For individuals and businesses operating across the Canada-US border, the tax treatment of dividend income can be particularly complex. Not only do both countries impose domestic taxes on dividends, but they also assert the right to tax dividends paid to non-residents. The interaction between domestic tax laws and the bilateral tax treaty (the Canada-US Tax Treaty) determines the ultimate tax burden and often dictates how withholding, foreign tax credits, and residency status affect the net return on cross border investments.
This blog post provides a high-level overview of how dividend income is taxed under US and Canadian domestic tax law, followed by a practical explanation of Article X of the Canada-US Tax Treaty, which governs the taxation of dividends in a cross border context.
Taxation of Dividend Income Under US Law
Under the Internal Revenue Code, US citizens and residents are taxed on their worldwide income, including dividends from both domestic and foreign corporations. Dividend income is generally classified into two categories:
- Qualified Dividends: Subject to preferential tax rates (0%, 15%, or 20%, depending on the taxpayer’s income level), provided that certain holding period and source requirements are met
- Ordinary (Non-Qualified) Dividends: Taxed at ordinary income tax rates, which can be as high as 37%
For US tax purposes:
- Dividends from US corporations typically qualify for the lower tax rate
- Dividends from Canadian corporations may qualify as ‘qualified dividends’ if the stock is traded on a US exchange or if the corporation is incorporated in a Treaty country and satisfies IRS criteria
Non-resident aliens receiving US-source dividends are subject to a withholding tax under IRC §871(a), typically at a 30% rate, unless reduced by a Treaty.
Taxation of Dividend Income Under Canadian Law
Under the Income Tax Act (Canada), Canadian residents are also taxed on their worldwide income, including dividends from both Canadian and foreign corporations. Canadian tax treatment varies depending on the source of the dividend:
- Dividends from Canadian corporations benefit from a gross-up and dividend tax credit system, encouraging investment in domestic firms and reducing double taxation at the corporate and personal levels
- Dividends from US corporations are taxed as foreign income and do not qualify for the Canadian dividend tax credit. However, a foreign tax credit (FTC) may be claimed for US withholding tax paid, subject to certain limitations
Non-residents of Canada are subject to a Part XIII withholding tax of 25% on Canadian-source dividends unless reduced by a Treaty.
Article X of the Canada-US Tax Treaty: Dividends
Article X of the Treaty governs the allocation of taxing rights between Canada and the US on cross border dividend income. Its primary purpose is to prevent double taxation and reduce the withholding tax rates that would otherwise apply under domestic law.
General Rule (Paragraph 2)
The country of source (where the dividend-paying company is resident) may tax the dividend paid to a resident of the other country, but the rate is limited to:
- 15% of the gross amount of the dividend, or
- 5% if the beneficial owner is a company owning at least 10% of the voting stock of the dividend-paying corporation
This means that:
- A US resident receiving dividends from a Canadian company will generally face Canadian withholding tax capped at 15%
- A Canadian resident receiving dividends from a US company will generally face US withholding tax capped at 15%, or 5% in qualifying corporate shareholder cases
US Citizens and Treaty ‘Savings Clause’ (Paragraph 4 & Article XXIX)
It is important to note that under the Treaty’s ‘savings clause’ (Article XXIX), the US retains the right to tax its citizens as if the Treaty did not exist. Thus, a US citizen residing in Canada remains fully taxable on their Canadian dividend income under US tax rules, although a foreign tax credit may be available for Canadian tax paid.
Similarly, a Canadian citizen residing in the US is subject to US tax on worldwide income, and the Treaty does not override US taxation of its residents or citizens.
Special Provisions for REITs (Paragraph 4 of Article X and Protocol Amendments)
A notable amendment to Article X addresses dividends paid by Real Estate Investment Trusts (REITs). In general, the 15% withholding cap does not apply to dividends paid by REITs unless:
- The beneficial owner holds no more than 10% of the REIT, and
- The dividends are paid from income derived from immovable property (e.g. rental income)
Otherwise, REIT dividends may be subject to withholding tax at a higher rate or taxed as effectively connected income in the US.
Coordinating Taxation Through Foreign Tax Credits
To avoid double taxation, both Canada and the US allow taxpayers to claim a foreign tax credit (FTC) for taxes paid to the other country, within limitations. For example:
- A US citizen receiving Canadian dividends will be taxed in the US, but may claim a foreign tax credit for the 15% Canadian withholding tax
- A Canadian resident receiving US dividends will pay Canadian tax on that income and may claim a foreign tax credit for the US withholding tax
The FTC is generally limited to the lesser of the foreign tax paid or the amount of Canadian/US tax otherwise payable on the same income.
However, taxpayers must carefully track the source of income, timing of recognition, and baskets of income to ensure proper crediting and avoid loss of FTC benefits.
Conclusion: Plan Proactively, Comply Diligently
Dividend income presents a deceptively simple surface, but in cross border scenarios, it gives rise to a web of legal and tax implications. The US and Canada both assert taxing rights over their residents and over income sourced within their borders. Article X of the Canada-US Tax Treaty plays a critical role in moderating those rights by limiting withholding taxes and providing relief from double taxation.
For individuals holding shares across the border, or dual citizens subject to complex reporting requirements, effective tax planning, proper residency classification, and careful compliance with foreign tax credit rules are essential. Professional advice from a cross border financial planner is strongly recommended to ensure the most efficient after-tax outcome on dividend income.