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Foreign Withholding Taxes in a CCPC

February 11, 2013 - 8 comments

If you invest in US-listed equity ETFs or mutual funds that hold US or international stocks through your Canadian controlled private corporation (CCPC), foreign withholding taxes will be levied on the dividends, and you will generally be able to recover only 26% of the taxes withheld. This tax drag arises while calculating the Refundable portion of Part I tax on a corporate tax return. In order to illustrate this concept better, we’ll compare this amount on the corporate tax return for two distinct investors:  

  • Melvin – a conservative investor who holds only guaranteed investment certificates (GICs) within his CCPC.  These generate $40,000 of Canadian interest each year.
  • Gord – a more aggressive investor who prefers to take some foreign equity risk with his investments.  In his CCPC, he holds GICs that generate $20,000 of Canadian interest, as well as a US-listed equity ETF, which generates another $20,000 of US foreign dividends each year (US dividends are subject to foreign withholding taxes of 15%).  In Gord’s situation, $3,000 would be withheld ($20,000 × 15% = $3,000).

Refundable portion of Part I tax:

The Refundable portion of Part I tax allows a CCPC to recover a portion of the taxes paid on investment income when the corporation pays a taxable dividend to its shareholders.  It is referred to on page 6 of the corporate tax return as amount F, and is equal to the lesser of amounts C, D, or E.  On Melvin’s corporate tax return below, amount F is equal to $10,667 (for simplicity, I’ve omitted the section of the corporate tax return that explains how amount E is calculated).

Now let’s see what happens to Gord’s Refundable portion of Part I tax when we assume half of the $40,000 of investment income came from US dividends.

As we can see in the example above, amounts C, D and E have all changed.  Amount F is now equal to $8,445 (the lesser of amounts C, D, or E).

Although we may be able to claim a foreign tax credit of $3,000 to offset the foreign withholding taxes levied, we will also have a reduction of the Refundable portion of Part I tax of $2,222 ($8,445 - $10,667 = -$2,222).  In other words, we will lose about 74% of the $3,000 of foreign withholding taxes levied ($2,222 / $3,000 ≈ 74%), recovering only 26%

Although this information should not cause you to make changes to your overall asset allocation, you may want to reconsider your asset location.  For example, if you or your spouse own personal non-registered accounts as well as corporate accounts, consider allocating your US and international equity ETFs and mutual funds to those accounts instead of to your CCPC.

Special thanks to George Hronis, CFP, for his comments and insights.

By: Justin Bender with 8 comments.
Comments
  02/02/2015 3:44:15 PM
Justin Bender
@Margalit - for U.S. equity exposure, a swap-based ETF (such as HXS) could be considered. I do not know of any swap-based options for international equities.

Please remember that even if there is an additional cost to holding U.S. and international equities in a corporate account, the overall drag on a balanced portfolio would be less than 0.10%. This seems like a small price to pay for diversification.
 
  31/01/2015 9:41:46 AM
Margalit
If all my investable money is only available in my holdco, is there any way to implement a tax efficient couch potato investment strategy (with US and international exposure)?

Thank you
 
  06/01/2014 10:05:12 AM
Justin Bender
@Ignac - I would recommend that you speak with your accountant about this specific question.
 
  04/01/2014 2:10:06 PM
Ignac Vucko
Does US withholding apply to capital gains?

Specifically:

1) If a Canadian sells stock of a US private C-corporation, resulting in a long-term US capital gain, are any taxes withheld?

2) If a CCPC sells stock of a US private C-corporation, resulting in a long-term US capital gain, are any taxes withheld?

Thanks,
Ignac
 
  31/10/2013 9:26:52 AM
Justin Bender
@Jon - it certainly depends on your situation - since you are deferring taxes on your active business income earned within your corporation, this is your main benefit (foreign withholding taxes are only a slight cost of the strategy).

However, if you have personal non-registered assets as well, it probably makes sense to hold as much of your VXUS and VTI in there first, while holding VCN in your corporate account.
 
  31/10/2013 12:41:15 AM
Jon
Hello Justin, Would the foreign withholding taxes be enough to offset the benefits of a lower tax rate when comparing money invested in a PC vs non registered account? Also any thoughts on whether to hold ETF's such as VCN or VXUS in PC vs non registered?
 
  25/02/2013 10:32:47 AM
Justin Bender
@Cancorp

Great question about HXS - Dan Bortolotti and I are going to look into this question in a bit more detail, and perhaps answer it in an upcoming post.

The withholding tax issue would be the same for VFV vs VTI.
 
  24/02/2013 5:21:20 PM
Cancorp
Would holding HXS in the corp get around this issue? Also would the same issue apply to a CDN domiciled ETF holding US stocks eg. VFV vs VTI?
 



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