When trustees distribute income of a trust to a non-resident beneficiary, they must be mindful of potential Canadian tax implications. Part XIII tax is a tax withheld at source when income is paid to a non-resident. For Canadian trust and estate purposes, Part XIII requires a non-resident beneficiary to pay tax on certain amounts that a Canadian trust or estate pays or credits (or is deemed to pay or credit) to such non-resident beneficiary. Income payable by a Canadian resident trust or estate to a non-resident beneficiary is subject to Part XIII withholding tax at a rate of 25%, subject to a reduced rate where Canada has a tax treaty with the other contracting state in which the beneficiary resides.
Application of Part XIII
For Part XIII withholding tax to apply to a payment by a trust or estate to a non-resident beneficiary, the payment must be for an amount that is “income of or from a trust or estate” under either trust law or the Income Tax Act (“Act”).
For trustees, the analysis must go further. Subsection 212(11) of the Act provides that an amount paid or credited by a trust or estate to a non-resident beneficiary is deemed to be income of the trust or estate, regardless of the source from which the income was derived by the trust or estate. Essentially, subsection 212(11) aims at imposing a withholding tax on a distribution made by a trust or estate where that distribution may reasonably be considered to relate to a capital dividend received by the trust or estate; this can easily be overlooked by trustees.
The Part XIII withholding tax applies notably, but not exclusively, to dividends on shares of Canadian resident corporations, interest income, royalties and capital gains (from non-taxable Canadian Property). It’s also worth noting that capital dividends paid to the trust or estate and then distributed to the non-resident beneficiary are subject to Part XIII tax, even if they were paid in a prior year and distributed as capital of the trust or estate.
Part XIII tax is imposed on the trust or estate’s income if the amount is included in computing the income of the non-resident beneficiary or can be reasonably considered to be a distribution of, or derived from, an amount received by the estate as a capital dividend from a Canadian resident corporation.
Responsibility of the Estate Trustees
It’s the responsibility of the payer (the resident or deemed resident in Canada) to withhold the Part XIII tax at the appropriate rate and to remit it directly to the Receiver General by the fifteenth of the month following the month of payment.
If the trustee fails to withhold the tax, he or she shall be held liable to pay the withholding tax plus interest and a penalty of 10% may also be charged on the withholding tax. For trustees, Part XIII will require professional advice since the potential liability associated with a failure or omission to withhold can be significant.