Canadian International Income Tax Rules

Page Index

General Rules and Principles

Canadian international tax provisions adhere to the international tax principles promoted by the Organization for Economic Co-operation and Development (OECD).

In particular, Canada's international tax rules are based on the principle of taxation of residents with priority to tax given to the source country.

Canadian international tax rules are based on three broad principles:

  • Worldwide taxation: A Canadian resident is liable for tax on its worldwide income. This is also called residence taxation. A corporation is resident in Canada for tax purposes if its central management and control are located in Canada, or if it is incorporated in Canada.
  • Elimination of country double taxation: A Canadian resident is entitled to relief from double taxation in the form of a foreign tax credit or exemption from tax in respect of foreign source income. This relief is intended to prevent economic double taxation that would otherwise occur from subjecting the same income to tax both in the source and residence countries. This corresponds to the international norm, which gives priority of taxation to the country in which the income is generated.
  • Permanent establishment: A foreign entity operating in Canada through a permanent establishment (i.e., an entity not legally separate from its parent corporation) is liable for tax only on income generated in Canada.

Taxation of Foreign Investment in Canada

Subsidiaries

Foreign investors undertaking business activities in Canada through a separate legal entity (i.e., subsidiary) are considered residents in Canada and they are taxed as such. That is, income tax is applied to their worldwide income and appropriate relief is provided for taxes paid in foreign jurisdictions if the subsidiary also carries out business abroad (see below).

In addition to income taxes, Canadian residents, including corporations controlled by non-residents, are subject to withholding taxes on payments that they make to non-resident persons, including foreign shareholders. Such withholding taxes can be viewed, in part, as proxy for the income taxes that shareholders would pay if they were residents of Canada. However, the totality of invested capital can be repatriated tax-free before any withholding taxes start to apply.

The statutory withholding tax rate is 25%. However, the applicable withholding tax rate is usually reduced in the extensive network of tax treaties entered into with other countries. The rates may vary according to the type of payment (e.g., interest, dividends, royalties). For example, the Canada-United States tax treaty provides for withholding tax rates of 10 percent on interest and royalties and 5 percent on dividends paid to non-resident corporations with a significant ownership in the corporation.

Canada is following the Organization for Economic Co-operation and Development (OECD) worldwide thrust to reduce withholding taxes.

Branches

A non-resident person carrying out business activities in Canada through a permanent establishment (e.g., branch) rather than a separate legal entity is liable for income tax in Canada on income attributable to the business conducted by it in Canada. In addition, a branch tax is imposed on the non-resident corporation's after-tax source income to the extent that the income has not been reinvested in Canada. The statutory branch tax rate is 25 percent and may be reduced by tax treaty (the rate is 5 percent in the Canada-U.S. tax treaty). The branch tax is a proxy for the withholding tax that would have been imposed on dividends if the business of the branch had been carried on in a subsidiary.

Mining-Specific Provisions

A non-resident person can also gain access to the special tax incentives provided under the Canadian resource income tax treatment by incorporating a Principal-Business Corporation (PBC) in Canada. A PBC is a corporation whose principal business is directly related to one or more of the mining or oil and gas activities such as exploration, development, extraction and processing. By incorporating a PBC, a non-resident investor can:

  • obtain additional domestic financing using the flow-through share mechanism;
  • receive a 100 percent write-off and indefinite carry-forward for its exploration and development expenses, and a 30 percent amortization of the cost of acquiring resources properties;
  • gain access to the accelerated capital cost allowance for capital costs on green-field mines or major expansions.

Taxation of Canadian Investment Abroad

Branch Income

When the foreign operations of a Canadian resident are conducted through a branch (a permanent establishment located in a foreign country), the branch's income is included in the resident's income to arrive at Canadian taxable income. A foreign tax credit can be claimed in respect of foreign taxes levied on income and profits that are attributable to the branch. The credit is limited to the Canadian tax payable on the foreign-source income computed on a country-by-country basis. While Canadian taxation cannot be deferred when a branch structure is elected, foreign losses are deductible against Canadian source income.

Subsidiary Income

Where foreign operations are conducted through a subsidiary, the income earned by the subsidiary is generally not subject to taxation in Canada until profits are remitted to Canadian shareholders in the form of dividends, or when a Canadian corporation dispose of its foreign subsidiary. The tax treatment of foreign subsidiaries depends on ownership: if ownership is less than 10 percent of common shares, then the income is portfolio income; if it is equal or greater than 10 percent but less than 50 percent, the foreign corporation is a foreign affiliate (FA); if it is greater than 50 percent, the corporation is a controlled foreign affiliate (CFA).

  • Portfolio income

    Portfolio income (for example, dividends, interest, rent and royalties) is taxable in the hands of the Canadian resident in the year received. Foreign taxes imposed on foreign portfolio income, whether levied by assessment or by withholding, are creditable against Canadian tax payable subject to the same per-country limitation applicable to foreign branch income. However, the foreign tax credit for individuals, with respect to foreign-source income from property other than real property, is limited to 15 percent; any foreign taxes imposed in excess of 15 percent are deductible, rather than creditable, in computing income.
  • Foreign Affiliate and Controlled Foreign Affiliate income

    The taxation of FAs and CFAs depends on whether the income earned is "active business income" or "passive income" and on whether Canada has a tax treaty with the country in which the FA or the CFA operates. The concept of active business income refers to income earned from the active conduct of a business as opposed to the earning of passive investment income.
  • Active business income - The tax treatment of active business income depends on whether or not this income is earned in a country with which Canada has a tax treaty.
    • Active business income earned in a treaty country is classified as "exempt surplus". The "exempt surplus" of a foreign affiliate also includes inter-affiliate dividends received out of the "exempt surplus" of other foreign affiliates, the exempt portion (25 percent) of all capital gains, and certain taxable capital gains. Dividends paid out of the "exempt surplus" of a foreign affiliate can be received free of additional taxes in Canada, since the profits out of which they are paid are considered to have borne a rate of tax in the treaty country comparable to that of Canada.
    • Active business income earned in non-treaty countries is "taxable surplus." The "taxable surplus" of a foreign affiliate also includes certain taxable capital gains and dividends paid out of the taxable surplus of another foreign affiliate. Dividends paid out of taxable surplus are taxable in Canada, subject to a tax credit for non-resident withholding taxes and the underlying income tax paid by the foreign affiliate in the source country.
  • Passive income - Passive income earned by a FA or a CFA in any country is "foreign accrual property income" (FAPI) and is included in the "taxable surplus" of a taxpayer. The FAPI of a CFA must be included in the income of Canadian shareholders on a current basis, subject to a foreign tax credit. The immediate recognition of FAPI in the taxable income of Canadian shareholders, regardless of whether or not the profits were repatriated, is intended to remove the tax advantage of earning passive income in low-tax countries.

Mining-Specific Provisions

Foreign Resource Expense (FRE) and Foreign Exploration and Development Expense (FEDE)