Foreign Income: Tax Treatment, Withholding Taxes, and Reporting Obligations
- Rylan Kaliel
- Apr 16
- 5 min read
Updated: Apr 27
As global investment opportunities expand, more Canadians find themselves earning income from sources outside Canada. Whether you have foreign investments, employment income from overseas, or rental properties abroad, understanding how Canada taxes foreign income is essential. This blog clarifies the treatment of foreign income, explains withholding taxes, outlines reporting obligations, and provides practical strategies to manage your international tax responsibilities effectively.
Types of Foreign Income
Common sources of foreign income for Canadian taxpayers include:
Investment Income: Dividends, interest, and capital gains from foreign securities.
Rental Income: Earnings from renting property located abroad.
Employment Income: Wages or salaries earned while working outside Canada.
Business Income: Profits from operating a business overseas.
Each type of income has unique tax implications and reporting requirements.
How Canada Taxes Foreign Income
Canada taxes residents on their worldwide income, meaning income earned from foreign sources must be reported on your Canadian tax return. Foreign income is generally taxed at the same rates as domestic income, but there are important nuances:
Investment Income: Interest and dividends are taxed similarly to Canadian investment income, except they are not eligible for dividend tax credits. See our blog on dividends for more information.
Capital Gains: Foreign capital gains are taxed similarly to Canadian capital gains, with 50% of the gain included in taxable income.
Employment and Business Income: Taxed at regular marginal rates, subject to adjustments based on any foreign taxes already paid.
Understanding Foreign Withholding Taxes
Foreign withholding taxes are amounts deducted at source by foreign governments before you receive income such as dividends, interest, or royalties. These withholding taxes typically range from 10% to 30%.
Many countries will apply these on various types of income. As an example, in Canada, there are a variety of income sources that, if paid to a person resident outside of Canada, require that 25% of the amount be withheld from payment and remitted to the Canada Revenue Agency (CRA).
This withholding tax rate can be reduced depending on the terms under the tax treaty between two countries. As an example, in the US-Canada Tax Treaty under Article X paragraph 2., the tax rate on dividends can be reduced to 5%, if the recipient holds at least 10% of the voting shares of the paying company, otherwise this is reduced to 15%.
Example: If you receive $1,000 in dividends from a U.S. investment, and the U.S. withholding tax rate is 15%, $150 would be withheld, leaving you with $850.
Avoiding Double Taxation: Foreign Tax Credits
To prevent double taxation (paying taxes in two countries on the same income), Canada allows you to claim a foreign tax credit (FTC) on your tax return. The FTC offsets Canadian taxes payable on foreign income by the amount already withheld or paid to the foreign government. These FTCs operate as a direct reduction to your taxes payable, that is to say that if you had $1,000 of taxes payable and FTC of $250 your taxes payable would be reduced to $750.
Example: Continuing the earlier example, you report the full $1,000 dividend on your Canadian tax return but claim a $150 foreign tax credit. This reduces your Canadian taxes payable on that income by the amount already withheld.
Properly utilizing FTCs helps minimize your overall tax burden.
Situations Where Foreign Tax Credits Are Not Directly Deductible
There may be cases where the full FTC is not deductible. In these situations, a deduction may still be available for the amount of the FTC that is not deductible. This deduction is not applied directly against taxes payable, but instead against taxable income. This means that the deduction gets multiplied against your marginal rate of tax, which would be less than a dollar-for-dollar deduction as an FTC. Review our blog on the Basics of Individual Taxation to learn more about the various types of deductions and how they impact your taxes payable.
Example: Continuing the earlier example, you report the full $1,000 dividend on your Canadian tax return. You pay taxes of $200, of which only $150 can be claimed as a foreign tax credit. Your marginal tax rate is 48%. You would receive a reduction of $174 ($150 as a foreign tax credit plus $24 (($200 - $150) * 48%) as this alternative deduction). If the full amount had been treated as an FTC you would have received a reduction of $200, noting a $26 difference.
Ensuring that you receive the maximum amount as an FTC ensures you get the largest tax reduction.
Tax Slips and Reporting
Some sources of income may be included on a tax slip to ease reporting, such as investment income may be reported on a T5. Where these are not reported on a tax slip, it is your responsibility to ensure that this income is reported on your tax return. As such, it is recommended that a reconciliation of investment statements, capital gains, and employment and business income be performed as part of the tax return to ensure the income is not missed.
Reporting Foreign Income: Form T1135
If you own foreign assets with a total cost exceeding CAD $100,000 at any point during the year, you must file Form T1135 Foreign Income Verification Statement. This form requires detailed disclosure about your foreign assets, including:
Investment accounts (stocks, bonds, mutual funds)
Real estate holdings
Other income-producing properties
Failing to file Form T1135 or incorrectly reporting can result in severe penalties. Accurate reporting is crucial.
Common Pitfalls and How to Avoid Them
Common mistakes Canadians make regarding foreign income include:
Omitting Foreign Income: Failing to report foreign income, thinking it's exempt because it was taxed abroad.
Not Claiming Foreign Tax Credits: Paying unnecessary double taxation by not correctly claiming FTCs.
Neglecting Form T1135: Forgetting to report foreign assets or misunderstanding reporting thresholds.
To avoid these issues:
Maintain detailed records of foreign transactions and taxes withheld.
Regularly review investment statements and annual tax slips.
Consult with tax professionals familiar with international taxation.
Strategic Considerations
Effectively managing foreign income involves strategic tax planning, such as:
Investing foreign dividend-paying securities in retirement accounts (like RRSPs) to reduce foreign withholding tax exposure.
Timing the sale of foreign investments to optimize capital gains taxation.
Structuring overseas employment or business activities to utilize foreign tax credits effectively.
Summary
Understanding how foreign income is taxed, the role of withholding taxes, and your reporting obligations helps you remain compliant and minimizes your global tax burden. With careful planning, you can confidently invest and operate internationally, knowing you’ve optimized your tax position.
Stay tuned for our next blog, which will focus on rental income and how to manage its unique tax considerations. KLV Accounting is here to help. Contact us today to enhance your financial strategy and drive business success!
For a free consultation, call us at 403-679-3772 or email us at info@klvaccounting.ca.
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