Holding United States Assets as a Canadian Investor

The site already deals with what happens to United States property when a Canadian dies. It has never dealt with the far more common question of what happens while they are alive and holding it. That question is not exotic. Any Canadian who owns a large American technology company, an American listed index fund, a rental condominium in Florida or a handful of shares inherited from a parent is inside a set of rules written by two countries and reconciled by a treaty between them. The rules decide how much of a dividend actually arrives, whether the account it sits in changes that, what has to be reported to the Canada Revenue Agency and in what currency, and whether a form has to be filed that most people have never heard of. Underneath all of it sits a second decision, entirely separate from the investment itself, about the currency the asset is denominated in. This article works through each of those in turn.

What counts as United States property

The category is defined by the source of the asset rather than by where the investor keeps it, and that single point is where most misunderstandings begin. Real property located in the United States is United States property. Tangible personal property physically located there is United States property. Most importantly for ordinary investors, shares of a corporation incorporated in the United States are United States property under section 2103 of the Internal Revenue Code with Treasury Regulation 20.2104-1(a)(5), regardless of where the certificate is held.

That last rule catches people who believe a Canadian brokerage account is a shield. It is not. Shares of an American corporation held in an account at a Canadian institution, denominated in Canadian dollars, bought through a Canadian broker, remain American property for these purposes. The account is the wrapper. The share is the thing.

Some things are outside the category. Cash on deposit with a United States financial institution is generally not United States property for estate purposes under section 2105(b) of the Code, where the depositor is a non resident who is not carrying on business there. Most United States bond interest paid to a non resident escapes withholding under the portfolio interest exemption in section 871(h). Shares of a Canadian corporation are Canadian property even where the corporation earns everything it earns in the United States.

The practical exercise is therefore to look through the account and list what is actually owned, by the residence of the issuer rather than by the currency shown on the statement or the location of the broker. Investors are regularly surprised in both directions.

Withholding on dividends, and the treaty rate

Section 871(a) of the Internal Revenue Code imposes tax at 30 per cent on United States source dividends paid to a non resident alien individual, and section 1441 collects it by requiring the payer to withhold before the money leaves. There is no filing to do and no assessment to receive. The dividend simply arrives smaller than the amount declared.

The Canada United States tax convention reduces that. Paragraph 2(b) of Article X sets the rate at 15 per cent of the gross amount of the dividend in all cases other than the qualifying company case, which is the ordinary portfolio investor case. The reduction is not automatic. It is a treaty benefit, and the payer applies it only where the beneficial owner has certified their status.

That certification is Form W-8BEN, the Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding and Reporting for individuals. Canadian brokers normally collect it when the account is opened and renew it on a schedule, which is why most investors have signed one without registering what it was. It matters when it lapses, when an account is transferred between institutions, or when shares are held somewhere that never asked. An investor who finds the higher rate has been applied should look first at whether a current form is on file.

Where withholding has been taken at more than the treaty rate, the excess is not a Canadian tax matter and Canada will not credit it. Recovering it means dealing with the American authority, which is slow, and the cost of doing so frequently exceeds the amount at stake. Keeping the form current is the cheapest form of tax planning available on an American holding.

What a registered account does, and does not, do

This is the part that surprises people, and it turns on a single sentence in the treaty. Paragraph 2 of Article XXI exempts from taxation in the other country the dividend and interest income of a trust, company, organisation or other arrangement that is resident in one country, generally exempt from income taxation there, and operated exclusively to administer or provide pension, retirement or employee benefits.

A registered retirement savings plan and a registered retirement income fund fit that description. United States dividends paid into one of them can therefore be received without the withholding, which is a genuine and permanent saving rather than a deferral.

A tax free savings account does not fit that description, because it is not operated exclusively to provide retirement benefits. Neither does a registered education savings plan, and neither does a first home savings account. United States dividends paid into any of them are subject to the treaty rate of withholding, and here is the sting: because Canada does not tax the income inside those accounts, there is no Canadian tax against which to claim a credit for the American tax. The withholding is simply lost.

That produces a result many investors have never been told. The same American dividend paying share is worse off inside a tax free savings account than inside a non registered account, on that one dimension. It does not mean the account is the wrong place for it once everything else is weighed, but it is a real cost and it belongs in the weighing. The general subject is covered at asset location, and the accounts themselves at registered accounts.

