Cross-Border Interest Income: Canada-US Treaty and Withholding

Interest paid between Canada and the US is generally exempt from withholding tax under the treaty. This is different from dividends (15% treaty rate) and a significant planning point for cross-border investors. If you hold US bonds, GICs at a Canadian bank while living in the US, or make a private loan across the border, the withholding treatment depends on the type of interest and the relationship between the parties.

How does the 0% rate on interest work?

Article XI(1) says interest arising in one country and “beneficially owned by” a resident of the other country “shall be taxable only in” the residence country. This is an exclusive allocation: the source country gets no taxing right at all on qualifying interest.

Without the treaty, Canada’s default withholding on interest paid to non-residents is 25% under ITA 212(1)(b), and the US default is 30% under IRC 1441. The treaty eliminates both for arm’s-length interest between residents of the two countries.

Practically: a US resident holding a GIC at a Canadian bank receives the interest without Canadian withholding. A Canadian resident holding a US Treasury bond receives the interest without US withholding. Neither needs to file a special form to claim the 0% rate on arm’s-length bank or government interest, because the financial institution applies the treaty rate based on the account holder’s residency information.

What about related-party interest?

Article XI(2) provides a 10% cap on withholding for interest paid to a related person (generally, a person who controls or is controlled by the debtor, or who shares common control). Before the Fifth Protocol (effective 2008), the treaty allowed 10% withholding on all interest. The Fifth Protocol reduced the general rate to 0% but kept 10% for related-party interest.

This matters for private loans between family members or between a shareholder and their Canadian corporation. If a US resident lends money to their Canadian corporation, the interest payments are subject to Canadian Part XIII withholding at 10% (not the general 25% domestic rate, and not the 0% arm’s-length treaty rate).

On the other side, Canada’s domestic law already exempts certain interest from Part XIII withholding (for example, interest paid on fully exempt obligations). When the domestic exemption applies, the treaty rate is academic. The interaction between the domestic exemption and the treaty rate requires checking both layers.

What is contingent interest?

Article XI(6) excludes certain types of interest from the 0% rate. Interest that is “contingent on the use of or production from property” or “computed by reference to receipts, sales, income, profits, or other cash flow of the debtor” is treated as a dividend under Article X, not as interest under Article XI. The dividend rate (15% for portfolio investors) applies instead.

This catches participating loans and revenue-based financing. If a Canadian company pays interest on a note where the rate varies based on the company’s revenue, the payment is recharacterized as a dividend for treaty purposes, and the 15% withholding applies.

How is interest taxed in the residence country?

The residence country taxes the interest at the recipient’s marginal rate with no special treatment:

Canadian resident receiving US interest: the interest is reported on the T1 as foreign income. No US withholding was taken (under the 0% treaty rate), so no FTC is needed. The interest is taxed at the Canadian marginal rate (federal plus provincial), the same as domestic interest.

US resident receiving Canadian interest: the interest is reported on Schedule B of Form 1040 as foreign interest. No Canadian withholding was taken, so no Form 1116 FTC is needed. The interest is taxed at the US marginal rate, the same as domestic interest.

When withholding does apply (related-party interest, contingent interest), the residence country gives an FTC for the withholding, preventing double taxation.

What about savings bonds and T-bills?

US Treasury securities (T-bills, T-notes, T-bonds, savings bonds like I-bonds and EE bonds) are exempt from US withholding even without the treaty, because IRC 871(h) exempts “portfolio interest” paid to non-resident aliens. The treaty 0% rate provides a second layer of protection, but the domestic exemption is usually sufficient.

Canadian government securities (Canada Savings Bonds, Treasury bills, provincial bonds) are exempt from Canadian withholding to non-residents under the treaty’s 0% rate.

For a Canadian resident holding US I-bonds: the interest accrues tax-deferred inside the bond (US domestic treatment), but Canada taxes the interest annually as it accrues (Canada does not recognize the US deferral). The interest is foreign income on the T1, with no US withholding and no FTC needed.

What about bank deposit interest?

Interest on bank deposits is a common cross-border situation. A US resident who kept a Canadian savings account after moving receives interest from the Canadian bank. Under the treaty, no Canadian withholding applies.

However, the Canadian bank may not automatically apply the 0% rate. The bank’s withholding system may apply the default 25% Part XIII withholding unless the account holder has notified the bank of their non-resident status and treaty eligibility. Filing Form NR301 with the bank establishes the treaty claim and stops the withholding.

If withholding was taken incorrectly, the excess can be recovered by filing a Canadian non-resident return (or by requesting a refund under the treaty from the CRA).

What about corporate bonds and ETFs?

Interest on corporate bonds follows the same treaty rules as bank interest: 0% for arm’s-length interest between unrelated parties. A US resident holding Canadian corporate bonds receives the interest without Canadian withholding.

Bond ETFs add complexity. A Canadian bond ETF distributes interest to its unitholders, but the ETF itself may also distribute capital gains, return of capital, or foreign income. The withholding treatment depends on the character of each component of the distribution, not just the label. The ETF’s T3 or T5 slip (for Canadian residents) or NR4 slip (for non-residents) breaks down the components.

For a US resident holding a Canadian bond ETF, the interest component should be exempt from Canadian withholding, but the fund administrator may withhold on the full distribution at the dividend rate (15% or 25%) and leave it to the investor to claim a refund for the over-withholding on the interest portion.

What should I do next?

If you hold interest-bearing investments across the border, confirm the withholding treatment. For arm’s-length bank and government interest, the rate should be 0%. If your bank is withholding, update your residency information and file NR301 (Canada) or W-8BEN (US) to stop it. For related-party loans or participating debt, the 10% or 15% rate applies, and the FTC on your home-country return prevents double taxation.

• Cross-border dividend withholding, the 15% rate that applies to dividends (different from interest)
• Form 1116 and the FTC, claiming credit when withholding does apply
• NR301: claiming treaty benefits, stopping Canadian over-withholding
• How to report an NR4 on a US return, the slip that shows Canadian withholding

This guide is general information, not tax advice for your specific situation. Which points apply, and how, depends on your facts.