Editor’s Note: The information below isn’t exhaustive of all possible US income tax considerations nor is it intended to provide legal or tax advice to any particular holder or potential holder of Canadian income or royalty trust units or common stock of Canadian corporations. Holders or potential holders of Canadian income or royalty trust units or common stock of Canada-based corporations should consult their own competent legal and tax advisers as to their particular tax consequences of holding Canadian income or royalty trust units or common stock issued by Canada-based corporations and the most beneficial way of reporting the distributions or dividends received and Canadian withholding tax paid to the appropriate taxation authorities located in the various jurisdictions.

Reputable brokerages, including Vanguard Brokerage Services, have informed investors that because of the costs and resources associated with furnishing up-to-date and accurate tax information to their transfer agent that it will not undertake such services. Scottrade has told clients that there is nothing that they can do about this withholding until the transfer agent, Depository Trust Company, stops the process. Others claim to be similarly impotent.

This effectively means the costs of stopping the 15 percent withholding tax on converted Canadian corporations and tax-paying SIFTs held within IRAs outweigh any potential benefit–that being fulfilling what should be a fiduciary obligation to ensure its clients and the accounts for which they act as custodian are made whole according to the law.

The essential problem of continuing improper withholding from dividends paid in respect of Canadian SIFTs and corporations that have converted from income trusts is that you–investors with units of tax-paying Canadian SIFTs or shares of former income trusts that have converted and are now paying corporate-level tax–are a subset of a subset.

There aren’t many of you concentrated in any one or two brokerages houses. There is little incentive for the brokerage house, the clearing corporations, the government agencies to absorb the time and expense it will take to make you whole.

Thanks, however, to work many of you have already done, we have a path that will get us if not to a satisfactory conclusion, to the point where the big boys will have to listen. It’s imperfect, time-consuming and acutely frustrating. As both private and public institutions on both sides of the border have acknowledged the letter of the law is on our side; this should be totally unnecessary.

Whether what follows be a long and winding road to nowhere, it’s your money. And every little bit counts.

The first step is to write a letter to the Canada Revenue Agency (CRA), the Great White Northern equivalent of our Internal Revenue Service (IRS), to request a Letter of Exemption under Article XXI of the US-Canada Income Tax Treaty. Your brokerage, as the custodian of the relevant account–the IRA of which you are the beneficiary–should write this letter, but this is one of the onerous service it’s refusing to engage in on your behalf.

Include your name, the name of your brokerage, the account number of the IRA, and an explanation of why there should be no withholding from dividends paid by Canadian SIFTs and Canadian corporations that converted from income trusts in respect of units or shares held in a US IRA account.

The argument, articulated here before and based on the contents of a letter to US Representative Phil Gingrey (R-GA) signed by Elizabeth U. Karzon, Branch Chief, Branch 1, Office of Associate Chief Counsel (International), US Dept of the Treasury, Internal Revenue Service, dated June 17, 2010, is as follows.

It’s a general rule of US federal taxation that an individual isn’t liable for US taxes on amounts earned through an IRA until those amounts are distributed. But US tax law can only defer US tax. US tax authorities have no power to influence a foreign country’s imposition of tax on income that the IRA derives from that country.

Distributions from Canadian income and royalty trusts therefore may be subject to tax in Canada depending on Canadian tax law and the terms of the US-Canada Income Tax Treaty (the Treaty).

Certain US entities that are generally exempt from taxation in a taxable year in the US–such as IRAs–are exempt from taxation on dividend income arising in Canada in that same taxable year, according to Article XXI of the Treaty, “Exempt Organizations.”

Based on a 2005 change in Canadian tax law, Canada began imposing a 15 percent withholding tax on distributions from income and royalty trusts to US residents. Canadian tax law didn’t initially treat these distributions as dividends, however, and so they weren’t exempt from Canadian tax under Article XXI of the Treaty.

In 2007, Canada amended its domestic law again and began taxing certain of these trusts as corporations and treating distributions from these trusts as dividends for purposes of both their domestic law and their tax treaties.

Canada and the US signed an exchange of diplomatic notes in 2007, on the same day the two parties signed the Fifth Protocol to the Treaty, that include what we’ve often referred to as “Annex B.” These notes confirmed, among other things, “that distributions from Canadian income trusts and royalty trusts that are treated as dividends under the taxation laws of Canada shall be considered dividends for the purposes of [the Treaty].”

However, Canadian law–the Tax Fairness Act–provides that Canada won’t tax income and royalty trusts already in existence as of Oct. 31, 2006, as corporations until Jan. 1, 2011. Until then, Canadian tax law won’t treat distributions from such trusts as dividends. Distributions from these pre-existing trusts won’t be exempt from Canadian tax under Article XXI of the treaty until 2011–when these income and royalty trusts will become “Specified Investment Flow-Throughs,” or SIFTs, taxed at the entity level.

The IRS acknowledges that investors who hold Canadian trust units in IRAs may not claim a foreign tax credit for the Canadian taxes withheld on the income paid in respect of those units. This is consistent with a general rule that foreign tax credits may not be credited against an individual’s tax liability unless the individual is liable for the tax. Nor can the IRA make use of a foreign tax credit because it’s exempt from tax in the US.

This may ultimately result in double taxation when the IRA distributes this income to the unitholder. The 2007 Tax Fairness Act, when it and the Fifth Protocol have full effect, will generally eliminate the 15 percent Canadian withholding tax on dividends paid by income and royalty trusts in respect of units held in US IRAs.

It may be helpful to attach to your letter a copy of Karzon’s letter to Rep. Gingrey; I’m happy to provide a pdf copy to anyone who requests it via e-mail to ddittman@kci-com.com.

Once the Letter of Exemption is issued you–or your broker–on behalf of your IRA must inform the transfer agent of the Canadian SIFT or former income trust that’s now a corporation from withholding for Canadian tax purposes.

The address for the Canada Revenue Agency is:

Non-Resident Withholding Accounts Division
International Tax Services Office
Canada Revenue Agency
2204 Walkley Road
Ottawa, ON
K1A 1A8
Canada

You can also call the CRA at 1-800-267-3395 or 1-613-952-2344. The fax number is 1-613-941-6905.

Contact information for transfer agents should be available on company websites, accessible via How They Rate. In addition to attaching a copy of the Karzon letter to your correspondence with the CRA and transfer agents, carbon copy your US congressman.

There’s no question this is an uphill battle. You’re likely to be told by the CRA that the brokerage, as the custodian of the IRA, must submit the request. That’s why we’re copying the folks on Capitol Hill. Let’s see, first, how accountable brokerages, transfer agents and government agencies are to self-directed investors and, second, whether the new wave of responsiveness washing over DC results in Congress correcting what should be an easily fixed problem.