Charities and non-profit organizations in Canada and the U.S. that derive income from across the border should consider the application of the Canada-U.S. Tax Convention (the “Treaty”) and whether it may be possible to obtain an exemption from taxes that would otherwise apply to such income.
Charities and non-profit organizations (“NPOs”) resident and operating in Canada are generally exempt from Canadian tax under the Income Tax Act (Canada) (“ITA”). Non-resident charities and NPOs however are generally subject to Canadian withholding tax on income derived from Canada.
Article XXI of the Treaty provides relief from either the Canadian or U.S. tax obligations that might otherwise apply to religious, scientific, literary, educational or charitable organizations that are exempt from tax under the domestic law of the state of which they are resident. Article XXI exempts certain types of income derived from either Canada or the US from tax to the extent that such income is tax-exempt in the state of residence (i.e., the United States or Canada, as the case may be).
In particular, Article XXI exempts dividend and interest income (as defined in the Treaty) from income tax, provided that:
- such income is derived by a trust, company, organization or other arrangement that is a resident of the either Canada or the U.S.;
- the entity deriving such income is generally tax-exempt in its state of residence;
- the entity is operated exclusively to administer or provide pension, retirement or employee benefits; and
- Such income is not derived from carrying on a trade or business or from certain related persons.
This could apply, for example, to dividend and interest income derived from Canada by a pension or retirement plan resident in the US and administered for the benefit of the clergy of a religious order in the U.S.
An entity seeking relief under Article XXI must apply to the relevant competent authority (either the Canada Revenue Agency or the Internal Revenue Service depending on the circumstances) for the exemption. The applicant will need to provide evidence of tax-exempt status in the state of residence. For Canadian purposes, the CRA generally issues Letters of Exemption under the Treaty for three-year periods. An application typically takes between six and eight weeks to process. As such, it is advisable to apply for the exemption and any renewals thereof sufficiently in advance to ensure that tax relief is available as and when needed.