In 2008, Canada eliminated most forms of withholding tax on interest payments to non-residents. However, the government made certain exceptions, "including participating debt interest," which remains subject to Canadian tax withholding.
The Income Tax Act defines "participating debt interest" as any interest payable on a debt if any of the interest payable depends on the the use or production from assets in Canada, or is derived from revenue, profit, cash flow, commodity price or any other comparable factor.
Applicability to Stocks
Participating debt interest also includes stock dividends from all classes of stock. For example, a common stock dividend from a company headquartered in Quebec would be required to withhold a portion of their dividend payment to an investor, even if that investor did not reside in Canada. A preferred stock dividend would also fall under the participating debt interest rule, since income from preferred stock is considered a dividend rather than an interest payment.
When a Canadian company issues a stock dividend to a Canadian non-resident, the company withholds a portion of the dividend and forwards it to Ottawa to ensure the non-resident pays his taxes. Otherwise the Crown would have few options available to collect the tax.