Not Just for Americans: The Case for Expanding Reciprocal Tax Exemptions for Foreign Investments by Pension Funds

From provision of OAS, GIS and CPP to the favourable taxation of Registered Pension Plans and RRSPs, Canada’s government has long focused policy efforts on better ensuring that working Canadians approach retirement with sufficient income supports in place. If the government wants to continue to move in this direction by trying to help maximize returns to pension plan members, while decreasing the portfolio risks faced by those pension plans, one step it could consider would be: Expanding the exemption for withholding taxes on foreign dividends and interest earned by pension plans. The exemptions for foreign interest and dividends are already available to U.S. investments, part of a reciprocal arrangement spelled out in the Canada-U.S. Tax Convention. Those exemptions allow U.S. and Canadian pension funds to participate in cross-border investments that would otherwise be too costly. Pension funds rely on international investments to optimize diversification and returns. And tax conventions between countries are typically designed to protect investors from the participating countries from being double taxed by both their resident country and the foreign jurisdiction where they invest. This good policy has certainly been Canada’s model in its numerous bilateral tax treaties. But while the U.S.-Canada Tax Convention extends the benefit of tax exemption to dividends and interest earned from cross-border investments by tax-exempt pension funds, when it comes to all other countries, there is no equivalent result. Yet, aspects of these same exemptions exist in certain bilateral treaties between other countries in treaties with one another. That certainly suggests that there are other trading partners, besides just the U.S., that are open to the possibility of these particular exemptions. If Canada could negotiate broadening these exemptions to countries beyond the United States, it would realize important advantages with little cost. By not moving further in this direction for non-U.S. foreign interest and dividend income of Canadian pension funds, these funds are left with lower benefits or higher contribution rates for pension plan members. It is also inevitably distorting the investment decisions being made by pension fund managers, producing a negative impact on risk-adjusted returns to their portfolios. While Canada may lose some revenue by forsaking some withholding tax, that would almost certainly be outweighed by the total economic gains as pension returns increase and, in reciprocal arrangements, Canada becomes more welcoming to foreign capital. With a number of countries already evidently open to the idea of tax exemptions for foreign interest and dividends earned by pension funds, and the economic effects for doing so overwhelmingly positive, the Canadian government should seriously consider getting started on negotiating reciprocal arrangements for cross-border pension fund investment with other countries.