What’s Your Tax Issue? Withholding on Interest

The Tax Issue:

I’m a Canadian real estate investor. My mortgage is up for renewal and I have a friend who is not a Canadian resident (lives outside of Canada) who’s going to fund the mortgage payment. I’m going to pay him interest on an annual basis. I’m keeping the money for 5 years but I may be selling the current property that I’m holding now within a year. At which point I will reinvest that money in another property. What are the withholding tax rules that apply?

The Answer:

Well, you’re in luck, because I just got back from the UK, and I’ve been suffering from jet lag for the last week, so I haven’t had the energy to post for a while, but your question is a quick one, so I thought I’d quickly answer.

The answer is, most likely, there will no withholding tax. In 2008 withholding tax on interest paid to any arm’s-length non-resident was eliminated. Assuming your friend is not related to you, and that he is charging you a fair interest rate, the relationship should be considered at arm’s length, and no withholding will apply.

Even if the relationship is deemed to not at arm’s length, if your friend is a U.S. resident, the Canada-U.S. Treaty will kick in, and again, no withholding will apply since it was phased out completely as of 2010.

So, generally, the only way you may have a withholding obligation for interest is if it is paid to a person with whom you do not deal at arm’s length and who does not reside in the U.S. In such cases, the withholding rate is 25%, but could be reduced by a Treaty with Canada.

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