provisions that can limit a subsidiary's ability to deduct interest paid on debts owed to specified non-residents. This is to prevent a foreign parent from loading up its Canadian subsidiary with debt to reduce the subsidiary's taxable income in Canada [more on thin capitalization rules].

• Claiming Treaty Benefits: To benefit from a reduced withholding tax rate under a treaty, the foreign parent corporation may need to provide the Canadian subsidiary with a completed tax form, such as a Form W-8BEN for U.S. residents, to certify its non-resident status and eligibility for the treaty's benefits [more on tax treaty benefits].

Further specifics as to the withholding tax and its application are set out in the CRA's NR4 - Non-Resident Withholding, Remitting and Reporting, with the engagement of knowledgeable Canadian legal and tax professionals being advantageous for the optimal structuring of your overseas commercial endeavors into Canada.

To learn more about how our law firm stands apart when it comes to expanding your business into Canada, in what we do differently from most larger law firms and how this can properly protect and advance your Canadian commercial venture, contact our law firm today for a confidential initial consultation at Chris@NeufeldLegal.com or 403-400-4092 / 905-616-8864.  

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