10.1 Dividends
The first question in determining how the Treaty may apply to a particular cross-border fact pattern is to understand how the transaction may be regarded under the tax rules and principles of the State that confers treaty relief.
Dividends are payable by a corporation to its shareholders. Therefore, three threshold issues that need to be considered under the applicable domestic corporate tax rules are:
- The proper classification of the entity making the distribution.
- The proper classification of the instrument on which the distribution is made.
- Whether the distribution would be regarded as a dividend.
Not all corporate distributions are dividends. Equally, a transaction that does not appear to be a dividend may still be characterized as a dividend under U.S. tax rules and case law, and therefore it is important to obtain the correct domestic characterization of a transaction before seeking to apply Article X or another provision of the Treaty.
Once it is determined that the payer is a corporation, the distribution is being made on stock, and that the distribution is a characterized as a dividend, the analysis turns to the proper characterization of the distribution under the sourcing rules. Under the U.S. domestic rules, a 30 percent withholding tax is applied to a U.S. sourced dividend distribution made to the foreign payee, unless an exception applies, or the rate is reduced by treaty. Under Canadian domestic tax, a 25 percent withholding tax will apply to the payments of dividend to non-resident payees.
The Treaty provides relief by reducing the rate of withholding tax on the payment of dividend. A dividend paid by a corporation resident in one Contracting State to a corporation resident in the other Contracting State that is the beneficial owner of the dividend, and that holds at least 10 percent of the votes of the payer, should generally be subject to withholding tax at the rate of 5 percent. In all other cases, the dividend withholding tax is reduced from the applicable domestic rate to 15 percent.
The tax laws of both Canada and the U.S. accord similar tax treatment to foreign corporations acting through branches. Thus, both the Act and the Code provide for a branch profits tax on the remittance of profits by the branches to their foreign home offices. The threshold application of the branch rules and a reduction in the branch rate are provided for under the respective domestic tax laws and the Treaty.
Against this backdrop, any cross-border dividend transaction must be subject to the further security of certain U.S. rules designed to prevent abuse of the use of the Treaty. In particular, where dividends are paid through the use of any kind of flow-through entity.
References:
Advisor’s Guide to Canada – U.S. Tax Treaty
By: Â Vitaly Timokhov, Raymond Montero, David Kerzner
Published by: Thomson Carswell