How does a US charity make sure that it does not pay Canadian tax? By applying for an exemption letter from the Canada Revenue Agency (CRA).
In Canada, only a charity that is a Canadian registered charity is exempt generally from Canadian income tax. A foreign charity is not able to become a Canadian registered charity. Subject to special rules for US charities, foreign charities should be careful to avoid earning Canadian income from a taxable source.
The Canada-US tax treaty (Treaty) provides in Article XXI that a recognized US 501(c)3 charity is exempt from Canadian tax on income other than business income. Many US charities assume that this is enough and that they may therefore earn Canadian program or investment income free of tax. This conclusion is not entirely accurate.
While the Treaty exempts US charities from Canadian tax, it does not exempt Canadians paying an amount to a non-resident from withholding tax on the payments. Although a US charity that receives a Canadian payment that has been reduced by withholding tax is able to file a Canadian tax return and receive a refund a year or more later (if CRA is convinced of its US status), this has an obvious downside.
It is also possible for a US charity to obtain a withholding tax waiver letter from CRA. This letter enables it to avoid Canadian withholding tax on its Canadian income. CRA sets out the process for obtaining a waiver letter in CRA Guide T4016. The Guide, re-issued on an annual basis, also includes a list of US charities with current waiver letters.
It is important for US charities to remember that the Treaty exemption does not extend to business income. This arises in two contexts. First, while Canadian tax law acknowledges that charitable activity can result in income, the distinction between that revenue and business income under Canadian tax law is not necessarily the same in Canada as in the US. Secondly, Canadian tax law treats limited partnership income generally as business income.
Miller Thomson’s charity tax specialists often provide advice to US charities on Canadian tax exemption issues and would be pleased to advise your organization on its Canadian tax obligations.