Tax Withholding – US Retirement Account

by Tax Guy - Burlington Accountant on January 12, 2009 Print This Post Print This Post

Question: I am a senior resident of the US who owned shares within my Roth IRA account of Fording Coal which was recently purchased by TECK.  I was wondering if there is any way to have some or all of the withholding tax refunded either by filing a non-resident tax return or by some other means?

Although I find it objectionable to have a 15% charge on all Canadian source dividends paid into my Roth account, I do not complain about that since dividends are earnings and new money. This was not new income in the same respect, but in great measure a return to me of money that was invested in the company on an after-tax basis.

Unfortunately, you will not be able to recover the withholding taxes related to Fording Coal because Fording was structured as a trust.

However, dividends you receive from Teck should not be subject to Canadian withholding taxes at all since Teck a corporation.

Under the Canada-US income tax treaty, interest and dividends received from investments in companies held inside an IRA or 401(k) are exempt from Canadian withholding taxes.  Fording Coal was not structured as a corporation and was a foreign (Canadian) trust and the distributions were not considered interest or dividends under the treaty and subject to withholding tax.

Note that although Fording was treated as a corporation under US tax law, this fact would have only changed the way in which the distributions were taxed outside of an IRA or 401(k), but would not have eliminated the withholding tax under the treaty.  If the investment in Fording was held outside of your IRA (or a 401k), then the withholding tax could have been claimed as a tax credit against your taxes on your 1040.  Since Fording was inside an IRA, there is no tax credit available.

The fact that Teck has acquired Fording is positive for those who originally held Fording inside an IRA or 401(k).  Teck is a corporation under Canadian law and the distributions are considered dividends for the purposes of the Canada-US income tax treaty.

Therefore, withholding tax on the dividends received should not be applied.

I would like to bring a couple of items to your attention that you should consider when investing in companies held outside of the U.S.

First, ensure that you invest in companies that are structured “legally” as a corporation, especially if you intend to hold investments inside an IRA or 401(k).  Withholding taxes will be applied to distributions of non-corporate investments and there is no tax credit available on withholding taxes.

Second, you should avoid investing in any sort of investment trusts (income trusts, real estate investment trusts [REIT], or Canadian mutual funds).  US law has some strict reporting requirements with respect to investments in trusts resident outside the US.  And while the reporting rules were never intended to capture publicly traded investment vehicles, the rules could be applied at any time.

Finally, be aware of any foreign investment inside an IRA or 401(k) that trades as an ADR on a US exchange.  Withholding tax will always be applied and is not covered by treaties.

I hope this helps.

Follow-up Question: I have an additional question.  If I had sold Fording stock in my Roth IRA before the buyout, would I have had a withholding tax applied to the proceeds?

As long as the company is publicly traded then there would have been no withholding (regardless of its legal structure).

About The Tax Guy...

Dean Paley CGA CFP is a Burlington accountant and financial planner who services individuals and business owners locally, nationally and internationally. Dean has appeared in the National Post, Toronto Star and Metro News.

To find out more, visit Dean's website Dean Paley CGA CFP or connect via Twitter @DeanPaleyCGACFP.

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