Section 899: What Canadian investors need to know

Overview: Proposed under the ​“One Big Beautiful Bill” currently working its way through the legislative process in the U.S., Section 899 is drafted with the intent to increase U.S. taxes in several ways which could be relevant to Canadian investors.

Who is caught in proposed Section 899: The legislation is aimed at nations that the U.S. deems to have enacted unfair tax laws aimed at Americans. While there are a number of heads of enumerated ​“unfair foreign taxes,” Canada is pulled into the fray in large part by virtue of our digital services tax, a 3% tax aimed at multi-national corporations with digital services revenues exceeding $20M that access the Canadian marketplace. Think, for example, of companies like Meta Platforms Inc.

Section 899 takes aim at Canadian resident taxpayers, including Canadian corporations, Canadian individuals, and Canadian investment vehicles such as mutual funds and ETFs, where these taxpayers hold U.S. debt or securities. Section 899 also proposes to catch U.S. corporations that are more than 50% owned, either by votes or value, by Canadians.

Who/​what is excluded: Canadian corporations may be excluded from the proposed rules if they are considered U.S. -owned, either by votes or by value. This could be relevant in a public company context, as well as some private equity deals. Under the current draft, it appears that interest earned on U.S. government bonds will be exempt from Section 899 and will continue to be received by Canadians free from withholding tax.

What is being taxed: Section 899 proposes two heads of taxes: one aimed at passive investors in the U.S. market, via increases to the existing withholding tax regime; and one aimed at multi-national corporations with operations in the U.S., via targeted amendments to the existing Base Erosion and Anti-Abuse Tax (BEAT) regime. Of most relevance to the BMO GAM investment space is the first head.

• Interest: Currently, often in reliance on exemptions contained in the Canada U.S. Tax Treaty, when a Canadian tax resident purchases arm’s length plain vanilla debt issued by an entity organized in the U.S., interest paid on that debt to the Canadian is not subject to withholding tax. The result is that the Canadian currently receives 100 cents on the dollar in respect of that interest payment. Section 899 proposes to apply withholding tax to those payments, with incremental annual increases of 5% up to a proposed maximum of 50%.

• Dividends: Similarly, under the current tax regime, dividends paid on shares of U.S.-organized corporations are subject to domestic withholding tax rates of 30%. These rates can be reduced under the Canada U.S. Tax Treaty to 15% where the recipient of those dividends is entitled to the benefits of that Treaty. Section 899 proposes to increase these Treaty rates again by increments of 5% each year, up to a potential maximum of 50%. Of note is that the Treaty currently exempts dividends paid on U.S. shares held in RRSP accounts of Canadians from all withholding taxes. There is some concern that this beneficial tax treatment will also be lost in upcoming turns of the bill.

Credit for foreign taxes paid: When a Canadian taxpayer is required to pay foreign taxes, the Canadian income tax system includes a series of rules that provide a credit towards Canadian taxes paid in respect of these foreign tax amounts. While there is scope in the existing Canadian rules for these new or increased taxes to be included in the foreign tax credit framework, Canadian taxpayers may not be entitled to fully offset the full value of these increased taxes against their Canadian taxes owing, resulting in a greater aggregate tax burden.

Macro and investing considerations: Remember that the United States runs a sizable current account deficit. That means, in the aggregate, that U.S. entities invest, and consume more than they save. The deficit in savings is made up by borrowing from the rest of the world – in the form of direct and portfolio investment. 

If we focus on foreign portfolio investment into the U.S., the footprint is sizeable enough to matter. For instance, foreign investment in U.S. securities accounts for 20% of the total market. At the margin, Section 899 would increase barriers to capital flow to the United States. Effectively, this would penalize those same foreign investors in U.S. securities. 

In our view, even if steps are taken by nations to remove ​“unfair taxes,” the escalation to a capital war could lead foreign investors to prioritize regional diversification and to reduce weights on U.S. exposure in their portfolios. Such a scenario would lead to lower valuations of U.S. securities.