Where the exemption stops reaching

The treaty exemption applies to the arrangement that receives the dividend. When an investor holds an American share directly in a retirement plan, the plan receives the dividend and the exemption applies. When the same exposure is obtained through a fund, a second layer appears, and the exemption does not necessarily reach through it.

A Canadian listed fund that itself owns American shares receives those dividends in its own right, and the withholding is applied to the fund. What reaches the investor is already net. Because the tax was paid by the fund and not by the plan, the treaty exemption at the plan level has nothing to attach to. Holding that fund inside a retirement plan does not recover it.

The structure of the fund therefore matters as much as the account it sits in, and the number of layers matters more than the label on the front of the fund. A Canadian fund that holds an American fund that holds American shares introduces a second point at which tax can be taken. None of this is visible on a statement. It is visible in the fund documents, and it is one of the reasons to read them. The general comparison of fund structures is at segregated funds against exchange traded funds and mutual funds.

None of this makes any structure right or wrong. It makes the comparison more complicated than a fee table, which is worth remembering whenever two funds holding apparently identical assets are being compared on cost alone.

The non registered account and the foreign tax credit

In a non registered account the American dividend is taxable in Canada as foreign income. It does not qualify for the Canadian dividend tax credit, which is reserved for dividends from taxable Canadian corporations, so it is taxed less favourably than a Canadian dividend of the same size. That is a structural difference and no account choice removes it.

Against that Canadian tax, the American tax already withheld can generally be claimed as a federal foreign tax credit, reported on line 40500 and calculated on Form T2209. The Canada Revenue Agency describes the credit as the lesser of the foreign tax paid and the Canadian tax otherwise payable on the net income from that country, so the credit relieves double taxation without turning the foreign tax into a refund.

The gross amount, not the net amount, is what goes on the Canadian return, with the withholding claimed separately as the credit. Reporting only what landed in the account understates the income and forfeits the credit at the same time. A Canadian broker generally reports both figures on the slip, and both figures have to be used. How the different kinds of investment income compare once this is taken into account is set out at how investment income is taxed.

Everything is reported in Canadian dollars

Section 261 of the Income Tax Act requires that amounts relevant to computing Canadian tax be reported in Canadian currency, converted at the relevant spot rate for the day the amount arose. The Canada Revenue Agency explains the mechanics in Income Tax Folio S5-F4-C1 and accepts the Bank of Canada rate, with an annual average rate available for streams of income received evenly through the year.

The consequence for an ordinary investor is that no American figure on a statement is the figure that goes on the return. A dividend received in American dollars is converted on the day it was received. Tax withheld is converted the same way. A purchase is converted at the rate on the purchase date and a sale at the rate on the sale date, and those are two different rates.

This is bookkeeping rather than strategy, but it is bookkeeping that has to be kept as it happens. Reconstructing years of conversions after the fact, from statements that show only American dollars, is one of the more expensive accounting exercises available, and the alternative is a spreadsheet updated at the time of each transaction.

How currency enters the capital gain

Because both ends of the transaction are converted, the exchange rate is inside the capital gain whether the investor wanted it there or not. The proceeds are the American sale price converted at the rate on the day of the sale. The cost is the American purchase price converted at the rate on the day of the purchase. The gain is the difference between those two Canadian figures.

The result can be counterintuitive in both directions. A share that fell in American dollar terms can still produce a taxable capital gain in Canada if the Canadian dollar weakened enough over the holding period. A share that rose in American dollar terms can produce a smaller gain than expected, or a loss, if the Canadian dollar strengthened. Neither outcome is an error. It is what reporting in Canadian dollars means.

The same logic applies to an American dollar cash balance held on its own. Converting American dollars back to Canadian dollars is itself a disposition of property, and it can produce a gain or a loss measured in Canadian dollars, though a modest de minimis rule keeps small personal transactions out of it. The inclusion of a capital gain in income is dealt with at the capital gains inclusion rate.

The foreign property reporting form

Form T1135, the Foreign Income Verification Statement, is a reporting form rather than a tax. It is required where a Canadian resident held specified foreign property whose total cost amount exceeded a prescribed threshold at any time in the year. The threshold is stated in the form and on the Canada Revenue Agency page for it, and it has been unchanged for long enough that people assume it will never move, which is exactly why it should be read rather than remembered.

Two features of the rule catch people. The test is on cost amount rather than on current value, so an asset that has grown a great deal may still sit below the line while a recently purchased one sits above it. And the test is on the total across all specified foreign property, not on any single holding, so several modest positions can cross the line together while none of them looks significant alone.

