New U.S.–Canada tax treaty benefits American investors

The Canadian and U.S. governments recently signed a new tax treaty that would eliminate the withholding tax on cross-border interest payments.

The new pact, which applies only to debt securities or mutual funds that invest in debt securities, is a boon for Canadian companies and American retail investors as it eliminates the 10% tax that U.S. investors had to pay on investment interest.

“It’s a great benefit to Canadian companies that are looking for financing specifically in the U.S,” says Jamie Golombek, vice-president, taxation and estate planning, AIM Trimark Investments. “It should open up the market now you’ve taken away this withholding tax.”

Golombek adds that with the greenback on par with the Canadian dollar, investing in debt securities in Canadian companies is more attractive than ever. “You could now be looking at financing across Canada and the U.S., since currency is not an issue.”

The tax treaty primarily benefits American investors because Canadian investors are already exempt from paying withholding tax under a law called the “portfolio interest exemption.”

However, eliminating the withholding tax will have a significant benefit to Canadian companies who borrow from U.S. banks as they will no longer have to pay the 10% tax on investment interest.

It’s expected that getting rid of the tax will cost the government $250 million in lost tax revenue over the next two fiscal years, but Nancy Hughes Anthony, CEO of the Canadian Bankers Association, says any financial loss is worth it. “This tax was a barrier to the free flow of capital between the two countries and impeded the efficient functioning of capital markets,” she says in a statement. “The elimination of this tax will result in increased investment and a reduced cost of capital.”

According to the Canadian Institute of Chartered Accountants, ditching the tax could result in $18 billion in additional investment, as the tax break cuts a company’s cost of capital.

Finance Minister Flaherty says that eliminating the tax was a way of “modernizing a long-standing tradition for the betterment of individuals, families and businesses on both sides of the border.” He adds that Canadians need to “continually explore ways to grow, expand and compete. Further improving and refining our relationship with our friends and neighbours to the south is essential.”

Making things more attractive to Canadian companies and foreign investors is that in the last budget, Flaherty promised to eliminate the withholding tax for every other country if the U.S.–Canadian treaty goes through.

“Canada has basically eliminated the withholding tax that was imposed on U.S. investors, and ultimately for global investors,” says Golombek. “This is not just going to be a treaty — it will become Canadian domestic law.”

The agreement changes the Canada–United States Income Tax Convention, which was first signed in 1980.

Filed by Bryan Borzykowski, Advisor.ca, bryan.borzykowski@advisor.rogers.com