Sometime ago, a relative of a Canadian taxpayer died in the US and she left her money in a charitable trust, with some of the income bequeathed to the Canadian taxpayer annually. The trust income is derived mostly from US dividends.
With a series of proposed adjustments to her personal tax returns, the taxpayer asked the Canada Revenue agency (“CRA”) why this income could not be treated as dividend income for Canadian tax purposes.
The CRA denied the request for adjustments and provided a detailed explanation.
The CRA noted that the Act provides that amounts included in the taxpayer’s income under the Act shall be deemed to be income from property that is an interest in the trust and not from any other source (unless the Act provides otherwise). The rules require the taxpayer to report the income as “income from a trust”; they do not require the Taxpayer to report the income as “interest”. However, both income from a trust and interest income are considered to be income from property. For Canadian tax purposes, the income that the taxpayer has received is deemed to be income from an interest in a trust; it does not retain its character as dividend income. If the amount had been a dividend received directly from a corporation (i.e. not through the trust), the dividend (converted to Canadian dollars) must be included in the taxpayer’s income in the year of receipt whether the dividend had been paid by a Canadian corporation or a foreign corporation.
Further the CRA noted that if the amount is a dividend, and the dividend is a taxable dividend paid by a corporation resident in Canada, the dividend would be “grossed-up” by an additional amount and the grossed-up dividend would be included in the taxpayer’s income. The taxpayer would also be eligible for a deduction from tax otherwise payable pursuant to the Act, commonly referred to as a “dividend tax credit”. Very generally, the dividend tax credit recognizes that the dividends are paid out of income on which the corporation has already paid Canadian tax.
However, dividends from foreign corporations do not qualify for the dividend tax credit. Therefore, even if the amount received by the taxpayer had been considered to be a dividend, she would not have been eligible for the dividend tax credit.
In the same correspondence, the taxpayer questioned the CRA on the application of the Canada-US Tax treaty (“Treaty”) in such matters. The CRA noted that the relevant section of the current Treaty states that dividends paid by a company that is a resident of the U.S. to an individual who is a resident of Canada may be taxed in Canada. The Treaty states that the amount of tax that the U.S. can withhold is limited to 15%. These paragraphs do not affect how Canada taxes its own residents; that is, the Treaty does not state that Canada is limited to taxing its own residents at 15%.
Furthermore, even if the U.S. considers that income paid from a trust retains its nature as dividend income, Canada does not. As noted above, in Canada, the income is considered to be income from a property that is an interest in a trust. The Treaty does not prevent Canada from characterizing the payment as income from a trust.