Shares of a non resident corporation are specified foreign property even when held in an account at a Canadian institution, which is the same look through principle that governs everything else in this article. Property held inside a registered plan is excluded, as is personal use property such as a vacation home used personally, and as is property used in carrying on an active business. A second and higher threshold separates a simplified method of reporting from a detailed one.

The penalties for not filing are significant and they are not proportionate to the tax at stake, because there is frequently no tax at stake at all. This is a form that costs nothing to file and a great deal to forget, and an investor who is anywhere near the line should simply ask their accountant each year rather than deciding alone.

Currency is a second decision, not part of the first

A Canadian who buys an American company is making two decisions at once, and usually thinking about only one of them. The first is whether to own that business. The second is whether to hold an exposure to the American dollar against the Canadian dollar for as long as the position is held. They are independent decisions and they can be right and wrong in any combination.

Over a long holding period the currency contribution is not trivial and it is not reliably positive. The Canadian dollar has spent long stretches both above and below its long run average against the American dollar, and the periods are measured in years rather than in quarters. An investor who buys after a long Canadian dollar decline is buying American exposure expensively, and one who buys after a long rise is doing the opposite, and neither is knowable in advance with any precision.

There is one honest simplification. A household whose future spending is in Canadian dollars has Canadian dollar liabilities, and holding foreign currency assets against them is a mismatch that has to be justified rather than assumed. A household that intends to spend part of its retirement in the United States has a different answer, because some of its future spending is denominated in the currency it is holding.

Hedged and unhedged exposure

A currency hedged fund holds the same underlying assets and adds contracts intended to offset the movement of the foreign currency against the Canadian dollar. The stated aim is to leave the investor with the return of the underlying market and without the currency movement. An unhedged fund holds the assets and leaves the currency where it falls.

Hedging is not free and it is not exact. The contracts cost something to maintain, the hedge is reset periodically and cannot track a continuously moving exposure perfectly, and the difference between the hedged result and the underlying market result over long periods is real. Cost and tracking are the price of removing the currency, and both belong in the comparison alongside the management fee, which is the subject of investment fees explained.

There is also an interaction with the currency itself that gets missed. Foreign currency exposure has historically behaved as a partial cushion for a Canadian investor during global equity declines, because the Canadian dollar has often weakened in those episodes and the foreign asset has therefore been worth more in Canadian terms at the worst moment. Hedging removes that cushion along with the rest of the currency movement. Whether that is a good trade depends on the household, not on the fund.

The reasonable position for most people is neither strong view. Decide deliberately, apply the decision consistently across the portfolio rather than fund by fund, and revisit it when the reason for it changes rather than when the currency does.

The estate tax exposure sitting underneath

Everything above concerns holding the property. There is a separate exposure that arrives at death, and it is the reason United States property is treated as its own subject in Canadian planning rather than as an ordinary asset.

The United States levies estate tax on the American property of a person who was neither a citizen nor domiciled there, which reaches American real estate and shares of American corporations under the situs rules described earlier. Article XXIX B of the Canada United States tax convention provides relief for a resident of Canada, including a pro rated unified credit, and the mechanics are set out in the dedicated article at United States situs assets and Canadians.

The point to carry from here is only that the two questions are connected. The decision to hold American shares directly rather than through a Canadian fund changes the withholding position, and it changes the estate position too, in the opposite direction. A structure that is efficient on one can be worse on the other, which is precisely why the choice belongs with a cross border tax professional rather than with a rule of thumb.

Putting it together

Four questions cover most of the ground for most households. What is actually owned, by the residence of the issuer rather than by the currency on the statement. Which account each holding sits in, and whether the treaty exemption reaches it. Whether the withholding certification on file is current. And whether the total cost of foreign property is anywhere near the reporting threshold.

Then the fifth question, which is different in kind. How much American dollar exposure the household wants to carry against future spending that is almost certainly in Canadian dollars, and whether that exposure is there because it was chosen or because nobody looked. That question is not answered by the tax rules at all.

None of this argues for or against owning American assets. Many Canadian portfolios should hold them and the reasons are ordinary ones. It argues that the holding brings a second country into the file, and the second country does not send a reminder.

Frequently Asked Questions

Continue Learning

Read United States situs assets and Canadians for the exposure that arrives at death rather than during the holding period, and how investment income is taxed for how foreign income compares with a Canadian dividend, interest and a capital gain. Asset location takes the account question further than this article does, registered against non registered deals with the order of contribution, and investment fees explained covers the other cost that hides inside a fund.